FINANCING ENERGY EFFICIENCY IN THE COMMERCIAL BUILDING SECTOR Is There Hope Post-PACE? Fall 2010

1. FINANCING ENERGY EFFICIENCY IN THE COMMERCIAL BUILDING SECTOR Is There Hope Post-PACE? Fall 2010

2. DISCUSSION CONTEXT • Federal, State, Local and Institutional already addressed. • Newly-constructed commercial already addressed. • Deep reductions in energy intensity in existing commercial investment properties are the challenge. • Efficiency in public/institutional buildings is “policy-driven”, while efficiency in commercial buildings is “market-driven”. • Focus is addressing market barriers to retrofit financing in the existing commercial sector.

3. ENERGY STAR AND INCREASED TENANCY Co-Star study shows higher occupancy rates for ENERGY STAR buildings Multiple other studies show similar results National average comparison of occupancy rates of Energy Star-labeled buildings vs. non-labeled buildings over a two-year period. • Lower operating costs/increased cash flow • Potential increase in occupancy • Potential increase in property value/sales valuation • Federal tax deduction

4. AVAILABILITY OF ENERGY EFFICIENCY FINANCING $3.5 billion/yr 12 billion/sf • Markets that Work • Federal • MUSH • Markets that Don’t Work • Residential • Office Buildings • Retail / Food Service • Hospitality • Key Differences • Owners not credit-worthy • Assets are Pledged 13% 80 billion/sf 87% $0.0 billion/yr The Focus of PACE Financing

5. CURRENT STATUS On-Bill Financing not broadly applicable ARRA funds unable to be leveraged With PACE stuck in the regulatory mud, does the industry have a Plan B? One possibility: expanding the federal Title XVII program to create a commercial performance contracting market, using the Federal ESPC market as a model

6. Creating a Commercial Performance Contracting Market, using Federal ESPC as a Model Goal is target and remove the point of market failure: LLC counter-party risk. Solution is to simulate the hybrid credit structure of a Federal ESPC. Critical elements -- back-stopping the property LLC with a Federal guarantee. -- confining the guaranty to LLC default, not performance. This would effectively simulate the hybrid credit structure of a Federal contract: LLC payment obligation tied to verified savings(Government-backed) Contractor payment obligation tied to unrealized savings

7. The Argument for Performance Contracting Primary financing tool utilized in the Federal/MUSH markets PC effectively parses counterparty and performance risk, allowing the former to be singled out for a guaranty. The value in EE retrofits is not the equipment cost, but the creation of ongoing savings over time. It is clear that the realization of long-term savings is tied to verification and liability*. The capital markets have accepted performance contracting. Option A (M&V) will facilitate lending to small-sized contractors and properties. * Performance contracting is the best means of assuring energy consumption and GHG emissions reductions will endure.

8. Exposure to the Taxpayer • High-occupancy • Moderate debt • Strong cash flow • Etc. Structural goal: Large, widely-diversified pool of PC loans to high-performing commercial properties. • Geography • Building purpose • Building size • Building age • Etc. Loss Reserve Goal: Assessed based on broad market average (i.e. 5%), while exposure is limited to high-performing buildings. Eligible Ineligible All large commercial buildings

9. Underwriting Federal ESPCs Lender’s Perspective Acceptable hybrid credit: If savings are verified, agency pays If not, contractor pays Firm cash flow Proven technologies Standardized contract Standardized M&V protocol Projects bundled by ‘aggregators’ to critical mass for securitization

10. Underwriting Commercial PC Lender’s Perspective Acceptable hybrid credit Same of Federal Firm cash flow Same of Federal Proven technologies Same as Federal Standardized contract BOMA BEPC Standardized M&V protocol Same as Federal Projects bundled by ‘aggregators’ Same as Federal

11. Critical Success Factors The Owner’s Perspective Make it simple !!!!! Streamlined contract Cost of capital Efficient approval process with DOE

12. Cost of Capital Best proxy for pricing Commercial PC is Federal ESPC. Federal ESPC pricing average roughly 225 bps over USTs. Commercial PCs may require a slight premium, e.g., 50 bps, at the outset, suggesting pricing at 275 over USTs. Cost comparisons on 10-Year* Projects -- Commercial PC may be priced lower than Federal ESPC for four reasons: greater volume, more competition, wider diversification, and make-whole provision.

13. Efficient Implementation Lenders/contractors screen projects according to published eligibility criteria* Owner/contractor screen candidate properties against the criteria Lenders aggregate projects into portfolios of critical mass. DOE may issue single guarantee covering entire portfolio. DOE due diligence focused on government exposure: property profile. DOE may outsource initial review process to a property management firm (JLL, CBRE, C&W, etc.) or a management consulting firm (BAH, Bearing Point, Accenture etc.) * Current appraisal, historical occupancy, debt service coverage, debt-to-value, etc. With largely objective criteria, there will be three levels of industry vetting – owner, contractor and lender. Four if review is outsourced.

14. Contact: John J. Christmas Hannon Armstrong Capital, L.L.C. 1997 Annapolis Exchange Suite 520 Annapolis, MD 21401 410-571-6164 www.hannonarmstrong.com