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Why Residential PACE Is Growing in Spite of Opposition From Federal Housing Lenders

California PACE growth

Last fall, California’s governor and treasury secretary came up with a plan to solve a longstanding conflict with federal housing authorities over residential property-assessed clean energy (PACE) programs.

The plan didn’t work. But does it even matter?

After years of a near standstill, residential PACE programs are back on the upswing in California and other states. And while federal support will be critical for the success of the program nationwide, experts say the promising clean energy financing model will still continue to grow.

By leveraging local bonding authority, PACE supports loans for energy efficiency, water conservation and solar projects. Those loans get paid back through incremental increases to property taxes over twenty years. California pioneered the concept, and state officials have been highly supportive its expansion.

But PACE hit a major snag in 2010, when the Federal Housing Finance Agency — the body that regulates the nation’s two biggest mortgage lenders — came out in opposition to the program. Because PACE loans take precedence over a mortgage in case of default or foreclosure, the agency argued that they are too risky for lenders to support. It instructed Fannie Mae and Freddie Mac to stop underwriting mortgages for customers taking advantage of PACE loans.

California responded with a lawsuit, which eventually failed. Governor Jerry Brown and State Treasurer Bill Lockyer decided to take a softer approach by creating a $10 million loan-loss reserve that could pay back lenders in case a homeowner defaulted. That also failed to change FHFA’s position. 

This spring, the agency wrote a letter to California officials informing them that the reserve fund was inadequate.

“The Reserve Fund does not sufficiently address the risks to the Enterprises [Fannie Mae and Freddie Mac] that we have previously described, and FHFA will continue our policy of not authorizing the Enterprises to purchase or refinance mortgages that are encumbered by PACE loans in a first lien position,” wrote Alfred Pollard, the agency’s general counsel.

Without the support of underwriters that account for two-thirds of the mortgage market, it might seem that FHFA’s latest rejection is a death sentence for residential PACE.

But the program is far from dead. 

“It’s a non-issue,” said J.P. McNeill, the CEO of Renovate America, a PACE administrator who has executed 95 percent of all residential projects in California.

McNeill isn’t dismissing FHFA’s concerns. In fact, his company meets regularly with the agency to discuss the program. He just doesn’t see the rule having a damaging impact on consumer decision-making.

“We’ve never had the view that PACE is dead. It’s just that PACE is hard,” said McNeill.

It’s not illegal for homeowners backed by Fannie or Freddie to participate in the program. They are simply required to pay off the loan first if they move or refinance their mortgage. That may deter some homeowners from considering a PACE loan, but a lot of them are still making the decision to finance a retrofit through PACE.

Stacey Lawson, the CEO of Ygrene, another large PACE administrator, said in a previous interview that it all comes down to communicating the implications of taking on the loan: “There’s been a lot of fear, uncertainty and misinformation in the marketplace around the risk to homeowners. But it’s really just a simple business decision they have to make.”

McNeill agreed, saying that most customers are not aware of the drama playing out between PACE advocates and federal housing authorities. As long as homeowners understand that they are on the hook to pay off the balance of the loan in certain circumstances, they are generally OK with moving forward.

“Has the program been limited? Yes. By a lot? No,” said McNeill. “The homeowner hasn’t been immersed in the story. From their perspective, they just view it as another form of financing.”

Over the last year, hundreds of millions of dollars have been raised for PACE programs in California, Connecticut, Florida and New York. And there are now 169 cities and counties in California that have adopted PACE.

Investors seem bullish on the growth potential of residential PACE as well. Last week, Renovate America raised $50 million in growth equity from Valor Equity Partners, Macquarie, RockPort Capital and Spring Creek. 

But those dollar amounts are nothing compared to the size of the mortgage market. So far, $350 million in residential PACE projects has been executed in communities across the country. Compared to the $5 trillion in mortgages underwritten by Fannie and Freddie, PACE is insignificant.

“We’re such a non-factor,” said McNeill. “We are less than 1/100th of a percent compared to the capital deployed through Fannie and Freddie.”

That might explain why FHFA’s policy has been mostly limited to public statements, rather than a crackdown on homeowners or communities supporting PACE. (Some have worried that the agency would completely redline cities or towns participating in the program, but that has not happened.)

Rather than try to stir up conflict with federal regulators, McNeill’s strategy at Renovate America is to “walk softly and get to critical mass.”

“The idea is to execute projects and gather data in the hopes that we could show that PACE has a positive or neutral impact on lenders,” he said.

Data showing energy efficiency’s positive impact on mortgage lenders is emerging. An in-depth study released last year by the Institute for Market Transformation found that Energy Star-rated homes were 32 percent less likely to go into default than the average home. 

PACE programs have not been around long enough to accumulate the same kind of data. With a few more years of experience, McNeill and others hope to show that mortgage lenders don’t need to worry about the risk. 

At this point, however, conversations with FHFA are all theoretical. In order to quantitatively prove that PACE is not harmful to Fannie and Freddie, many more projects will need to be executed. But if recent program expansion in California is any indication, there will eventually be a time when PACE administrators can argue their case to federal regulators with actual performance data.

“California is moving forward,” wrote Jim Evans, a press spokesperson for Governor Jerry Brown, in an email. “We are continuing to work with the federal government and local governments to improve and expand the program.”

Photo Credit: California PACE and Federal Housing Lenders/shutterstock

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