Property Assessed Clean Energy (PACE) programs allow financing of energy efficiency and renewable energy improvements using special assessments that secure local government bonds, notes or other obligations that do not require the borrower or the sponsoring local government to pledge its credit. PACE programs attach the obligation to repay the cost of these types of improvements to real property instead of to the individual borrower. In Ohio, the first step in the creation of a PACE program is the creation of a Special Improvement District (SID) under Ohio Revised Code Chapter 1710, as recently amended by House Bill 1 (HB 1), effective October 15, 2009.
PACE Policy Framework
In October 2009, a Policy Framework was released by the White House and PACE advocacy groups to encourage states and local governments to adopt pilot PACE programs. The Policy Framework was released at the same time a Funding Opportunity Announcement for competitive grants under the Energy Efficiency and Block Grant Program of the United States Department of Energy was released. The Policy Framework is designed to provide important safeguards in the creation of Ohio PACE programs, including homeowner and mortgage lender protections, as well as to serve as a resource for state, local, and tribal governments in developing PACE programs. While the scope of the Policy Framework is limited to residential PACE programs, the principles established by the Policy Framework are applicable to and consistent with PACE financings undertaken to benefit commercial and industrial property owners.
The Policy Framework's goal is the development of best practices and innovation in design of PACE programs. An important tenet of PACE program design is that property owners "opt-in" to attach up to 100% of the cost of energy improvements to their real property tax bill. In the event of nonpayment of the assessment, the assessing local government has the ability to foreclose on the delinquent real property in the same manner as for nonpayment of taxes, or it may choose to wait for another party to initiate foreclosure.
Importantly, as a protection for mortgage lenders on the property, the Policy Framework limits liability for the assessment in foreclosures to amounts in arrears at that time, and the full cost of the improvement is not accelerated or due in full. An assessment runs with the property and successor owners become responsible for remaining balances.
The Policy Framework recommends that PACE programs are designed to include a reserve fund to backstop late assessment payments, helping to assure that investors in energy efficiency and renewable energy loans are paid on time. The use of reserve funds also reduces risk to the first mortgage lender and other private lien-holders because initial losses to those who fund energy efficiency and renewable energy loans are paid out of the reserve fund. The Policy Framework also suggests that governments might share the risk of assessment nonpayment with contractors through a variety of conditional contract mechanisms. Lastly, the Policy Framework recognizes that PACE is a new tool. Some of the best practices announced below may not be applicable in all circumstances.
Best Practices for Homeowner Protection
As indicated above, the Policy Framework was written in connection with the release of the DOE's Funding Opportunity Announcement and contains best practices for homeowners and consumer protection in the delivery of energy efficiency or renewable energy PACE programs. The announced best practices to ensure the protection of homeowners include:
- Savings to Investment Ratio. Each improvement should "pay for itself," i.e., the expected average monthly utility savings to homeowners should be greater than the expected monthly increase in real property assessments due to the PACE energy efficiency or renewable energy improvements.
- Financing High-Value Investments. Financing should be limited to investments that have a high return in terms of energy efficiency or renewable energy gains.
- Assuring that Retrofit is Constructed as Intended. PACE programs should be developed with a list of presumptively-efficient improvements or else improvements should include an energy audit conducted by a qualified auditor or inspector. Each improvements should be installed by a validly licensed contractor or installer. After-the-fact qualify assurance guarantees should be available.
Best Practices for Mortgage Holder Protection
In addition to the homeowner protections identified above, the Policy Framework also supports additional measures to further limit risk to mortgage lenders:
- Length of Time. The length of time for a homeowner to repay the PACE assessments should not exceed the expected useful life of the energy efficiency or renewable energy improvements.
- Size of Financing Relative to Home Value. As a general matter, PACE assessments should not exceed a certain percentage of appraised value of the home, generally 10%.
- Clear Title. Applicants must prove they are the legal owners of a property, unanimous approval of property-holders is required, and the title should be clear of easements or subordination agreements that conflict with the assessment.
- No Uncured Defaults. Participation in a PACE program should not be allowed unless: (i) property taxes are current; (ii) no outstanding and unsatisfied tax liens are on the property; (iii) there are no notices of default or other evidence of property-based debt delinquency for the lesser of the past three years or the property owner's period of ownership; and (iv) the property is current on all mortgage debt.
- No Negative Equity Financing. PACE loans to borrowers who are "underwater" -- whose mortgage and other debt on the property is greater than the current value of the house -- raise particular risks because such loans are especially likely to default with less than full payment to private lienholders. PACE programs should require a current estimate of appraised value, and outstanding property-based debt cannot be less than the value of the property.
- Vulnerable Areas. Local governments should be cautious in using the PACE model in areas experiencing large home price declines, where large numbers of "underwater" loans may exist. PACE programs in such areas should proceed only after careful attention to local real estate conditions and programmatic safeguards to avoid contributing to additional borrower defaults.
- Escrow. To reduce the risk of assessment nonpayment, homeowners should escrow payments for PACE programs in the common situations where they already escrow other property tax assessments.
Ohio municipalities and townships that approve the creation of SIDs to finance special energy improvement projects authorized under HB 1 should strive to ensure that their SID plans align with the PACE Policy Framework and are responsive to the abovementioned best practices.