Energy Efficiency Finance Models Spelled Out To Achieve Modernization
Work environments across the nation battle crumbling infrastructure, dim lights and antiquated energy systems. Building owners wrack their brains trying to find a solution to keep their workers happy, comfortable and productive without breaking their bank.
There are ways to acquire modernization without expending up-front capital through energy financing. There are many energy efficiency finance models available, and it can be difficult for most business owners to understand which is best for them. Below is a list of common energy efficiency finance models summarized from the U.S. Department of Energy Better Buildings website.
An organization seeking improvements to their energy systems should team up with an energy systems optimization company who will guide them through the process of acquiring financing. The energy experts should provide the most cost-effective project that saves energy and improves their facilities for users.
Energy Efficiency Finance Model 1: Lease
One of the more common energy financing options is a lease or a simple contract that allows a customer to use energy efficiency equipment without purchasing it outright. At the end of the lease, the customer may have the option to purchase the equipment, return the equipment or extend the contract, depending on the type of lease used. Lease financing is offered by many equipment manufacturers and vendors as well as third-party lessors. Partnering with an energy systems optimization firm allows their relationship with manufacturers, vendors and third-party lessors makes this option viable and will ensure the best terms possible.
Leases work best for those who want a simple, quick accessible financing option with a simple contract; considering working with a manufacturer or energy systems optimization company who offer lease financing; and have good credit and are willing to take on risk.
The three most used leases are:
CAPITAL LEASE – Capital lease energy financing functions much like a loan and is sometimes called a “finance lease.” However, capital leases offer a few advantages over bank loans, like little to no upfront fees, less paperwork, and faster approvals. In a capital lease, the customer is the owner of the equipment and must declare the equipment as an asset and the lease payments as a liability for accounting and legal purposes. The customer may depreciate the equipment as an asset to provide a tax benefit, but the lessor typically takes a security interest in the equipment so that it can be reclaimed in the event of default. At the end of the lease term, the customer can purchase the equipment for a discounted bargain price.
OPERATING LEASE – In an operating lease, the lessor owns the equipment and the customer rents it at a fixed monthly payment. These rental payments are treated as an operating expense for tax purposes and are therefore tax deductible. In order to qualify as an operating lease, a transaction must pass several tests set by the Financial Accounting Standards Board (FASB). At the end of the lease, the customer can extend the lease, purchase the equipment for fair market value, or return the equipment.
TAX EXEMPT MUNICIPAL LEASE – Also known as a municipal lease, a tax-exempt municipal lease-purchase agreement is a common financing structure that allows a public organization to pay for efficiency using its annual revenues. This option is an effective alternative to traditional debt financing but is only available to municipalities and other political subdivisions that qualify. Tax-exempt leases have two unique attributes. First, the lessor may claim a federal income tax exemption on the interest they receive from the customer under the lease, allowing them to offer a lower rate. Second, the lease contract usually stipulates that if the customer fails to appropriate funds to make payments on the lease in any given year, its obligations to the lessor ends. Although the financing terms for tax-exempt leases may extend as long as 15 to 20 years, they are usually shorter than 12 years and are limited by the useful life of the equipment. The customer has title to the equipment throughout the term of the lease and retains ownership once the lease is paid off.
- Widely available and quick to close
- Simple to use easy to finance with flexibility on a company’s balance sheet and at the end of term
- Project size limitations
- No specialized benefits
Energy Efficiency Finance Model 2: Energy Performance Contracting
Of all the energy financing options, this is defined as using the guaranteed energy savings to pay for the project. An energy systems optimization company that implements the upgrades typically guarantees the savings. That means there are no upfront costs. Of the energy financing options, this one is best for those considering a bundled energy project over $1M, wants a third party to take on risk and provide a guarantee and is comfortable with a long-term contract.
ENERGY PERFORMANCE CONTRACTING ADVANTAGES:
- Low risk as the energy savings is guaranteed
- Outsourced project management
- Improved, reliable operations
- Standardized process
- Scalable, which means it can start small and grow as needs increase
ENERGY PERFORMANCE CONTRACTING DISADVANTAGES:
- Long close times
- Building ownership constraints
- Project size limitations
- High cost relative to in-house implementation are some of the disadvantages
Energy Efficiency Finance Model 3: Energy Services Agreement
Of all the energy financing options, this mechanism is a pay for performance solution that allows customers to implement energy and water efficiency projects without upfront capital expenditure. The provider pays for the development, construction and maintenance costs. Once a project is operational, the customer makes service payments based on actual energy savings, resulting in immediately reduced operating expenses. An energy services agreement may be the right fit for an organization who wants to pursue retrofits across a portfolio without spending their own capital prefers off-balance sheet treatment for the delivery of efficiency services; and desires a pay-for-performance solution where a third party takes on performance risk and provides project management and maintenance and is looking for a contract term ranging from 5-15 years with periodic buy-out options.
ENERGY SERVICES AGREEMENT ADVANTAGES:
- Energy savings pays for the project
- Off-balance sheet financing
- Improved reliability of operations
- Flexible financing
ENERGY SERVICES AGREEMENT DISADVANTAGES:
- Project size limitations
- Ownership constraints
- Longer close times
Energy Efficiency Finance Model 4: Property Assessed Clean Energy (PACE)
Perfect for organizations that own or occupy facilities located in jurisdictions with such programs; desire long-term financing at low interest rates; prefers to do pilot projects at a few locations before implementing more broadly; and does not plan to own or occupy its facilities long term, instead transferring financing obligations at the time of the sale. Of the energy financing options, this structure is when building owners borrow money for energy efficiency or renewable energy projects and make repayments with an assessment on their property tax bill. The deal remains with the property even if it is sold, facilitating long-term investments in building efficiency. It may be funded by private investors or government programs, but it is only available in jurisdictions that have passed the required legislation.
- Positive cash flows
- Favorable terms
- Ability to transfer the deal
- Limited availability
- Mortgage lender approval
- Limited to individual properties
With so many ways to finance infrastructure modernization, the question shouldn’t be how, but rather which. Still confused? Download our Energy Financing Comparison Guide for more information on which option is best for you.