Amid a flurry of high-level changes at the nation’s housing finance agencies, one major trend may be flying under the radar: a new wave of incentives for green property upgrades that has far-reaching implications for investors, developers and financiers.
The changes come against the backdrop of increased recognition of the value of sustainability: operational savings, potential for increased returns, and greater marketability with environmental, social and governance principles. Investors are under pressure to think holistically about embracing the entire scope of ESG principles, contends David Borsos, vice president of capital markets at the National Multifamily Housing Council.
“It’s here and it’s fully embraced … it’s (drawing) everybody,” said Borsos, who manages finance policy for the organization. Green finance benefits the multifamily market because it drives capital formation, he added.
The impact of new sustainability-related bonds created by Freddie Mac is now rippling through the industry. These products help investors improve workforce and affordable properties through energy- and water-efficiency upgrades, and pass along utility savings to the resident. The products were introduced just two years ago, and by December 2020, Freddie Mac had issued $3.3 billion in green bonds, $877 million in social bonds and $971 million in sustainability bonds, the GSE reported in April.
The appetite for multifamily green bonds is rising steadily as investors strive to finance projects in a more environmentally responsible way. Such is the case with Freddie Mac’s five-year-old Green Advantage Program. “We needed a separate green deal to have those investors satisfy some of those ESG needs,” said Luba Kim-Reynolds, director of investor relations & ESG initiatives at Freddie Mac.
The program is tailored to affordable and workforce housing properties—which are primarily older stock—because the less efficient housing benefits substantially from energy-efficient upgrades. Through September 2020, the program’s total purchase volume was $60.7 billion across 596,058 units, according to the GSE. Freddie Mac is now on its sixth green bond deal and interest from investors is picking up, Kim-Reynolds said.
For its part, Fannie Mae issued $13 billion in green bonds last year, bringing the total since 2012 to $88 billion. Owners can choose from two programs—Green Rewards and Green Building Certification—both of which require water and energy consumption reporting. Both kinds of loans can also be resecuritized into a green bond. The Fannie Mae Green MBS, for example, requires borrowers to submit to an energy or water audit or produce an eligible green certification. Fannie Mae lets borrowers pick from a list of 40 certifications from organizations that range from BREEAM USA and the U.S. Green Building Council to Passive House Institute US.
Dwight Capital recently closed the largest loan to date in a key Department of Housing and Urban Development program, according to the Mortgage Bankers Association. In April, Dwight closed a $128 million refinancing for City Market at O Street, a mixed-use project in Washington, D.C., that includes more than 400 residential units plus a 182-key Cambria Suites hotel and 87,000 square feet of retail, on behalf of Roadside Development, the project’s sponsor.
HUD’s Green Mortgage Insurance Premium Reduction initiative incentivizes borrowers to make energy-efficient improvements and earn a green certification, noted Dwight Capital Managing Director Brandon Baksh. The program offers a reduction to 25 basis points for properties that meet the requirements, which “really allows you to get more proceeds, and for sponsors, allows you to make sure your debt service coverage ratio is not being stressed unnecessarily,” he said.
Because HUD’s program offers fully amortizing fixed loans, it makes economic sense for sponsors to go green, Baksh said. Starting in March 2020, HUD began requiring borrowers to achieve an Energy Star performance score in the top 25th percentile, submit for the Energy Star Certification and earn an additional green certification to qualify for the MIP reduction.
That rule change rewards borrowers for significant investments in improvements. Prior to that, Baksh said, it was “easier to qualify for Energy Star certification without actually putting in any significant capex dollars.” Under HUD’s program, such improvements as common-area lighting upgrades and low-flow fixtures, are savings that the lender can underwrite up to 80 percent.
Hitting New Heights
The market has evolved not only from a regulatory perspective but also from a demand perspective. Although multifamily green finance has come a long way, Borsos said, “There’s a lot to be learned in terms of how to address it.”
Regulatory incentives and tax credits are critical for efficiency improvements on existing buildings, which can be expensive to retrofit with upgrades like triple-pane windows and energy-efficient HVAC systems. Investors don’t immediately see a huge return on these larger-scale conversions, and the same is true of older properties, which are more capital-intensive to adapt.
Regulatory amendments are driving efficiency objectives. No more can borrowers argue, “I would never want to spend that much money,” Borsos noted. The idea that efficiency goals are uneconomical doesn’t make sense. “Today, that’s the only thing available,” he observed. “You don’t have an option.”
Fannie Mae’s Multifamily Green Rewards Mortgage Loan requires evaluating and measuring the potential for solar photovoltaic systems. The agency’s Technical Solar Report is required for all Green Rewards Properties that install such systems.
In 2019, the GSE added the Towards Zero Green Building Certification group to its Green Building Certification program, which requires borrowers to achieve a more than 50 percent reduction of energy or water use from national baselines. The first property to receive financing under Fannie Mae’s Towards Zero group was Pax Futura, a Passive House project completed two years ago in Seattle.
Freddie Mac’s Green Advantage program requires a consumption savings threshold of 30 percent, with at least 15 percent saved on energy and an additional 15 percent reduction in energy and/or water use. Borrowers must also retain a third-party consultant to monitor and input benchmarking data. Through the third quarter of 2020, the agency funded 479 loans under the 30 percent requirement, for a total volume of more than $13.7 billion.
From August 2016 through the third quarter of 2020, Green Advantage borrowers reported more than 827 million gallons in cumulative water savings and a 152 million kBtu reduction in energy consumption. “We can measure it very easily because of the utility results and on average, it’s about $114 per year,” Kim-Reynolds said.
The Policy Picture
The biggest change this year at the Federal Housing Finance Agency involves the loan purchase caps for Fannie Mae and Freddie Mac. The new limits are set at $70 billion each for each agency. At least 50 percent of multifamily loans must be used for affordable housing—a major uptick from the previous requirement of 37.5 percent.
Another issue worth watching is federal funding for energy- and climate-efficient housing programs. The Biden Administration’s proposed budget includes $212.5 million in loans and grants that would target retrofits, green investments and resiliency improvements for multifamily housing. Another $25 million is intended for benchmarking and data-collection advancements.
Introduced in December 2020, the bipartisan Energy Efficient Qualified Improvement Property Act would provide a 10-year straight-line amortization schedule for qualified energy-efficient retrofits. Dubbed the E-QUIP Act by its sponsors, the bill’s goal is to incentivize investors and streamline the process for making improvements. The act covers the conversion of lighting and HVAC systems and the building envelope. “We are supportive of the simplicity behind that, as long as it’s a well-designed tax incentive without a lot of other hooks of requirement,” said NMHC’s Borsos.
Investors seeking these green finance programs are indicating a commitment to conducting more ESG business. They are glad to check that box with green bonds that offer high social and economic impacts. “But not all projects are a match for the requirements set out by the GSEs to be eligible for their green loan programs,” noted Brendan Coleman, senior managing director & head of Walker & Dunlop’s Debt and Structured Finance Group.
The ratio of utility cost reduction and the economic benefits, are important drivers in the level of investment and maintenance that borrowers are willing to undertake. “Lenders end up having to do a lot of legwork to get developers to consider including green and energy-efficient features into their projects, so they qualify for one of the loans,” Coleman said. Above all, he said, borrowers should work with a qualified engineer to construct a plan before choosing a green financing program that fits their needs.