Energy Efficiency Financing: PACE and Beyond

Energy efficiency financing has emerged as one of the most accessible and cost-effective pathways for building owners to reduce operating costs while meeting sustainability goals. With commercial buildings accounting for approximately 36% of total U.S. energy consumption, the market for energy efficiency upgrades represents a multi-billion dollar opportunity. Property Assessed Clean Energy (PACE) loans have revolutionized how building owners approach efficiency improvements, but they're just one tool in an expanding toolkit of financing mechanisms designed to overcome the upfront cost barrier that has historically limited efficiency adoption.

Property Assessed Clean Energy (PACE) Overview

Property Assessed Clean Energy (PACE) financing represents one of the most innovative approaches to funding building retrofit funding projects developed in the past two decades. PACE programs allow property owners to finance energy efficiency, renewable energy, and water conservation improvements through a special assessment on their property tax bill, creating a unique financing structure that addresses many traditional barriers to efficiency investment.

How PACE Financing Works

PACE loans are structured as voluntary property tax assessments that are repaid over extended periods, typically 10-25 years. The financing is attached to the property rather than the owner, meaning the repayment obligation transfers with property ownership. This feature differentiates PACE from conventional loans and creates unique advantages for both lenders and borrowers.

The basic PACE transaction flow includes:

• Application and approval: Property owners apply through authorized PACE providers who evaluate property eligibility and project feasibility
• Contractor selection: Owners work with approved contractors to design and price energy efficiency improvements
• Funding and installation: Upon approval, PACE providers fund the project and contractors complete the work
• Repayment: The property assessment appears on the owner's property tax bill and is repaid over the agreed term

Commercial PACE vs. Residential PACE

While residential PACE programs faced regulatory challenges following FHFA guidance that limited participation in properties with federally-backed mortgages, Commercial PACE (C-PACE) has flourished. As of 2024, C-PACE programs operate in 38 states and have financed over $7 billion in commercial building improvements since inception.

PACE Eligibility and Requirements

Not all properties or improvements qualify for energy efficiency financing through PACE programs. Typical eligibility criteria include:

Property requirements: Most C-PACE programs require properties to be commercial, industrial, multifamily (5+ units), or non-profit facilities. The property must be current on all tax payments, and senior lenders must consent to the PACE assessment taking priority in case of foreclosure.

Project requirements: Improvements must meet program-specific guidelines, which typically require projects to either generate energy savings exceeding the annual assessment payment or meet predetermined efficiency standards. Many programs require third-party energy audits or engineering studies to verify projected savings.

Financial requirements: Properties generally cannot have more than 30% loan-to-value when combining existing debt with the PACE assessment. Some programs require demonstration of positive cash flow and may perform credit checks on owners.

PACE Advantages and Limitations

PACE loans offer several compelling advantages that have driven their popularity among commercial building owners:

100% financing: PACE can cover the entire project cost including equipment, installation, engineering, and soft costs, eliminating the need for upfront capital.

Extended repayment terms: The 15-25 year repayment periods available through PACE align with the useful life of efficiency equipment, allowing energy savings to exceed assessment payments from day one.

Off-balance-sheet treatment: For many entities, PACE assessments are treated as operating expenses rather than debt, preserving borrowing capacity for other needs.

Transferability: Since the obligation runs with the property, selling before the assessment is repaid doesn't trigger acceleration or prepayment penalties.

However, PACE also presents considerations that may limit its applicability:

Senior lien priority: PACE assessments typically take priority over existing mortgages in foreclosure, which can make senior lenders reluctant to provide consent. While this protects PACE investors, it may create roadblocks for borrowers.

Geographic availability: PACE is only available in states and municipalities that have enacted enabling legislation and established programs.

Cost: PACE interest rates typically exceed senior debt rates, though they remain competitive with other forms of building retrofit funding that don't require collateral or recourse.

Commercial Energy Efficiency Upgrades

Commercial buildings offer tremendous opportunities for energy efficiency improvements that deliver immediate operational savings alongside long-term sustainability benefits. Understanding which upgrades deliver the strongest returns helps building owners prioritize investments and structure appropriate financing.

High-ROI Efficiency Improvements

Energy efficiency upgrades vary significantly in cost, complexity, and return on investment. The most financially attractive improvements typically share three characteristics: significant energy savings, relatively low installed costs, and minimal operational disruption.

LED lighting conversions consistently rank among the highest-ROI efficiency investments. Replacing fluorescent, metal halide, or incandescent lighting with LED alternatives typically reduces lighting energy consumption by 50-75% while improving light quality and reducing maintenance costs. With project costs ranging from $2-6 per square foot and simple paybacks of 2-5 years, lighting upgrades often serve as anchor projects in larger efficiency financing packages.

HVAC system optimization and replacement addresses the largest energy end-use in most commercial buildings. High-efficiency rooftop units, variable refrigerant flow (VRF) systems, and energy recovery ventilators can reduce HVAC energy consumption by 30-50%. While these systems require larger capital investments ($15-35 per square foot for complete replacement), the energy savings justify the cost, particularly when financed through mechanisms that align payments with savings.

Building automation and controls leverage technology to optimize energy use without requiring equipment replacement. Advanced building management systems, occupancy sensors, and demand-controlled ventilation can reduce total building energy use by 15-30%. With costs of $2-8 per square foot, these systems often achieve simple paybacks of 3-7 years.

Building envelope improvements including upgraded insulation, high-performance windows, and air sealing reduce both heating and cooling loads. While envelope upgrades require significant investment ($10-25 per square foot), they create permanent efficiency improvements that benefit every subsequent building system upgrade.

Deep Energy Retrofits vs. Incremental Improvements

Building owners face a strategic choice between comprehensive deep energy retrofits and incremental, opportunistic improvements. Each approach suits different situations and financing structures.

Deep energy retrofits aim to reduce building energy consumption by 50% or more through coordinated, comprehensive improvements across all major systems. These projects typically address lighting, HVAC, envelope, controls, and sometimes on-site generation in a single coordinated effort. Deep retrofits cost $20-60 per square foot but create buildings that approach or achieve net-zero energy operation.

The comprehensive nature of deep retrofits creates several financing advantages. Larger project sizes make them more suitable for energy efficiency financing through mechanisms like PACE loans or performance contracts. The significant energy savings generate strong cash flows that support larger debt service. Additionally, the coordinated design allows optimization across systems, maximizing overall performance.

Incremental improvements address individual systems as they reach end-of-life or when capital becomes available. While this approach requires less upfront planning and capital, it may result in higher total costs and missed optimization opportunities. However, incremental improvements offer advantages in terms of lower financing requirements, reduced operational disruption, and the ability to incorporate newer technologies as they become available.

Energy Audit and Investment Grade Analysis Requirements

Securing energy efficiency financing typically requires professional energy analysis to verify projected savings and justify the investment. The level of analysis required depends on project size, financing mechanism, and lender requirements.

ASHRAE Level 1-2 audits cost $0.10-0.30 per square foot and provide preliminary energy assessments identifying major savings opportunities with basic cost-benefit analysis. These audits suit smaller projects and early-stage planning.

Investment Grade Audits (IGA) cost $0.30-0.75 per square foot and include detailed engineering analysis, precise savings calculations, and project cost estimates with 10-15% accuracy. IGAs meet the requirements of most building retrofit funding programs and performance contractors.

Measurement and verification (M&V) plans establish protocols for tracking actual energy savings post-installation, ensuring that financed projects deliver promised results. M&V typically follows IPMVP protocols and costs $5,000-25,000 depending on project complexity.

Financing Mechanisms Comparison

Energy efficiency financing encompasses diverse mechanisms, each with distinct structures, advantages, and optimal applications. Understanding these options allows building owners to select the most appropriate funding strategy for their circumstances.

Comprehensive Financing Options Matrix

Traditional Bank Loans for Efficiency Projects

Conventional commercial loans remain widely used for building retrofit funding despite not being specifically designed for efficiency projects. Banks typically offer the lowest interest rates (4.5-7.5%) but require strong borrower credit, property equity, and shorter repayment terms (5-10 years) that may not align with energy savings cash flows.

Traditional loans work best when building owners have strong balance sheets, substantial equity in the property, and prefer the simplicity and speed of conventional financing over specialized efficiency programs. The shorter terms require that energy savings significantly exceed debt service to justify the investment.

Utility-Sponsored Programs

Many utilities offer energy efficiency financing through on-bill financing or on-bill repayment programs. These programs address the "split incentive" problem in tenant-occupied buildings and reduce barriers for owners with limited access to capital.

On-bill financing programs provide loans directly from the utility, with repayment appearing as a line item on the monthly utility bill. These programs typically offer favorable terms (0-7% interest) and simplified underwriting, though loan amounts are often limited to $50,000-250,000.

On-bill repayment differs from on-bill financing in that a third-party lender provides capital while the utility collects payments through the billing system. This structure allows utilities to facilitate efficiency financing without dedicating capital to loan programs.

Utility programs work particularly well for small-to-medium efficiency projects where simplified underwriting and the convenience of bill integration outweigh potentially higher interest rates than traditional bank loans.

Green Bonds and Sustainability-Linked Financing

Organizations with large building portfolios increasingly access capital markets through green bonds specifically designated for energy efficiency and sustainability projects. The green bond market exceeded $500 billion in annual issuance in 2023, with building efficiency representing a significant allocation category.

Green bonds offer several advantages for portfolio efficiency programs:

• Lower cost of capital: Green bonds typically price 5-25 basis points below comparable conventional bonds due to strong investor demand
• Larger capital availability: Bond issuances of $250 million to several billion dollars can fund efficiency improvements across entire property portfolios
• Enhanced reputation: Green bond issuance signals sustainability commitment to stakeholders, tenants, and investors
• Reporting frameworks: Green bonds require impact reporting that creates accountability for achieving efficiency goals

Sustainability-linked loans (SLLs) tie interest rates to achievement of predetermined sustainability performance targets, including energy efficiency metrics. Borrowers that meet targets receive interest rate reductions (typically 2.5-10 basis points), while those that fall short may face rate increases. This structure aligns lender and borrower interests in achieving efficiency outcomes.

Performance Contracting Models

Energy performance contracting eliminates the upfront capital barrier to efficiency improvements while transferring performance risk from building owners to specialized energy service companies (ESCOs). This financing approach has enabled over $40 billion in efficiency projects since 2000, particularly in government and institutional facilities where budget constraints limit conventional capital investment.

Energy Savings Performance Contracts (ESPCs) Structure

Energy Savings Performance Contracts represent the most common performance contracting model in the United States, with particularly strong adoption in federal facilities, schools, hospitals, and municipal buildings. ESPCs follow a well-established structure that balances risk allocation with financing efficiency.

Under an ESPC, the energy service company:

• Conducts comprehensive energy audits identifying efficiency opportunities
• Designs and engineers efficiency improvements
• Arranges financing for the project (typically through third-party lenders)
• Installs all equipment using qualified contractors
• Guarantees that energy savings will meet or exceed projections
• Maintains equipment and verifies savings throughout the contract term

The building owner repays project costs through energy savings over contract terms typically ranging from 10-25 years. The ESCO's savings guarantee ensures that if actual savings fall short of projections, the ESCO makes up the difference, protecting the owner from performance risk.

Shared Savings vs. Guaranteed Savings Models

Performance contracts utilize two primary payment structures that allocate savings and risks differently between owners and ESCOs:

Guaranteed savings ESPCs remain more common, particularly in public sector projects. Under this model, the building owner secures financing (often through municipal bonds or bank loans) to fund the project upfront. The ESCO guarantees specific savings levels and pays the difference if actual savings fall short. The owner retains all savings exceeding the guarantee and pays a fixed contract amount to the ESCO for design, installation, and M&V services.

This structure offers owners several advantages: they keep excess savings, maintain control over financing terms, and benefit from ESCO expertise without sharing savings upside. However, owners must have borrowing capacity and accept responsibility for debt service even if savings fall short of projections (though the ESCO guarantee provides protection).

Shared savings ESPCs involve the ESCO arranging and holding financing responsibility. Rather than guaranteeing a specific savings level, the ESCO shares actual measured savings with the owner according to a predetermined split (commonly 70-90% to owner, 10-30% to ESCO). The ESCO assumes both financing responsibility and performance risk.

Shared savings models suit owners who lack borrowing capacity or prefer to avoid taking on debt. However, the shared savings structure typically results in higher total costs as ESCOs price in the cost of capital plus performance risk. Additionally, owners receive only a portion of achieved savings rather than the full benefit.

Federal ESPC Programs and Frameworks

The federal government pioneered energy performance contracting through programs that have delivered over $9 billion in efficiency improvements across federal facilities. The Department of Energy maintains indefinite delivery, indefinite quantity (IDIQ) contracts with pre-qualified ESCOs, creating a streamlined procurement process that federal agencies can leverage.

The federal ESPC framework offers several features that accelerate project development:

Pre-competed contracts: Agencies can task order against existing IDIQ contracts rather than conducting full competitive procurements, reducing transaction time from 12-24 months to 6-12 months.

Standardized terms: DOE-developed contract templates establish balanced risk allocation and clear terms that have been tested through hundreds of projects.

Financing facilitation: The framework includes provisions for third-party financing and ensures that appropriations law requirements are met.

Technology inclusiveness: Federal ESPCs can include water conservation, renewable energy, and distributed generation alongside traditional efficiency measures, enabling comprehensive projects.

ESPC Financial Analysis and Project Economics

Evaluating performance contract economics requires understanding how ESCO pricing incorporates development costs, financing costs, performance risk, and profit margins. While ESPCs eliminate upfront capital requirements, the total project cost typically exceeds owner-financed alternatives by 15-35%.

Consider a $2 million efficiency project with projected annual savings of $250,000:

Owner-financed scenario: The owner secures a $2 million loan at 5.5% over 15 years, resulting in annual payments of $196,000. Net positive cash flow begins immediately ($54,000 annually), and after loan repayment, the owner captures the full $250,000 in annual savings.

Guaranteed savings ESPC: The owner finances $2.2 million (project cost plus ESCO fees) at 5.5% over 15 years, creating annual payments of $216,000. Net positive cash flow is $34,000 annually during the contract term. The higher total cost results from ESCO development fees, M&V costs, and guarantee pricing, but the owner gains savings certainty and comprehensive service.

Shared savings ESPC: The ESCO finances $2.3 million and shares 75% of savings with the owner. The owner receives $187,500 annually in savings share with no debt obligation, while the ESCO receives $62,500 to cover debt service and profit. After 15 years when the contract ends, the owner captures full savings.

The appropriate model depends on owner priorities. Organizations with capital access and risk tolerance typically achieve better economics through owner-financed approaches, while those with capital constraints or strong risk aversion benefit from performance contracting despite higher total costs.

M&V Protocols and Savings Verification

Measurement and verification provides the foundation for performance contracting by establishing rigorous protocols for quantifying energy savings. The International Performance Measurement and Verification Protocol (IPMVP) provides globally-recognized standards that most ESPCs reference.

IPMVP defines four M&V options with varying levels of precision and cost:

Option A (Retrofit Isolation - Key Parameter): Measures key performance parameters while estimating others, suitable for lighting, motors, and other projects where operating hours can be stipulated.

Option B (Retrofit Isolation - All Parameters): Measures all relevant parameters, used for HVAC systems and other complex measures where multiple variables affect performance.

Option C (Whole Facility): Analyzes utility meter data for the entire facility, appropriate when improvements affect multiple systems or when comprehensive retrofits are implemented.

Option D (Calibrated Simulation): Uses building energy modeling calibrated to actual performance, suitable for complex projects where interactive effects between measures must be quantified.

M&V costs typically represent 2-10% of total project costs depending on protocol complexity and contract duration. While this represents a significant expense, robust M&V protects both owners and ESCOs by providing transparent, defensible savings calculations that support guaranteed savings contracts.

Keys to Successful Performance Contracts

Performance contracting succeeds when building owners and ESCOs align expectations, allocate risks appropriately, and maintain clear communication throughout project development and implementation. Several factors distinguish successful ESPCs from troubled projects:

Comprehensive baseline development: Accurate savings calculations require detailed understanding of current energy use patterns. Investing in 12-24 months of baseline energy data collection, despite delaying project implementation, creates more accurate savings projections and reduces disputes.

Conservative projections: ESCOs that over-promise savings to win contracts create disappointment even when projects perform well. Owners should prefer realistic projections with opportunities for excess savings over optimistic estimates that may not materialize.

Operational coordination: Efficiency improvements require ongoing operational support to maintain performance. Building operators must understand new systems, adjust operations appropriately, and avoid override settings that compromise savings.

Clear escalation provisions: Energy prices fluctuate over contract terms. Well-structured ESPCs include clear escalation clauses that adjust savings calculations based on actual energy prices, preventing disputes when prices diverge from projections.

Organizations considering performance contracting should evaluate ESCOs based on technical competence, financial stability, project references, and cultural fit rather than simply selecting the lowest-cost proposal or highest savings projection.

Strategic Considerations for Energy Efficiency Investment

Selecting the optimal energy efficiency financing approach requires balancing multiple factors including capital availability, risk tolerance, operational capacity, and strategic objectives. Building owners should consider several key questions when structuring efficiency investments:

What is the organization's capital position? Organizations with strong balance sheets and available capital often achieve better economics through direct investment or traditional financing rather than performance contracting or PACE loans. However, preserving capital for core business activities may justify higher-cost financing that doesn't consume borrowing capacity.

What level of performance risk is acceptable? Conservative organizations may prefer guaranteed savings performance contracts despite higher costs, while those comfortable with modest risk can capture savings upside through owner-financed projects with professional M&V.

Does the organization have technical capacity for project management? Comprehensive ESPCs provide turnkey solutions ideal for organizations without engineering staff, while those with technical capacity can reduce costs by managing traditional contractors directly.

How important is speed to implementation? PACE programs and performance contracts involve longer development timelines (6-18 months) than traditional financing but may accelerate overall implementation by eliminating budget allocation delays.

What are the tax implications? Different financing structures create different tax consequences. Equipment purchases may qualify for depreciation and tax credits, while certain lease and performance contract structures may receive different treatment. Consult tax advisors to optimize structure.

Conclusion

Energy efficiency financing has matured into a sophisticated market offering building owners multiple pathways to overcome the upfront cost barrier that has historically limited efficiency adoption. PACE loans have opened new possibilities for commercial building owners, while performance contracting continues evolving to address more complex projects with stronger risk allocation. Traditional financing, utility programs, and capital markets instruments round out an ecosystem that can accommodate virtually any efficiency project scale and owner circumstance.

The most successful efficiency investments result from careful matching of project characteristics, owner capabilities, and financing mechanisms rather than defaulting to a single approach. As building performance requirements tighten, energy costs fluctuate, and sustainability becomes a competitive differentiator, building retrofit funding will continue growing. Organizations that develop sophisticated energy efficiency financing strategies will capture both the operational savings and strategic advantages that high-performance buildings deliver.