Financing Low-Carbon Housing on a Massive Scale

May 11, 2021 | By: David Heslam

Older homes in Florida
It’s no secret that the vast majority of America’s housing stock is in need of improvements—for reasons of comfort, safety, and health, but especially to address sub-par energy performance. To adequately tackle our climate imperatives, those home energy improvements need to happen quickly and at scale. And yet, when aggregated, the upfront costs for meaningful home energy performance improvements across the entire nation are daunting to consider. Utility incentives and government subsidies will never, by themselves, be enough to create deep impact. Home energy improvements at the volume and pace that is needed are not likely to happen without scalable, low-cost financing solutions that average Americans can easily access - in some cases without even realizing they are doing so. 

This conundrum is the main driver behind Earth Advantage’s focus on several cross-cutting initiatives: leading a national effort on the use of home energy labels, creating our Green Building Registry® where verified green home information can be captured and stored, and working with partners to engage with the Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac in the effort to develop green mortgage backed securities (green MBS) for existing residential properties.   

Let’s start with our conviction that green MBS for the existing home market can become a primary investment vehicle for deploying billions of dollars a year to home improvements that reduce residential emissions across the US. As the recent RMI - Earth Advantage Build Back Better Homes report highlights, organizations like ours are helping to create the conditions for exponential growth in demand for green mortgages. GSEs are moving quickly to develop guidelines for how to define and capture the environmental benefits of home improvements and then channel those green home mortgages into a massive new green bond market. The potential numbers identified in the report are incredibly compelling:  

RMI ten year impacts graphic
(source: RMI Build Back Better Homes) 

Earth Advantage’s role in this effort

Not surprisingly, there are many components needed to unlock the market for green MBS for the US housing stock. Earth Advantage is focusing on addressing several based on our specific competencies and the amount of impact our relatively small organization can impart.   

Documenting home performance: Without a trustworthy home energy label to document a home’s current energy performance or carbon impacts, it is very difficult to determine what impact a home improvement has had and whether it should qualify as a green mortgage and then get bundled into a green MBS. For existing homes, the US Department of Energy developed Home Energy Score™ is perfectly positioned to be that consistent metric for use on in every corner of the country, regardless of regional climate or local housing stock. Earth Advantage is already working with USDOE and local and state governments to ensure that Home Energy Scores become a more regular part of real estate transactions. 

Capturing, storing and transmitting home data: In order to qualify and bundle mortgages into green MBS, GSEs will need a means to quickly verify home performance information. Our Green Building Registry(R) is the largest single source of home performance information in the country and can be that conduit between market activity and the GSE’s financial products. Green Building Registry makes it easy to find validated, third-party verified green home data so that it can become integrated into lending, underwriting, and green MBS bundling processes. 

Supporting market drivers: With a readily acceptable metric to document homes with small carbon footprints and a clearinghouse of validated home performance data, GSEs can then more efficiently bundle these home mortgages and sell them as green MBS to investors seeking environmentally beneficial investments. This creates a built-in incentive structure for homeowners. Because the GSE’s see market interest in green mortgages (and the subsequent green MBS), they could offer preferential terms to those borrowers to either make the home improvements or purchase an already improved home. The result is a market-based incentive toward energy efficient housing with the potential to influence consumer behavior in a way that surpasses the impact of traditional direct incentive payments to homeowners. 

Historic challenges with residential energy lending 
Before we get too excited about the potential of green MBS energizing a more active green mortgage marketplace, we have to acknowledge that lending for energy efficiency and clean energy improvements has historically been challenging. As recent experience has shown, efforts like residential PACE lending have produced some good outcomes (including financing over 300,000 home upgrades), but this success has too frequently been achieved through high cost/low savings energy measures and predatory lending practices. A recent report on residential PACE in Missouri underscores that a poorly crafted and regulated lending program can have adverse impacts within more vulnerable communities. Expanding access to green capital must include a place for low-to-moderate income households and underserved communities access benefits while being protected from harm. GSEs’ are obligated to address this issue through their Duty to Serve plans, which require Fannie Mae and Freddie Mac to facilitate a secondary market for mortgages on housing for low-to-moderate income families in three underserved markets: Manufactured Housing, Affordable Housing Preservation, and Rural Housing.

It’s also true that the use of energy efficient and green mortgages have historically been distressingly low. We see this as a result of several factors: 

  • the overall stress and uncertainty of the home purchase process

  • the difficulty in motivating a new buyer to take action on issues for which they have yet to encounter

  • the lack of an incentive structure and perceived complexity for real estate agents and lenders to actively promote the use of an energy efficient mortgage. 

Why is this moment in time different? With exponential growth in investor interest in environmentally beneficial investment products, there is a cascading incentive to develop the supply to meet that new demand. In this new investment context, verified and valid green mortgages become a valuable commodity that will be sought in numbers not seen at any time in the past. This investor demand creates the opportunity to scale a market-based incentive for home improvements that have documented carbon reduction benefits. Paired with existing (and future) utility and government incentive programs, we feel that the US is set to finally and comprehensively take on the problems inherent in our country’s carbon intensive housing stock. These mortgages will not be the device that convinces homeowners to make energy improvements, but they will be the most secure and affordable way for the homeowner to pay for those improvements.

As we have seen with the recent residential PACE experience, strong regulatory oversight and third-party validation need to be part of any financing protocol to ensure that the activity is truly producing social and environmental benefits. Earth Advantage will continue to advocate that the GSE’s develop rules and use tools that ensure lending processes and loan bundling is done using dependable and third-party verified home performance data. 

Continue the conversation: 
Twitter: @dheslam 

#sustainablefinance #greenbonds #climateaction