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What are the most promising opportunities to promote greater residential energy efficiency? Is there a role for the federal government?

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By David A. Smith

To boost greater residential energy efficiency, eliminate perverse incentives and split incentives.

Leave aside homeownership, where a cornucopia of programs Federal, state, and utility is available for retrofits of all kinds. The real wins are in affordable multifamily. The inventory is old, large-scale, and in many places highly energy inefficient. Analytic methodologies such as Green Capital Needs Assessments can quantify expected engineering-related savings, and a plethora of lenders are interested in making such loans if the savings can be underwritten. Energy conservation ought to be a layup, yet it doesn’t happen because program rules written into statutes and regulations decades ago block the parties from doing the ‘energy right thing’ in two ways:

  1. Perverse incentives. Many regulatory structures presumably seek deliberately to hobble the owner’s cash flow or economic potential, on the belief that extra cash flow must ipso facto mean overcharged residents. Public housing’s operating subsidy drops dollar for dollar of energy savings. Older assisted properties (Section 221d3 or 236) have cash distribution limitations that effectively preclude any above-the-line payments of new debt service (say, on an energy conservation loan) and throw any serendipitous cash into a HUD-locked residual receipts account. Budget-based rents suck up any operating expense savings, and Operating Cost Adjustment Factors (OCAFs) likewise seek to grow rents by only the growth of operating expenses. LIHTC rents must be reduced dollar for dollar for resident-paid utility costs. Why would owners put themselves through effort and new risk, only to gain no benefit from doing so, and in fact often to incur greater nitpicking oversight?
  2. Split incentives. The most critical energy-consumption monitor is the resident’s wallet or pocketbook, yet in by far the majority of public and affordable housing properties, residents are neither penalized for energy waste nor rewarded for energy savings. Why tell your eight-year-old to close the window if there’s nothing in it for him or you?

Add to these challenges the blockages of installing new conservation equipment and carving away the energy savings as a dedicated source of debt service for the energy service company (ESCo) or energy conservation loan, and the result is that even though resident, owner, ESCo and regulator all agree that a given set of improvements will reduce overall energy consumption, it is currently impossible to write a contractual arrangement that both comports with Federal regulatory requirements.

Perverse and split incentives are like valves turn to Off. If you want to turn them on, put serious bipartisan effort into rewriting the statutes and regulations.

David A. Smith is chairman of Recap of Real Estate Advisors

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