New financial model aims to encourage decarbonisation

An estimated $700bn per year of investment is required to decarbonise the built environment globally by 2050.

However, the financial mechanisms currently available struggle to address major barriers such as the high upfront costs of energy efficiency improvements, long payback periods for low-carbon technologies, and split incentives and motivations between landlords and tenants.

Division between a property owner and occupant adds complexity in motivating landlords to invest in energy efficiency upgrades for a home.

Since tenants are usually responsible for energy bills and would reap the benefits of reduced costs, landlords may not directly benefit from the energy savings that could offset the expenses of home improvements.

This split incentive dynamic reflects a key barrier to incentivising investment in energy efficiency within the private rental sector.

Supplying the necessary investment will require financial innovations that help property owners decarbonise and also provide attractive, risk-adjusted returns for lenders. Property-linked finance (PLF) can provide one such approach.

This overcomes the payback-period barrier, a major challenge to the decarbonisation of UK buildings, whereby owners are deterred from making environmental improvements to their properties if the owners expect to move in the near- to medium-term and the energy savings are not expected to offset the project costs during this duration.

This form of finance can fund projects that improve the environmental performance of a property and addresses the major barriers to retrofitting by covering up to 100% of the costs on payment terms that match the useful lifetime of such measures.

Having finance linked to a property means that owners only pay for the measures up until they sell, while buyers will benefit from a more energy-efficient and comfortable property in return for continuing to make regular payments towards upgrades.

If potential purchasers don't wish to pay for these features or don't see the value in them, there would be the ability to prepay the PLF early if needed, so the seller would be in no worse a position as if they'd taken out another form of finance to pay for the measures.

PLF products have been developed in the US, Canada and Australia, and are currently being developed by the Green Finance Institute (GFI) in the UK and Spain.

Owners make payments based on an assessment of the property's tax bill, and these payments automatically transfer to a new owner on sale.

PACE assessments are filed with the local municipality as a senior lien on the property, enabled by state legislation and, at the local level, by cities and counties themselves.

PACE has enabled the investment of $18bn-plus of capital in improving the energy efficiency and resilience of more than 400,000 buildings in the US, according to the US trade body PACENation, generating in excess of 268,000 job-years and $30bn of economic impact.

PACE is also available in Canada in the provinces of Nova Scotia, Ontario and Alberta. Provincial legislation is required to let municipalities use PACE recuperation mechanisms to finance upgrades for private properties, and once this is in place municipalities in turn need to determine the programme specifications. 

The Canadian PACE market is at a nascent stage, with legislation enacted in several but not all municipalities. Wider adoption is therefore needed to take full advantage of this programme.

In Australia, meanwhile, PLF arrangements are referred to as environmental upgrade agreements, and are made voluntarily between a commercial building owner, a financial institution and a local authority to enable building improvements and generate savings that can then be used for repayments.

According to data compiled by the Better Building Finance, as of 2023, more than AUS$143.8m worth of energy consumption has been saved by such agreements, preventing 855,960 tonnes of greenhouse gas emissions. 

Research commissioned by GFI in 2023 found that, if implemented and scaled, PLF could support between £52bn and £70bn of investment in building decarbonisation across England, Scotland and Wales in the residential market alone.

The recent Greenprint for property-linked finance in the UK, published by GFI, Lloyds Banking Group and NatWest Group, further identified the key features for UK PLF, including the need for the payment obligation to transfer to a new owner on sale and, in the event of non-payment, to limit the liability to the amount in arrears at the time rather than the total outstanding balance.

This report also recommends the creation of a PLF local land charge that would automatically connect financing to a property. 

However, as this will require primary legislation, testing the PLF model through a pilot utilising a restriction-on-title approach for commercial properties will be helpful in refining the model for PLF.

The restriction-on-title approach will include a restriction on the sale of property unless the PLF has been novated to the new buyer or repaid at the point of sale.

To create a thriving PLF market in the UK, the report further recommends priming the market through engaging with financial institutions, conveyancers, property owners, regulators and local authorities, and continually improving and refining the PLF products once they have been introduced.

Spain's National Integrated Energy and Climate Plan (PNIEC), therefore, aims to renovate 1.37m dwellings by 2030, requiring an additional investment of €32.4bn between 2021 and 2030. To enable this, scalable and replicable private financing schemes must be developed.

Building on the success of PACE in the US and PLF findings in the UK, GFI España is piloting the use of established frameworks in Spanish law to introduce PLF, rather than changing regulations.

A new PLF product known as the PACE Canon, or an ecological fee, could thus be introduced to develop a financing structure driven by the private sector, covering residential and commercial properties alike.

Under the PACE Canon, initial capital would be provided to property owners as a permanent benefit rather than a loan, generating periodic payments as rent for deep retrofit investments, typically over 20 years, and secured by a charge on the property.

Importantly, these periodic payments cannot be accelerated, meaning that, as in the UK, liability would be limited to the amount in arrears at the time of any non-payment, rather than the total outstanding balance.

The mechanism, which again attaches to the property and would transfer with ownership, provides an off-balance-sheet form of finance akin to a property tax or ongoing operational expense.

This model aims to provide affordable, inclusive financing based on property value, with obligations tied to the property itself for added security.

Its link to a property rather than to an individual owner allows for:

• the inclusion of individuals regardless of their credit history, as the focus is on the property rather than the owner's credit profile
• no upfront capital being required
• financial repayments to occur only during the individual's ownership. If the property is transferred, the financial obligation is passed on to the new owner.

The model's scalable, adaptable design allows for easy implementation across EU and Latin American markets, supporting climate goals, enhancing resilience and potentially creating local jobs.

A 2023 members-only PACENation report showed that existing markets have taken 7.3 years on average to exceed $100m of capital deployed, due to fragmentation across geographies, submarkets and project types.

PLF enables access to affordable retrofits to improve environmental performance, including energy efficiency, which could lower energy costs.

More than half the respondents to GFI's 2022 consumer research indicated that future socio-economic pressures would make them more likely to consider using PLF, with the primary reason being to reduce energy bills. 

GFI is also engaging with government and regulators, financial institutions, business groups, real-estate and retrofit specialists as it continues to develop the UK PLF market to ensure this has minimal negative impact on the housing market, with purchasers being put off from taking on properties with PLF attached.

We will be ensuring strong consumer protections are in place because PLF will only be available for projects using accredited contractors through trusted certification schemes such as TrustMark and MCS.

While PLF will initially appear in just a small number of UK homes until the market has scaled up, consumers surveyed thought it could become a significant part of the market in the future. 

By working together with the market to educate consumers on the financial benefits of retrofit and PLF, our aim is that a newly retrofitted home would be considered attractive to potential buyers, and thus without negative impacts on the house buying and selling process.

A coordinated global effort to scale PLF is imperative. If clear objectives, unifying principles and pathways are established along with active support for differing cultural, legal and economic contexts, local markets around the world will be able to benefit from this model.