How does green energy figure into an insurance investment portfolio?
Alexandra Cooley and Lara Devieux recently sat down with Insurance Investor to discuss the ins and outs of Commercial Property Assessed Clean Energy (C-PACE) green financing. In this Q&A article, learn more this relatively new asset class and how we see it continuing to evolve over the next few years.
At Nuveen, we believe it's possible for investments to generate attractive returns while still having a positive impact, and C-PACE is a perfect example of such an investment.
Given that C-PACE as an asset class is in its infancy, can you give us a brief rundown: What is it? What are its main goals? And who are the stakeholders?
Alexandra Cooley: C-PACE stands for Commercial Property Assessed Clean Energy. It's a state-level policy where a state classifies installing clean energy measures on commercial real estate as a public benefit. This enables commercial building owners in the US to create a special taxing district on their property and raise the upfront capital to install clean energy upgrades – similar to the way public entities raise money for public benefits such as sewer systems or school districts. This means that individual building owners can use the security of a special assessment (specifically, a tax assessment) to secure attractive capital for clean energy upgrades on their property – for example, implementing solar energy.
This is a powerful funding mechanism for building owners because it addresses a classic financing need in the commercial real estate sector. The sector is extremely diverse in terms of property type, ownership, structures, and location and thus hard to standardise. By using the assessment structure, C-PACE offers a secure and elegant way of standardising across this industry. It allows commercial building owners to access efficient, long-dated, relatively low cost capital for these upgrades, which usually require a significant amount of capital upfront for durable energy or operational savings over time.
Then, once the state passes policy, a program administrator – typically a public sector entity – is put in place to lay out the rules of the road and ensure that individual clean energy projects are eligible for C-PACE. They need to make sure the approval process is clear and predictable, and then they approve each project to ensure that proceeds are financing eligible measures. These administrators are also responsible for ensuring that the assessment is placed on the property tax bill and remitting those funds back to the private lenders, such as Nuveen Green Capital.
The last stakeholder group are the Private lenders like ourselves at Nuveen Green Capital. We educate the market – lenders, investors, and commercial building owners who want to upgrade their properties or build above code green new construction. Because our financing is secured with a senior assessment ahead of a mortgage, in arrears like any other public benefit assessment, we’re able to aggregate capital from efficient sources seeking predictable, long-term returns like insurance companies and asset managers. CPACE investments are also ESG-friendly because the public sector puts these rules in place to ensure that projects are eligible as public benefits.
How large is the current C-PACE addressable market, and – based on trends you are seeing in the space – how do you see the asset class evolving in the next 1, 5 and 10 years?
Ali: It’s a relatively new asset class that’s scaled quite a bit in the past couple years. To date, there have been in excess of about $4 billion in C-PACE originations, but more than 30% of that $4 billion originated in 2022.
There’s a lot of growth potential in this market for a few reasons. One, we’re seeing a lot more activity on the public sector side – such as the Inflation Reduction Act that was recently passed and New York City local law 97, as well as other mandates across the country, which requires buildings of a certain size to reduce their emissions. This is the push that much of the commercial real estate (CRE) market may need to make these upgrades more cost efficient.
Two, we’re seeing market volatility facing the real estate industry, and interest rate increases mean that the fixed-rate, long-dated nature of C-PACE – again, because we are secured by the underlying property rather than the building owner themselves – is attractive.
Three, our borrowers are seeing a “pull” from investors and tenants demanding greener measures in general. There was a recent Jones Lang LaSalle report that found a 6% rent premium and a 7.6% sales premium for green buildings. So, at a time when CRE property values are being challenged by rising interest rates, building owners are looking to do everything they can to optimise their financials – and going green is one key way to do that.
Four, geographic expansion is a big factor. The first PACE policies were passed in the early 2000s and when we started Greenworks Lending (now Nuveen Green Capital) in 2015 there were only a handful of states that had implemented programs. There are nearly 40 states today with active C-PACE program. This number is quickly growing as states see the benefit of getting this tool to their commercial real estate sectors. There’s more demand simply with an expanded market size.
How do C-PACE loans fit within an insurance portfolio, and what benefits do they offer insurance investors?
Lara Devieux: It’s a good fit for insurance portfolios – especially ones with longer dated liabilities, which match well from an asset/liability management (ALM) perspective – due to the long duration of loans, which have an average weighted life of 10 years.
C-PACE offers attractive, capital-adjusted yields given the consistent and durable income returns. Because it’s a private asset class, there’s a focus on spread premiums over publics. For C-PACE we think investors are well compensated for liquidity risk by the spread premiums over public commercial mortgage-backed security (CMBS) benchmarks.
As liquidity has come into the C-PACE market there has been some tightening of the spread premiums, but we’ve historically seen interest rates on loans range from almost 100 basis points to 400 basis points over comparable Investment-Grade (IG) CMBS bonds.
Another benefit is the high-quality nature of the loans with strong performance across cycles. C-PACE loans are well structured to avoid principal losses – given their senior position and low loan-to-value ratio that averages about 20%.
The third benefit is diversification; given the fact that it’s a relatively new asset class, it’s a complement to an insurer’s public and private corporates and their structured products portfolio.
Then, finally, you have the ESG benefits because C-PACE loans finance renewable energy and energy efficiency projects – which reduces the negative environmental impact and increases climate resiliency in building, creating jobs in the process. Additionally, by reducing operating expenses for businesses, they’re able to compete better at the local and global level.
Let’s drill down into the ESG benefits. How can these investments help meet insurers’ sustainability goals?
Lara: Insurance companies are at different stages of their ESG journeys, ranging from ESG integration as part of the investment decision-making process to deliberate impact investments, including those insurers who have made net-zero commitments. Wherever an insurer sits on the ESG spectrum, C-PACE can provide inherently green benefits as every loan achieves a public benefit related to the climate or environment.
At Nuveen, we believe it's possible for investments to generate attractive returns while still having a positive impact, and C-PACE is a perfect example of such an investment. We also often hear from investors about the difficulties of quantifying ESG benefits, but C-PACE allows for quantifiable key performance indicators (KPIs). Specifically, energy savings are measured for each individual loan and for all projects that are financed there’s an external engineering review that calculates lifetime energy saving for each project.
For example, KPIs might include megawatt hours and lifetime energy generated and saved, which then translates into dollar energy savings for property owners and additional energy jobs created. Nuveen provides reports on these KPIs to investors quarterly. In addition, ESG benefits can be mapped to specific Sustainable Development Goals (SDGs).inally, C-PACE securitisations have been green bond certified by S&P. So, not only are the durable returns and portfolio benefits attractive, but insurance companies will also be able to easily supplement and strengthen their sustainability reports and disclosures, which are increasingly important to various stakeholders.
How has the asset class performed historically, and what qualities should investors be looking for during the manager selection process?
Ali: Existing C-PACE portfolios have performed strongly. Our historic delinquencies have averaged less than 50 basis points, and our portfolio has never taken a loss. Because C-PACE is a non-accelerable, non-extinguishable assessment that runs with the land, it has tended to stay on the property longer than other types of CRE lending. Borrowers can prepay at any time – usually with a penalty – and industry average for annual prepayment rate has been around 5-6%, which compares favorably with similar lending products. So the prepayment performance has been attractive to investors looking for durable returns.
Since 2017, we’ve completed four securitisations: two public, two private. On those securitisations, we’ve maintained our investment grade rating of A or better and have never been downgraded.
Because C-PACE is relatively new, there isn’t enough product to match investor demand. So, first and foremost, investors are looking for access to flow and high quality originations, and we’ve invested in building these aspects up since 2015.
This means ensuring that there’s a robust process around credit and assessing the underlying investments and program quality. It’s important for managers to follow the rules of the road and to make sure they understand how this public/private partnership works in their respective states (it varies from state to state).
Once an assessment is closed, the servicing need is fairly light-touch – but it is specialised. It means interfacing with these programs to ensure that the lien is being filed, that the funds are flowing to the right accounts, and maintaining a robust servicing team to do so. This is also something we’ve invested heavily in, and have an inhouse team focused on asset management specific to C-PACE.
How can investors access the C-PACE market?
Ali: We have noticed a lot of interest from investors who want long exposure to C-PACE. To date, the primary way to do so is by buying IG bonds in pooled public or private securitisations – or by participating in Single Asset Single Borrower (SASB) CMBS securitisation.
But as this market has scaled and grown, there will likely be new products available to investors so that they can access return profiles beyond those of the IG bonds available in the securitisation markets.