September 14, 2013 The Honorable Andrew M.

Cuomo Governor of New York State NYS State Capitol Building Albany, NY 12224 Dear Governor Cuomo: Re: Green Bank, GHG- reductions and Real Estate recovery an open letter The announcement of a Green Bank for our state is tremendously exciting. It gives us a chance to finally create a breakthrough in renewable energy, progress that has been held back in the past largely by existing programs that have been perversely advantageous to the carbon energy business. These programs have not really stimulated the development of renewable energy business at all.

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The Green Bank is an historical opportunity which can rapidly help reduce GHG-emissions from buildings, as well as boost real estate values around the state. Renewable energy retrofits can change energy provisioning from liability to asset for a property. It is also of great importance in helping create a measure of building resiliency. In short, if done right, renewable energy investment will boost property values. This insight was the crux of the concept of PACE bonds, but even the PACE industry missed it by embracing the prevalent but mistaken focus on energy efficiency.

Why programs have failed to produce a renewable energy boom and GHG-reductions
From the federal level on down, existing incentive programs have missed the boat in the retrofit market, primarily because there is an ingrained bias for focusing on technologies, not buildings. The result has been a tendency to justify one technology over another based on its incremental, marginal contribution in terms of energy savings. The underlying analytical mistake is the focus on incremental energy efficiency first, which is a secondary objective, not a primary one. Obviously, any system runs better if its more efficient. But, we first need to decide what system we want. In most cases, this is a make or buy decision, since the renewable energy option mostly involves building mounted equipment that generates energy locally at the demand side to whatever degree is practical. From the standpoint of a property as an economic entity, energy savings produce diminishing returns, in line with the adage you cant save yourself rich. You simply end up spending more and more money on saving less and less energy, so it is a financial trap to promote investment in energy savings, and hopefully the Green

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Bank could avoid this pitfall. The resulting financial quagmire has stymied the industry for too long already. A Green Bank can change the model, by focusing on renewable energy options first, and thereby enforcing a proper project valuation methodology. The best projects will then get the priority they deserve, and reducing green house gases can go hand in hand with boosting real estate values.

In order to shift the focus to the dual objectives of GHG-reductions and asset appreciation of the properties involvedthereby reducing the lending risk, toothe components of Green Bank loan applications should include:

Analysis with EPAs ENERGY STAR Portfolio Manager as a standardized methodology to evaluate the reductions in GHG emissions, and a 30 year capital budget from the property owners, to show how a retrofit project improves asset values.

Financial Markets and Green Finance for Retrofits Programs of the pastfocused on energy savings have not worked, and can never work, and if nothing else, this has shown up in the difficulties of marketing securities based on energy retrofit loans, as both NYSERDA and the Commonwealth of Pennsylvania have recently experienced. The challenge in valuing these securities will ultimately be found in the fact that they dont have a sound financial basis. The typical energy savings of 20-30% are meaningless, because it necessarily

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implies commitment to a dead-end financial strategy with diminishing returns which will undermine asset values in the long run. Ultimately, if an investment has energy savings as a primary driver rather than as a secondary and subsidiary objective, the diminishing returns on progressive savings, will undermine the long term economic prospects for the properties involved. It will create the slums of the future, and runs counter to a stated desire for housing preservation. Clearly, in new construction, net-zero emissions is becoming the benchmark. In retrofits that is not always easy to achieve. However, the fact remains that investment in building mounted energy generation is productive, and has the potential for producing compound returns. When multiple technologies are combined, portfolio effects ensue, whereas investments in energy savings commit a property to a path of diminishing returns along a single dimension. As a result, the overall effect is not an investment at all, but a financing solution with limited follow-on benefit and no persistent return. If energy savings drive the equation, the resulting programs benefit the investors in carbon energy. We are making carbon-based energy cheaper and therefore more competitive against green energy. We inadvertently prolong the addiction to carbon energy. By analogy, energy efficiency and energy savings are the methadone of the carbon energy economy. They make the addiction tolerable, and soften some of the negative effects and by doing so make the problem worse in the long run. As addiction pundits have reported from clinical research, kicking methadone is harder than kicking heroin.

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The failures of various programs are universal and can be summed up as follows: They are driven by the old insight from the first US energy crisis that on the margin a dollar invested in reducing demand is more effective than adding supply. That wisdom holds as long as the power grid is the only optiona situation that has long since stopped being the case.

Specifically, the following programs are prime examples of old thinking driving current failures:

ENERGY STAR/ITC the perverse effect of tying Investment Tax Credits to specific Energy Star rated equipment is to undermine asset appreciation. It fosters a marginal analysis based on energy savings. Owners and managers will make suboptimal investment capital allocations whenever there is a viable renewable energy strategy available. Only a 30-year CAPM model, without consideration of subsidies and special financing, will reveal the optimal investment strategies. NYSERDA MPP (and many, if not most other NYSERDA programs) suffers from the same issue. The program tries to compensate for the problem of diminishing returns from energy savings, by focusing on an overall total percentage reduction of energy consumption for a property. The approach locks a building owner into a non-productive path of energy savings investments, which is financially and economically disastrous because of diminishing returns through time. PACE bonds. PACE, also, has missed the markdue to its focus on energy savings. PACE got its nose bloodied by

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Fannie Mae and Freddie Mac, and was curtailed as a result. Had PACE promoters properly understood the compound positive returns from investments in renewable energy versus the deleterious effects of the diminishing returns from investments in energy savings, Fannie and Freddie, and FHA could have embraced PACE bonds as the preserver of real estate valuations, and a welcome path to recovery from the tide of poor mortgage underwriting. As it is, PACE missed the opportunity. PACE might yet adjust its course to embrace the long-term asset-appreciation modeling approach suggested here, but the limitations it had to accept will permanently confine it to a more marginal role than originally intended. However, the program can still become a tremendous force for progress in reducing GHG-emissions, boosting real estate values, and long term building preservation in the process. If so, the program can become a tremendous force for progress in reducing GHG-emissions, boosting real estate values and longterm building preservation in the process.

NYC Clean Heat. This program is a case of good intentions gone awryand amounts to government sponsored capital destruction in many cases. Given the system GHG-emissions profile of Natural Gas, the push for gas conversions boils down to NYC exporting GHG-emissions, and that is even before considering any other environmental issues with fracking. Very likely 80% of buildings now converting to natural gas under this program would be viable candidates for far better renewable energy retrofits. Instead, the program prolongs the citys addiction to carbon-based energy. In fact systemic financial and economic risks increase with the greater reliance on the energy mono-culture and dependence on a single fuel,

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just at a time when multiple renewable technologies are becoming economically feasible for apartment buildings. The most charitable view of this program is that, as a society, we are in this case investing for a dubious relative value differential akin to the choice of whether the Titanic would sink in five minutes or ten. The programdriven once again by false proxy of energy savingsamounts to corporate welfare for natural gas companies. It succeeds at the expense of potential property appreciation. It also sacrifices building resiliency to short-term economic advantage, and undermines long term building preservation. Building owners might even have a legitimate case for having their asset appreciation usurped by this mandate. Of course, arguably, these owners would have been free to come up with a better alternative along the lines already suggested here. An available exemption from the program does exist. One would hope that any building owner who outperforms the plan objectives would qualify for such an exemption.

Low Income Housing/HPD/CPC rehab financing. This is a New York City issue, but no doubt the equivalent occurs elsewhere. The effective rules of certain CPC rehab financings prevent a developer from re-engineering the energy infrastructure of a building (and going renewable), as they specifically only allow replacements of existing equipment with a more efficient modern equivalent, thereby ensuring the continuation of carbon-fuel dependency, and the formation of the slums of tomorrow.

For all of the above reasons, the Green Bank can create a real breakthrough. By establishing underwriting practices that are based

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on sound economics and finance, as opposed to financially unsound energy savings, the Green Bank is bound to be a success. Not only that, it would create a sound secondary market for energy retrofit loan portfolios based on these principles. Why most Green Retrofit Finance is another form of Predatory Finance As long as the models we use focus on increments of marginal savings on energy costs, the models only appear to work well, that is they are attractive to financiers. These market participants are already rushing to offer Green Financing options. However, this financing trend seems to be merely the latest example of Wall Street preying on Main Street, and absconding with asset appreciation that belongs to the legitimate owners. While the short term cash flow of a building improves with energy savings, the long term appreciation of the property suffers if there is any viable renewable energy strategy for that same building. With the plethora of technologies that are available today, this would most often be the case. The upshot: through proper lending standards, the Green Bank can encourage a major economic breakthrough with benefits to the competitive position of New York State. The underwriting culture within real estate markets will be improved by the shift toward an actionable longer-term focus on building valuations.

The Alternative, based on the EPA ENERGY STAR Portfolio Manager

The alternative approach already exists and simply needs sanction. The EPA already provides its ENERGY STAR Portfolio Manager, a tool to model energy retrofits for their impact on GHG-emissions.

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That evaluation should go hand in hand with doing a 30 year capital budget for each property, showing the contribution of renewable projects to asset values. Particularly where the Green Bank functions as the lead, or makes their participation in any financing conditional upon this methodology, it can set the standards. In this role, the Green Bank will do more for progress to reduce GHG-emissions than anything else has done to date. Our problem is not primarily technology, which is now plentiful in this area, but financial and economic discipline. As long as the ITC targets specific technologies, and not properties, it will continue to create obstacles, because it will tend to distract the attention from good design by introducing a false secondary objective. Nevertheless, by doing a proper long term CAPM model for each building, it will become increasingly evident that decades without energy bills will outperform 20-30% energy savings in most cases, even if you might lose out on an ITC here or there. Often times, in the short run, choosing the wrong equipment in response to the ITC may satisfy those accountants who pursue bonuses based on money saved this year, whether or not the savings ultimately make economic sense. However, requiring the 30 year model will curb this abuse based on short-term thinking. Eventually, we may hope that the federal government may change the practice, and target incentives to buildings instead of individual technologies or equipment at the components level.

In summary, whats holding us back is not technology, but the internally conflicting incentives combined with bad practices in finance, and a lack of understanding of the economics of renewable

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energy. The Green Bank has the unique historical potential to make all the difference in the world and become the start of a sea change in forty years of energy policy failure.

Yours sincerely,

Rogier F. van Vlissingen N.B. This letter will be made available on Scribd, and an annotated version will be published on my blog at www.vliscony.com. c.c.: Richard L. Kauffman, Chairman, NYSERDA NYC Mayor Michael Bloomberg New York Times Jill Abramson, Executive Editor Bloomberg Business News Matthew Winkler, Editor In Chief The Wall Street Journal Gerard Baker, Managing Editor NYC HPD, RuthAnne Visnauskas, Commissioner NYC OLTPS, Sergej Mahnovski, Director NYC DEP, Carter Strickland, Commissioner USGBC, NY, Rohit T. Aggarwala, Special Advisor to the Chair, C40 Cities Climate Leadership Group US EPA, James Critchfield, Director, Clean Energy Technology Initiatives PACE Now, David Gabrielson, Executive Director Cisco de Vries, President of Renewable Funding, LLC. Mr. Richard LeFrak, CEO, The LeFrak Organization