Eco policy lesson: Think things all the way through

While property-assessed clean energy programs make green home improvements more accessible, they also make obtaining home loans more challenging says an ASU accountancy expert.

To avoid catastrophic impacts from climate change, most developed countries are now trying to reach net-zero greenhouse gas emissions by 2050. McKinsey & Company estimates the global cost of attaining those goals will require an extra $3.5 trillion in green investments yearly. "The transition to a greener economy is going to be expensive," says Roger White, associate professor of accountancy. "If we don't make careful, thoughtful policy choices, that transition will be even more expensive."

This is a conclusion White made after researching the financial impact of property-assessed clean energy (PACE) programs designed to boost green home improvements like residential solar adoption. While PACE programs make financing for rooftop solar generation more accessible, White found that these programs also make home loans themselves more challenging to get. That then slows down home sales and home price appreciation, weakening the real estate market for homes with and without PACE loans attached to them.

On the sunny side

PACE programs have been around for commercial property owners for nearly two decades. Through them, local governments raise money by selling bonds but then contract with private, third-party companies to manage the loans. In residential markets, these companies sign homeowners for loans that finance rooftop solar, high-efficiency HVAC equipment, LED lighting, and other sustainable home improvements.

Residential PACE programs are only available in a few states, with California and Florida leading the pack. Early research showed that there was plenty of upside to these well-intentioned initiatives. For one thing, they did what they were designed to do.

"These programs make it easier for homeowners to finance green improvements," White says. "A handful of researchers have studied them and found that solar panel uptake doubles after implementation."

White adds that such programs also help local economies because contractors, electricians, and construction crews get more work, so more money flows through the local economy. The bump up is "on the order of a few basis points — less than a percentage — but enough to be measurable," he explains.

One advocate for such programs claimed PACE loans could raise the value of all houses in the area, not just those with PACE-financed improvements. White and his research colleague, Melanie Millar from Indiana University, found the opposite was true.

Lien on me

The problem with PACE loans is how they work. "They're funded by local government bonds and repaid through your property taxes," White says. "The local government secures these loans by placing a lien on your home, which means you can't sell it without paying off this debt."

He adds that mortgage lenders won't lend to properties with liens because tax debt takes priority over mortgage debt. If you're delinquent on your taxes, there may be a tax sale, and the tax debt gets paid before the mortgage company. If the mortgage is delinquent and the property goes into foreclosure, the local government still gets paid before the mortgage lender does.

Another problem with PACE loans is that they're administered by loan companies that target credit-constrained customers. "You see a lot of uptake on these loans in poor neighborhoods where financial literacy isn't super strong," White says. "Many of these loan customers have outstanding debts, their credit scores are low, or their incomes aren't high enough for conventional lenders to make the loan. Then one of these PACE financing companies comes by and says, 'Sure, we'll make the loan. The interest rate will be double what you would pay otherwise, and there's going to be a 10% loan origination fee.'"

The result? That high-efficiency air conditioner someone had to buy when their old one failed winds up costing more than it should and could result in a tax delinquency. Past research has found that distressed home sales and property tax delinquencies have been shown to lower the property values of nearby houses.

Worse, if a home with a PACE loan attracts a buyer, that loan may only be discovered once a title search is done after the homebuyer has already negotiated a price with the home seller and has a lender lined up. Since lenders avoid homes with liens, this can blow up the entire sale. If the seller pays off the tax lien and the sale goes through, the mortgage lender may have another problem. Some 70% of U.S. home loans get sold to government-sponsored enterprises like Fannie Mae and Freddie Mac. Still, the Federal Housing Finance Agency prohibits these organizations from buying properties with PACE liens. This vastly reduces the secondary market for an existing mortgage.

Bringing down the house

Not surprisingly, mortgage lenders proved less willing to lend money in areas where residential PACE programs are in effect. White and Millar examined real estate transactions in 27 of Florida's 67 counties, starting in 2012, well before PACE programs began going into effect and ending in 2019, three years after these programs began to increase. The research team used the remaining counties as a control group and compared results based on federal housing data.

The team found that the likelihood that a loan would be approved in an area after a PACE program went into effect dropped by about 0.7%, which is about the same impact as if a borrower's income fell by 10%.

The scholars then reasoned that fewer houses would sell if it were harder for people to get mortgages approved. Sure enough, they saw a 5% reduction in area home sales after the PACE program began.

"This adds to the evidence that these programs cause problems in real estate markets," White says. "PACE programs add paperwork, headaches, and hassles, making people less likely to want to do business in these areas. They slow everything down."

The programs also slowed down home price appreciation. "When these programs go into effect, they tend to drive down house price appreciation by about a third," White explains. Throughout our sample, average house price appreciation was 5% or 6%, but after a county introduced a PACE program, appreciation dropped by 1.5% to 2%."

Findings from this research prompt White to emphasize the importance of knowing the risks before putting PACE loan programs — or any policy change — into practice. "We need to shift our economy to be more sustainable, but there are good green policies and not-so-good policies," White says. "We shouldn't push sustainable initiatives without fully understanding the costs and benefits these initiatives will create."