Rethink Real Estate: Qualified Energy Conservation Bonds

The Parker Ranch installation in Hawaii. Photo by the U.S. Department of Energy.

Earlier this month, Smart Growth America released Federal Involvement in Real Estate, a survey of over 50 federal programs that influence real estate in some way. This post is the second in a series taking a closer look at some of the programs included in that survey. Today’s post is about Qualified Energy Conservation Bonds .

Qualified Energy Conservation Bonds (QECBs) give state and local governments a low-cost financing option to encourage energy conservation.

Funding from the program has been used to retrofit public buildings, to power buildings with renewable energy, and to improve public transit infrastructure. Authorized by Congress as part of the 2008 Energy Improvement and Extension Act, the original legislation allocated $800 million in federal funding to the effort and has since been increased to $3.2 billion as a result of the 2009 American Recovery and Reinvestment Act. As of July 2012, about $760 million in allocated funding had been spent. Because QECBs do not have to be spent within a certain time period, a great deal remains untapped.

QECBs were originally structured solely as a tax credit bond, in which the bond purchaser received a federal tax credit equal to 70 percent of the interest rate multiplied by the principle amount of the QECB. However, the Hiring Incentives to Restore Employment Act of 2010 (HIRE) allowed for a direct subsidy bond option due to a lack of investor interest in using the tax credit structure. Under the direct subsidy option, QECBs are among the lowest-cost public financing tools because the U.S. Department of Treasury subsidizes the issuer’s borrowing costs by offering a direct cash subsidy to the bond issuer.

The Treasury allocates QECBs to states based on population, and then states sub-allocate the bonds to municipalities with populations of 100,000 or more. The Treasury also sets the bond’s interest rate and maximum term. Though states choose which municipalities receive the bonds, they are required to formally accept the allocation through an agreed upon process or else the funding is returned to the state. Municipalities sell taxable QECBs to investors as a term-limited bullet bond. Because of the structure of the direct subsidy bond option, the municipality pays a taxable coupon to the investor and also repays the principle when the bond matures. The Treasury then pays the municipality the lesser of the taxable coupon rate or 70% of the tax credit rate as a rebate. Proceeds from the sale of the bonds are used to fund qualified projects and must be spent within three years of issuance.

Qualified projects must be used to either reduce energy consumption in publicly owned buildings by at least 20%; for rural development (including the production of renewable energy); for certain renewable energy facilities (such as wind, solar, and biomass); and to implement green community programs (including the use of grants, loans, or other repayment mechanisms to implement such programs). The Treasury also requires that at least 70% of a state’s allocation must be used for governmental purposes, but the other 30% can be used to improve privately owned buildings.

In 2012, the IRS issued additional guidance (Internal Revenue Code § 54D) to address questions surrounding the types of activities that can be financed with QECBs including what constitutes a “green community program.” The clarifying guidance is meant to allow municipalities and states to use a variety of energy-saving methods to lower fiscal cost and improve sustainability. For instance, transportation initiatives that conserve energy or support alternative infrastructure, such as improvements to bike paths or mass transit infrastructure, can use QECBs as a funding source.

By providing a needed financing mechanism for energy-efficiency projects, the QECB program can be a useful resource for municipalities that want to promote sustainability best practices by reducing energy consumption in public buildings or improved infrastructure.