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Published on April 4th, 2014 | by Rocky Mountain Institute

17

4 Solutions To Make Solar Financing Less Weird

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April 4th, 2014 by
 

Originally published on Rocky Mountain Institute.
By Dan Seif and James Mandel

When people say “Keep Austin weird” they really mean keep it small and special. And we’re all for keeping Austin weird as it’s a cool city with awesome music. While utility scale solar finance is still “weird” in that it involves tax equity, it also involves infrastructure funds, IPPs, utilities, and other mainstream sources of sponsor equity and project debt. On the other hand, distributed solar finance is decidedly weird, but keeping it small and special would be a bad economic and environmental outcome. It’s weird in that it is mostly limited to expensive sponsor equity and a few tax equity investors generating outsized yield versus risk. This weirdness impedes faster growth both due to insufficient capital and higher cost to the customer.

While it’s easy to get accustomed to how solar finance works once one is immersed in the space, the uninitiated are generally surprised at how weird the space is. Usually weird finance is reserved for small-dollar, high margin, high-risk propositions, often executed by a small, tight-knit community of investors. And yet solar finance yields long-term, stable cash flows that would be attractive at half their current yield. And what’s more, the use of solar power is growing at an explosive rate.

Tax equity investors are few, highly sophisticated, and demand a large cut of any deal they are involved in (approximately 9–11 percent returns in distributed solar and slightly lower in utility-scale). The structures that support these deals are complicated partnership structures, such as flips, sale-leasebacks, and inverted leases.

Current efforts to scale solar finance have often focused on comprehending and navigating through this weirdness. Indeed, efforts at helping investors overcome the complexities, particularly in hopes of expanding beyond the 25 or so tax equity investors, is a governmental and NGO focus. RMI has also worked with companies with large tax appetites to consider renewable tax equity investment. Oddly it’s difficult to convince companies to get S&P 500-outperform returns on treasury bill-like risks. Yet more efforts should also be focused on overcoming, rather than tunneling through, the weirdness.

Why? Because solar’s weird financing is insufficiently scalable. If distributed solar is to attain anywhere close to the penetration levels RMI outlined in Reinventing Fire, its financing must become much more boring and less weird. It should start to look like everyday financing.

Therefore, and in alignment with the NREL-RMI roadmap for soft costs and financing released last summer, we propose more basic debt solutions and a broader approach to financing. The following four recommendations would help break solar’s penchant for weirdness:

1. LOAN AGAINST SOLAR VALUE

Recently, loan products have been springing up from a variety of providers, cutting into the third party finance (lease/PPA) market share, albeit only a little. While we applaud the expansion of options to customers in how they can pay for their solar, we see a clear missing element in nearly all existing loan offerings—loan value predicated on solar installation value.

An intriguing exception, Sungage recently announced a loan program for Connecticut—in concert with the Clean Energy Finance and Investment Authority (CEFIA) and Mosaic—which lends to residential projects based on the net present value of savings from the solar installation. In this system the lender appraises a clear present value to the customer and predicates financing based on it, rather than solely on a customer’s credit rating, salary, or unrelated collateral. Put another way, Sungage’s customer payments are directly based on their energy savings, or willingness to pay, and not just on ability to pay. While there are a number of innovative aspects of this financing package, this simple, but rarely practiced, form of solar lending is crucial to solar’s future.

2. MIGRATE TO MAINSTREAM RESIDENTIAL REAL ESTATE LOANS

We’d like to see solar value-based loans incorporated into mortgages (first or refinance) and home equity loans. This is admittedly a bit tricky on two levels.

First, solar has been treated as personal property instead of real estate in third party financing. Real estate investment trusts (REITs) have been at the forefront of changing that paradigm, and have submitted private letter ruling (PLR) requests to the IRS to have solar on real estate count toward REIT-qualifying real estate assets and operating cash flows. Unfortunately, the IRS has made this a bit more challenging, deeming REIT investment in solar as only qualifying as real estate investing if the REIT has a lien on the total property. In addition, property tax rules can get complicated in states that haven’t made clear exemptions.

Second, solar is not yet included in the appraised value for most home mortgages. This is despite clear evidence that solar adds to the selling price of the home by even more than the purchase cost of the solar! Sandia National Labs and Energy Sense Finance have done great work on the PV Value™ software to enable jurisdictional assessors and bank appraisers to include solar value in the home real estate value. The PV Value™ software has been approved by the Appraisal Institute which is educating their members on how to use it. Unfortunately, right now most solar in residential real estate gets appraised at $0. Until there’s real “pull” from the major residential mortgage underwriters, Fannie Mae and Freddie Mac, inclusion of PV value in real estate finance products is unlikely.

3. MOVE TOWARDS CORPORATE FINANCINGS

Ultimately, solar finance is weird because of the underlying tax incentive structures. Two critical incentives improve the economics of solar markedly: the 30 percent Investment Tax Credit (ITC) and accelerated depreciation, which allows companies to deduct their investment six years under standard accounting. That’s why solar financiers own (via lease or PPA) your system. It offers the customer the lowest “optical” cost (perhaps not the lowest levelized cost of ownership (LCOE) versus cash purchasing or loans) in contracts, because financiers can monetize these tax benefits and offer you the net price.

Yet these tax benefits were put into legislation not to necessitate exotic tax partnership platforms, but to reduce the tax liabilities of solar developers. Tax credits are only useful to clean energy developers who are profitable enough to actually pay income taxes. That might change as SolarCity and others turn the corner and become regularly profitable entities. Nonetheless, no large telecoms, engineering companies, or other multi-product technical firms have financed and developed residential solar as a core business operation without a tax partnership (as opposed to just an outgrowth of their finance arm, such as GE Financial).

Without these large companies taking on the full equity financing on their balance sheets, “tax equity” partnerships, and all their incumbent weirdness, are still needed.

4. USE TENANCY ANALYSIS IN COMMERCIAL SOLAR FINANCING

Distributed solar finance, especially for commercial projects, is analyzed based almost solely on the person or company buying the power—the residential or commercial tenant sitting under the roof. The roof itself, on the other hand (along with the rest of the building), is financed based on the fundamentals of the building as a long-term, cash-producing asset—tenancy dynamics, stable rents, stable or increasing real estate prices—often regardless of who is the current or initial tenant. The commercial solar PV market, in particular, is stalling out as a result of this weird risk analysis. It grew sluggishly at 4 percent from 2012 to 2013, while the overall solar market grew by 41 percent. Perhaps it’s time to change the commercial “offtaker” (the lessee or the PPA-payer) credit analysis lens from the offtaker’s credit rating (e.g. bond ratings, Dun & Bradstreet ratings, or S&P commercial credit assessments) to the fundamentals of solar as a long-term, cash producing asset. The credit rating lens leaves about 90 percent of the commercial real estate out of the solar financing opportunity set, as most commercial properties are not owned by entities with viable ratings or any ratings at all.

NAVIGATING AROUND THE WEIRD

High profile governmental and consortia efforts, such as NREL’s Solar Access to Public Capital (SAPC) and truSolar, work to navigate around solar’s weirdness, trying to grow solar financing beyond high capital and transaction costs by increasing industry participation and producing credit analysis and contracting standards. It’s really good, important work, and it’s yielding progress. NREL SAPC’s November 2013 achievement of standard residential leases and commercial power purchase agreements could be huge.

However, these efforts focus on streamlining existing solar financing products, predicated on tax equity (versus credit) participation. They drive toward increased securitization on the sponsor equity side, which would allow the public to buy solar cash flows after the tax equity participants have taken their cut. The theory goes that if sponsor equity can consistently and profitably exit the investment, they will demand a lower return upfront, which will ultimately lead to lower prices for consumers. It’s sort of a trickle-down theory, which has proven effective in many other markets.

But will this “solar as an asset” class treatment lead to normalization of mainstream solar financing, or streamlining of the current odd financing paradigm? We hope for both, with eventually the former prevailing, but time will tell.

TIME TO OUTGROW THE WEIRD

Solar finance can’t stay in its current form and enable major scale. The solar industry has been breathlessly exciting, including its financing innovation, for some time now. But with the U.S. at only about 0.5 percent annual generation from solar most of the growth story hopefully is still in front of us. It’s time to have solar finance move out of the weird and enter the mainstream.

Image courtesy of Shutterstock.

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About the Author

Since 1982, Rocky Mountain Institute has advanced market-based solutions that transform global energy use to create a clean, prosperous and secure future. An independent, nonprofit think-and-do tank, RMI engages with businesses, communities and institutions to accelerate and scale replicable solutions that drive the cost-effective shift from fossil fuels to efficiency and renewables. Please visit http://www.rmi.org for more information.



  • Will E

    Solar Panels 4000 kWh cost 4000 Euros
    production rate here is about 1 to 1
    I understand in Australia 1 to 4
    4000 Solar makes 4000 kWh energy
    savings 1000 euro one year, 1 kWh is 25 cents.
    pay off in 20 year is 200 Euro a year.
    invest 200 a year to make 1000 Euro a year
    that is a profit range of 5 x 200 is 1000
    is 500 percent return on investment with Solar Power every year.
    for 4000 savings in the bank is 2% is 80 Euro a year.
    Solar 1000, bank 80, Solar beats bank
    is this correct?

  • christimathews

    Solar power helps to reduce your power bills and is the best method for generating electricity these days. Love all the methods explained.

    http://piedpiperchildrensshoes.com/

  • JamesWimberley

    If the utilities had any sense, they would get into this. They have a low cost of capital, understand the business, and are customers of the product. Solar roofs are part of the connected grid.

    When is the FHFA going to pull back from its absurd blockage of residential PACE financing, by making houses with PACE liens ineligible for Fannie Mae amd Freddie Mac? Obama made a serious mistake in keeping on Bush appointee Edward deMarco as Director of the agency, and only replaced him with Melvin Watt (an Afro-American Democrat) in January 2014. Maybe Watt will act.

    • Bob_Wallace

      If the utilities had good sense they would be setting up end-user roofs as their solar wholesale suppliers. They’d offer decent long term PPAs for end-user supplied power and go ahead and start writing off their outdated thermal plants.

      If they screw around much longer they will simply give away a significant portion of their market.

      • Omega Centauri

        If I were wearing a utility CFO hat, I’d be asking, where do I put the PV that maximizes my corps net present value. From the utilities standpoint, do residential or even commercial roofs compete against utility owned PV farms in terms of return on capital to the utility? These guys have a fiduciary duty to maximize shareholder value, not to perform social engineering. I would think that by analysing the value to the utility business you could predict how they would act.

        • Bob_Wallace

          Well, with end-users there’s no capital investment on the part of the utility. Just treat the end-user as one would a gas plant owned by someone else. Contract for a reasonable price and let the owner worry about maintenance, etc.

          The danger to the utility is that if they install a lot of their own solar and then end-users install a lot and pull down midday demand they may not earn as much as they anticipated on their investment.

          I’m really thinking that the smart thing to do is for utilities to break into grid owners/electricity dealers and electricity producers. Protect their grid business and let happen what will with the legacy thermal plants.

          • Omega Centauri

            Wasn’t your original proposal that utilities use their own capital to finance rooftop PV? In which case, they have to determine what sort of financial returns they will get on that investment. Now if they are making loans, the calculation (and the uncertainties) would be different from what they would be if someone else invested the capital and they were on the end of a PPA, or were to buy the power on the spot market (or simply weren’t collecting as much revenue from the customer). They also have to look into various forms of loses, such as foreclosure of the property, which might make the loan uncollectable -but they might then have a claim on ownership of the power (presumably now valued at wholesale rather than retail).

          • Bob_Wallace

            I was thinking about utilities helping end-users. Reaching out, helping them through the process. Just facilitating in general.

            Hitting their customers with info on potential savings/how to find an installer along with their bill would be a minimal way to assist.

            Possibly loaning money, but that’s not especially needed since there’s the FHA program.

            Loans would be riskier since they’d hold essentially a second mortgage.

  • Ray Boggs

    Market share for solar leases and PPAs has largely leveled off now that the availability of $0 down loans and PACE financing with tax deductible interest are rapidly penetrating the market.

    Unlike a lease or PPA, $0 down solar loans allow the consumer to own their solar system while retaining the 30% federal tax credit and any applicable cash rebate and are typically offered by dealers that offer considerably lower pricing than the pricing provided by the solar lease/PPA companies.

    Despite the fact that consumers have had to forfeit all of their incentives and pay a higher price to the leasing companies, solar leases/PPAs have maintained their popularity.

    From 2008 through 2013 the demand for solar leases and PPAs grew due to the fact that there were very few competing $0 down financing options available. In 2014 though this trend is experiencing a reversal as more consumers are becoming aware of the availability of much lower pricing (sub $2.20 per watt installed after the tax credit) coupled with the availability of $0 down solar loans with tax deductible interest.

    In my opinion which is backed by over 16 years of experience in the wholesale/retail portion of the PV industry, I feel confident that by the fourth quarter of 2014, solar/leases and PPAs will constitute only small fraction of the existing solar financing market.

  • spec9

    The most simple solar financing scheme: A home equity loan. Get several bids, take out a home equity loan for the lowest bidder amount, install system with loan, take the 30% tax-credit, then deduct the interest on the home equity loan.

    • Bob_Wallace

      Get one of the low cost FHA no money down loans.

      • Ronald Brakels

        Home loans tend to be around 5% in Australia at the moment. (Floating rate of course, none of this weird fixed loan business.) What are people looking at for a home loan in the US currently?

        • Ronald Brakels

          Oh wait, I’m so lazy. The internet says about 4.3%. That is bizarrely high given the Fed rate is around zero. But I guess that might be some sort of weird American locked in rate that doesn’t go up down like in Australia.

        • Bob_Wallace

          My credit unions says 2.875 for 10 years, 4.75% for 30 years. (Fixed rate of course, none of this weird “wonder what it will be next week” business.)

          Adjustable starting around 2.375% with a maximum cap of 6.375%.

          • Ronald Brakels

            So it looks as though home owners can finance their rooftop solar at about 3% or less as opposed to say 5% in Australia. All else equal that makes solar electricity significantly cheaper than in Australia. And as there is no reason why the US can’t install solar as cheaply or cheaper than Australia soon all else should be equal in the sunnier half of the US.

          • Bob_Wallace

            The US simply didn’t have the economic environment that Germany and Australia had with their higher retail electricity prices.

            We’re getting our installation rates down, slowly. Actually I expect major moves down over the next year as some big players get established. SolarCity has had people in Home Depot grabbing people and talking to them about solar.

          • Ronald Brakels

            Australian installation prices and a 3% cost of capital gives solar electricity at under 9 cents a kilowatt-hour for a lot of Americans and German installation costs drop it even lower. As costs drop it looks like there is going to be a considerable amount of rooftop solar installed in the US. Particularly since most US states don’t have huge coal industries fighting against it.

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