By the close of 2018, the world’s installed global capacity of renewable energy had reached 480.3 GW - around one-third of the world’s total installed electricity generation, according to IRENA. In the United States, the EIA reports that 2018 solar generation rose to 96 million megawatt-hours, up from 2 million megawatt-hours in 2008.Everywhere we look there is clear, positive renewable energy momentum to celebrate. The boom is breaking through beyond the industry too, with corporations and investors paying attention, and driving new opportunities.
Behind the encouraging data and headlines, we may be overlooking the role that project developers play in supporting this industry; the inefficient and costly financing options that are currently available to developers may inhibit these key players from propelling the market forward to its full potential. With changes to the solar investment tax credit (ITC) looming, there is an opportunity to address some of the long-term financing challenges that have dogged the industry for years. New debt financing vehicles, with terms that match the full operational life of solar projects, will support continued industry growth (even after-tax incentives have changed), giving developers of all sizes the opportunity to build a thriving business.
Growing interest in sustainability outside of core renewable energy industry
Sustainability is top of mind for many, even those outside of the traditional parameters of the renewable energy industry. Corporations and investors are seeking opportunities to integrate sustainable practices into their own business operations. You’ve likely heard the terms corporate social responsibility (CSR) and environmental, social governance (ESG) thrown around – the former is a set of parameters a company puts in place in order to ensure certain actions and decisions have a positive impact on the environment, consumers, employees and wider communities. Environmental, social governance (ESG) performance indicators ensure investments have a measurable sustainable or ethical impact, such as reducing carbon outputs. Both CSR and ESG prioritize the long-term impact of business decisions and practices under these umbrellas, and are becoming more common.
Even with the increased interest in responsible business decisions and investing, a recent study indicates that only half of U.S. investors feel they have the necessary information to make socially responsible investment decisions. This is where solar investment becomes particularly compelling. Since the carbon reduction and emissions offsets of solar installations are measurable and significant, solar investments present a quantifiable ESG investment opportunity.
Solar financing today
All of this positive momentum has translated into a borrower’s market for solar developers, but most of the loans available today have shorter terms that are not aligned with the operational life of projects. According to Wood Mackenzie Power and Renewables’ U.S. Solar Project Finance and M&A Landscape, mini-perm debt structures are currently the most common financing vehicle. The number of total lenders and new market entrants is rising, which is increasing competition. This has generally outweighed the negative effects of the ITC step down (a bit more on that later).
With mini-perm debt structures, the lender offers repayment terms of 4-7 years, after which the project sponsor must refinance. This structure is akin to financing your mortgage with a car loan, and results in negative project cash flows from day one. The result is a paradigm in which developers must flip their projects to investors in order to have working capital to develop their next project. In effect, this means that project developers are only as successful as their last project. New models of long-term financing - like the solar mortgage REIT - can help break this cycle, aligning debt repayment terms to the operational life of the project, and ensuring positive cash flow from commercial operation.
This is not a niche problem. 90 percent of solar projects in the U.S. are financed; we cannot overlook the impact that financing has on the success of projects and continued market growth. If we can align financing terms with the operational life of solar projects, smaller developers will be able to grow their businesses more sustainably, with the option to either sell projects to aggregators, or hold the cash flow of their most lucrative projects on their own balance sheets. It is a fundamental shift in how we think about the business of project development.
What is a solar mortgage REIT, and how will it help?
Real estate investment trusts (REITs) are widely deployed and proven in the real estate industry. With similar attributes for the solar market, solar mortgage REITs can lower the cost of capital for projects, increase the net operating income of an asset, and ensure positive cash flows over the lifetime of the PPA. Solar mortgage REITs offer fixed-rate and long-term mortgage loans to solar developers for new installations, or long-term refinancing for existing projects. Ultimately, solar mortgage REITs can provide developers with the option to maintain ownership of a project.
On paper, it may be true that the ITC step down hasn’t negatively impacted installed capacity growth, but the changes that come with shifting tax structures are important to recognize. One silver lining to the step down is that expensive tax equity will become a smaller piece of the project finance puzzle, making more room for more cost effective, long-term debt to fill the gap. Again, this ultimately enables developers to maintain ownership of more of their assets.
Project developers are the cornerstone of a successful solar industry, bridging the gap between technology and deployment. But even with the market success of solar as a reliable investment, developers continue to be hindered by suboptimal financing solutions. As we enter the ITC sunset, bringing proven investment vehicles for long-term financing will help to ensure solar’s growth is sustainable for many years to come.
Jim Spano is the Co-Founder and Head of Originations atRadiantREIT, and Managing Partner of Spano Partners Holdings, LLC.
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