Commercial property is generally distinguished into four components by the real estate industry:
The problem with placing solar on these properties is several-fold. First, there is credit. As mentioned above, small businesses don't have rated credit because they are not in the public markets for debt. The SolarCity securitization referenced above included only commercial and governmental customers with an investment-grade rating from a nationally recognized rating agency or it's equivalent.
Second, there is long-term occupancy expectations. Businesses generally lease their space, and do so over relatively short time frames. The national average lease term for offices and industrial properties is 4 to 5 years, far shorter than the timeframe necessary for solar equipment cost recovery. Of course, this is true for real estate in general. But real estate is its own security — the asset can be resold with minimal loss in value. Solar property, however, is generally considered “unsecured” because much of the value is in the installation process. The conventional wisdom is that the cost to remove the panels and inverters and re-use them on another property is too high and thus not an economic alternative if systems are not paid for.
Third, a large percentage of commercial property owners do not pay electricity costs associated with their properties. Commercial properties are contracted under what are called "triple-net leases" — whereby the tenants pay for taxes, insurance and interior maintenance — or other contractual structures that pass the cost of power to the tenant. In these cases, solar installations only directly benefit the tenant and provide no direct incentive for the property owner. But tenants are not likely to purchase systems where they do not own the property and are uncertain of their tenancy over time.
So, if solar-adopting end-users are not expected to remain in the properties, does it really matter if they have rated credit? Or alternatively, is there a better metric to evaluate whether a solar system on a commercial rooftop will produce cash flow as predicted? And last, if a solar system is expected to reduce power bills for the tenant, is it reasonable to assume it will do the same for the next tenant so long as the general usage doesn't change?
With those questions in mind, I researched national and regional vacancy rates for commercial properties. According to the National Association of Realtors, the following vacancy rates (shown in Table 1) are projected for 2014 and 2015 and a few top markets in each category:
Table 1: Projected Vacancy Rates by Commercial Property Type 2014 – 2015, with Vacancy Rates for Top Markets in Q1 2014
So here's the $64 million question: can commercial solar portfolios be designed for securitization whereby low vacancy rates and high economic value of the solar energy represents a material credit enhancement to the security? And if real estate can be developed without tenancy certainty over the life of the asset, can a solar facility with near zero operating costs be afforded the same benefit?All categories of commercial real estate are improving, and default rates in the best geographic regions are frequently in the low single digits. Interestingly, some of the areas listed in Table 1 are also some of the most active solar development regions as well.
This article was originally published on NREL Renewable Energy Finance and was republished with permission.
Lead image: Solar installation via Shutterstock