By Jim Spano
Installed solar capacity in the United States exceeded 10 GW for the third year in a row in 2018, and the pace of growth is expected to continue. The first quarter of 2019 was the strongest in the history of the U.S. solar market, according to a recent report from Solar Energy Industries Association (SEIA) and Wood Mackenzie Power & Renewables. Yet inefficient and costly project financing inhibits many solar developers from tapping into the market’s true potential.
With changes to the investment tax credit (ITC) looming, there is an opportunity to address some of the long-term financing challenges that have confronted the industry for many years. New debt financing vehicles, with terms that match the full operational life of solar projects will support continued industry growth as utilities are increasingly establishing renewable energy targets or supporting similar state goals.
Solar financing today
The solar finance landscape remains a borrower’s market, but most of the loans that are available to developers today have shorter terms that are not in line with the operational life of projects. According to Wood Mackenzie, mini-perm debt structures are the most common financing vehicle today. The number of total lenders and new market entrants is rising, which is increasing competition and has generally outweighed the negative effects of the ITC step down (a bit more on that later).
Mini-perm debt structures mean the lender offers repayment terms of 4-7 years, after which the project sponsor must refinance. This process repeats multiple times over the course of a 20-30 year contract. In recognizing this mismatch, the industry has been discussing the benefits of shifting towards shorter PPAs, but this transition would still leave small to midsize project developers with the same structure of today, which is akin to financing your mortgage with a car loan. The result is a paradigm of negative project cash flows from day one in which developers must flip their projects to investors in order to have working capital to develop their next projects.
Wood Mackenzie U.S. Solar Market Insight Q2 2019
Impacts on industry growth
New models of long-term financing like the solar mortgage REIT can help break this cycle and align debt repayment terms to the operational life of the project. This is not a niche problem to address. 90 percent of solar projects in the U.S. are financed – meaning we cannot overlook the impact that financing has on whether or not projects succeed, market growth continues and utilities are able to meet increasing demands for renewable energy.
Solar PV was by far the largest renewable energy employer worldwide in 2018, meaning there are abundant opportunities for the industry to support job 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. It is a fundamental shift in how we think about the business of project development. If more developers are able to adopt this approach, they will be more prolific in the number of projects produced and feed utilities’ ever-growing need for solar.
What is a solar mortgage REIT?
Real estate investment trusts (REITs) are widely deployed and proven in the real estate industry, and 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 or job growth, but the changes that come with shifting tax structures are important to recognize. One silver lining to the step down is that tax equity will become a smaller part of the capital stack for solar projects, making more room for debt to fill in that gap – so long as that debt is cost effective and long-term. Again, this ultimately enables ongoing industry growth and meets the needs of utilities looking for more renewable energy resources.
Project developers are the cornerstone of a successful solar industry, bridging the gap between technology and deployments. 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 through changing incentives and for many years to come.
Jim Spano is the Co-Founder and Head of Originations at RadiantREIT, and Managing Partner of Spano Partners Holdings, LLC.