Solar Farm Financing
Solar Project Finance Drivers
When it comes to solar project finance, cash is queen: most energy consumers, or “offtakers,” finance their solar installations. There are three factors driving the prevalence of solar project finance:
Savvy buyers employ a “matching strategy” to reduce solar project finance exposure and risk by tying the duration of the asset’s financing to its lifespan. A well installed solar facility should produce energy for 30+ years, so longer term financing makes sense.
Today’s debt is cheap. In our persistent low-interest rate economy, US investors are increasingly turning to solar investments to deliver a reliable, compelling returns. Faced with 20-year T-bill yields under 3%, many investors prefer the stability and return of a solar project finance investment.
Most importantly, the newly reinstated Investment Tax Credit and Bonus Depreciation can recoup almost half of a solar project’s cost via tax savings in the year following project completion. Thus “tax appetite”– the potential to fully benefit from tax savings – is a key driver of the solar project finance choice.
Here’s a simple rule of thumb: If the offtaker’s tax bill exceeds half the solar project cost, they may benefit by owning the system and paying via cash, a loan or a capital lease. But if the offtaker is a non-profit, a government entity or a commercial enterprise that pays no or few taxes, a third-party owned system financed by an operating lease or PPA may be a better fit.
Let’s look at your options…
Solar energy off-takers who pay half of their prospective solar facility’s costs in taxes can own the system and use solar project finance to eliminate taxes and capital expenditures. Most energy consumers use one of these five solar project finance approaches to pay for solar facilities:
If the off-taker has plenty of cash, won’t be relocating soon and likes to keep it simple, then an all-cash purchase can be a good option. A well designed solar facility in sunny climes will generate enough savings to break even in a few years, and if well operated and maintained it will generate green energy and savings for a generation.
If a cash purchase is not your best option, read on… but be advised that financing comes with limitations. Most lenders will require solid a credit rating, three years of profitable financials or a credit-worthy guarantor. Changing accounting rules have wiped out off-balance sheet accounting options for anything other than a PPA. And more sophisticated instruments like PPAs and CREBS won’t pencil well for smaller projects.
Today’s bank loans offer a simple, inexpensive financing option for up to 80% of the solar asset. Loans are often a fit for good-credit off-takers that pay substantial taxes but lack cash, retain capital for reinvestment or want to spread project payments. In some situations, a low cost longer-term loan may be a superior option for nonprofits or others who strand the tax benefits of solar. In any case, the off-taker’s existing bank should be its first stop as other lenders will need to subordinate liens to existing creditors. But many regional banks don’t know how to underwrite solar: if your bank is not solar-friendly, EA can help you find a more capable lender.
Property Assessed Clean Energy Financing (PACE) may be a good fit for off-takers with weak credit, for those facing a potential relocation, and for those who prefer a financing term more in line with the solar asset’s life. PACE programs place the solar payments on your tax bill over 15 to 20 years. Since payments are tied to property taxes, off-taker credit is not an issue, and in the event of business relocation the solar project and its financing stay with the property… along with the energy savings benefit. But PACE is not available in all jurisdictions, and PACE financing is often more expensive than alternatives. PACE loans are typically capped at the lower of 20% of assessed property value or 100% of aggregate Lien-To-Value… often that’s not enough to finance a non-residential solar project. And some PACE loans require your existing lien-holders to subordinate their lien and to attorn that subordination… a request they’ll likely resist.
Certain government entities are eligible for Clean Renewable Energy Bonds(CREBs) – taxable bonds with interest rate subsidies in the form of Federal tax credits paid to the issuer. CREBS offer the potential for a 0% to 1.5% interest rate over 15 – 20 years depending on off-taker credit. Eligible off-takers include cities, counties, school districts state and other local governmental entities as well as select cooperative electric companies. Economies of scale apply – it can be hard to CREB-fund projects under 1MW. CREB funding is limited and allocated nationally on a first come, first serve basis.
In each of the above solar project finance scenarios the energy consumer is also the system owner, and will bear all of the risks and responsibilities of ownership: the solar facility and any related financing will sit on the offtaker-owners’ balance sheet and that offtaker-owner must insure, operate, maintain and manage the solar facility. Prudent solar project finance clients will protect themselves by working with established solar installer that offer ongoing O&M and Asset Management services.
Also known as a Tax Lease or True Lease, these are flexible solar project finance vehicles that allow for the use of the solar asset, but do not convey its ownership rights. Operating leases typically have shorter terms (5-7 years) and can thus provide a fast path to system ownership while substantially reducing capital requirements. For Solar investments the lessors typically monetize the ITC and Depreciation to pay down interest rates. Either the lessee or the lessor may retain rights to solar incentives and environmental attributes. FASB’s lease rules are changing so consult with your tax accountant.
PPAs are the preferred solar project finance approach for larger government and nonprofit energy projects, but many private enterprises and homeowners use them as well. Most people don’t realize that they are already PPA participants: they have agreed to purchase power from the local electric utility. A solar PPA is no different – private investor(s) own the solar facility, and sell energy to the off-taker who then buys less energy from the existing electric utility. Third party solar investors use the benefits of ownership – tax breaks, incentives, environmental attributes and PPA revenue – to fund the construction and operation of the solar facility… which might conveniently be located on the energy off-taker’s property.
PPAs have relatively complicated financing structures and heavier operating costs, so are better suited to larger projects and higher energy rates. It is prudent to engage EA or another experienced PPA provider to perform a structured financing analysis early in PPA process to ensure the project economics can adequately reward all stakeholders including the offtaker, installer, developer and different classes of investors.
Solar Project Finance Summary & Conclusions
Tax incentives, inexpensive debt and prudent matching strategies drive a robust and diverse solar project finance marketplace. The principles outlined in this solar project finance guide can help prospective solar customers narrow their options and determine whether a PPA, lease, loan or cash purchase merits further investigation.
See our Blog for more solar project finance and development insights: EA has helped hundreds of solar offtakers, developers, installers and investors evaluate and structure solar project finance solutions. We welcome the opportunity to help your organization think through solar challenges and opportunities; contact us for a free consultation.
The Author is not a CPA, Financial Advisor, Municipal Advisor, or Tax Lawyer. This document is a summary only and does not purport to be cover all solar project finance alternatives.
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