The U.S. Nonprofit sector is filled with entities that occupy, and often, own commercial buildings, with ideal roof and parking space for solar power. With the U.S. Government phasing out cash grants, while extending tax credits for renewable energy projects, it is unlikely that many of these buildings will ever see a solar system on their roof, or in their parking lot. Given that the current Federal Investment Tax Credit (ITC) for renewable energy equates to 30% of the total eligible cost of a solar PV system, this is a substantial incentive that non-profits cannot take advantage of since they don’t pay federal income tax. The typical system suitable for the vast majority of these buildings ranges between 50 kW and 500 kW in size, with a small percentage needing systems larger than 1 MW.
To demonstrate the magnitude of this problem, here are some numbers that show just how many buildings in the United States are currently unable to take advantage of the Federal ITC:
# of Churches in the U.S. – roughly 350,000 (as of 2010 census data)
# of Municipal buildings in the U.S. – roughly 20,000 municipal governments in the U.S. – if we assume each municipality has 5 government buildings, that’s about 100,000 total buildings
# of Public Schools – roughly 100,000 (as of 2010 census data)
Taking into account just these three categories of energy consumers, we are talking about over 550,000 buildings in the U.S. that cannot take advantage of the 30% ITC incentive. So, what’s being done about this? Let’s explore some different options:
- Operating Leases – Operating leases are common financial instruments that are often used to acquire expensive equipment such as vehicles, computing equipment and machinery. Operating leases allow the lessee to benefit from lessor owned assets, over a number of years (typically 5-10) using fixed payments. Since this is such a well-known product, many nonprofits have looked to leases as a possible option for adopting solar. However, due to tax, code, lessors are unable to capture the ITC while offering operating leases to..
- Loans –Loans, like operating leases allow borrowers to acquire assets over a number of years (typically 3-20 depending on the type of asset). However, because the borrower/owner is a nonprofit, this vehicle does not allow for the nonprofit to take advantage of the ITC. In addition, loans taken out to purchase solar systems reduce the amount of borrowing capacity of the borrower.
- Power Purchase Agreements (PPAs) – PPAs are agreements that allow energy consumers to consume solar energy with no money out of pocket, and in most cases allow energy consumers to take advantage of lower electricity bills from day 1. In this case, a third party owner buys and installs the solar system and sells that building owner electricity at rates lower than their current utility rates. This allows the third party owner (which is a tax paying entity) to monetize the ITC, and offer discounted electricity rates to the building owner.
Of these three options, PPAs have become the most popular financing vehicle for nonprofit entities for the reasons stated above. However, most companies that offer PPA financing do not offer financing for projects smaller than 1 MW, and almost none that will go below 500 kW.
Sustainable Capital (SCF) believes that this is a vast and very under supported part of the overall solar PV market. We offer PPA financing for projects as small as 100 kW and happily support nonprofit organizations. If you are a solar installer or a solar developer, please fill out our partner registration form to learn more.
About Sustainable Capital Finance: Sustainable Capital Finance (SCF) is a third party financier & owner/operator of commercial & industrial (C&I) solar assets and is comprised of experts that specialize in structured finance and solar development. SCF has a vast network of EPCs and Developers across the US that submit project development opportunities through SCF’s cloud-based platform, the “SCF Suite”. This allows SCF to acquire and develop early to mid-stage C&I solar projects, while aggregating them into large portfolios.
When evaluating PPA opportunities for Solar PV projects, soft costs often don’t get enough consideration. For most financiers, there’s a general budget for each category of soft costs and that number doesn’t get reevaluated despite the nuances of a project. Soft costs include the following:
- Legal Fees – to review documents like PPAs, EPCs and Site Leases
- Accounting Fees – to review the eligibility of system costs per IRS guidelines
- Real Estate – depending on the type of project being built, a number of different fees can come into play to assure the financier that the off taker is the legal owner of the site and that the project being built does not intrude on any existing encumbrances.
- Independent Engineering – For every project, an independent engineer needs to evaluate the system being built to confirm that it meets local and national building codes, that the system is built to specification, and that the system will meet the production estimates that are built into the financial modeling
For larger projects (Utility Scale), soft costs are impactful, but relatively, to a lesser extent. For smaller projects in the Commercial and Industrial (C&I) market, soft costs can be very impactful, and can actually derail many projects financially. If a project incurs $100K in soft costs for a 5 MW project that can be built for $1.75/watt, (5 MW x $1.75 = $8.75M in total build costs), then as a percentage, soft costs equate to a little more than 1% of the overall project cost ($100K/$8.75M = 1.1%). For a 200 kW system with a $2.25/watt build cost (200 kW x $2.25 = $450K), and $50K of soft costs, 11% is added to the overall project cost; a substantial amount for a project that may be difficult to finance in the first place. If small projects have trouble creating economies of scale with regards to soft costs, it’s fair to ponder, how do residential projects ever get financed then? The simple answer is standardization. Companies like Vivint, Sunrun, and Solar City use the same contracts and don’t expose themselves to lengthy negotiations with several red-lines being lobbed back-and-forth. It’s pretty much a take it or leave it proposition. By utilizing common documentation, one of the main drivers of soft costs, namely legal support, is effectively negated.
So, how can we achieve similar soft cost reductions and economies of scale for the small C&I market? Another way of stating that would be, “How can we make small and medium sized C&I look more like the residential market?” This is the task that SCF has set for itself. Over several years and through the use of the SCF Suite (SCF’s online project pricing, and management software offered to all of its EPC and Developer partners), and standardization of processes and documentation, SCF has been able to significantly reduce costs related to legal, accounting, independent engineering and asset management . This has allowed SCF to reduce its minimum project size to 100 kW, with a focus of an even lower minimum over time. By taming the soft cost beast, SCF is able to provide financing to the sorely neglected small to medium size C&I market.
To learn more about how to partner with SCF please fill our brief partner survey.
About Sustainable Capital Finance:
A lot of press has been written lately related to California’s aggressive new policy to promote a 100% RPS by 2045. This issue has become much more relevant in light of President Trump’s recent decision to pull out of the Paris Climate agreement. Essentially, states are looking to supplant the Federal Government in the area of addressing Global Climate Change. As David Hochschild of the California Energy Commission recently stated, “ California has the sixth largest economy in the world and is home to 40 million people – we’re larger in many metrics than most countries in the world. I think particularly given recent events, leadership on the renewables has shifted to the states.” This is a very telling statement, because it says to the rest of the world, if the U.S. Federal Government will not step up, many of the largest states (by both geography and population) in the U.S. are not going to wait for them. States are going to continue to push policies that promote renewable energy and to increase the amount of energy coming from renewable sources.
That being said, as many have chimed in already, the reality of an energy grid being powered by 100% renewable energy is fraught with hurdles. Many of those hurdles are “supply side” issues related to the intermittent nature of renewable energy and the inability of today’s energy grid to balance the supply and demand of that energy production through the use of large utility-scale storage. Many have written on this topic extensively, but few are discussing the “demand side”. It’s one thing to build a grid that can support the use of 100% renewables. It’s quite another to fund the implementation and construction of those energy assets. To date, the vast majority of solar PV systems that have been installed in California have been either residential or utility scale systems. If we assume that the residential sector represents 15-20% of the overall market and the utility sector at 30-35%, we would only get to 45-55% of the total available market. The lion’s share of the usage of electricity comes from the Commercial and Industrial (C&I) sector. Why then, don’t we see the majority of solar PV installations coming from this sector? The simple answer is that this is the least funded sector from an investment perspective.
Solar PV is an expensive proposition and while many companies have a strong desire to adopt renewable energy, they also prefer to use their CAPEX budgets to build and support their own businesses, rather than funding long-term renewable assets. Solar City learned this lesson many years ago when it started in the residential market. Once they began offering low-cost, long-term financing to support solar PV, their sales soared. The C&I market is no different. Without a systematic, well-funded financing program for C&I assets, this market will languish. What makes matters worse is that by almost all accounts, this sector is (by far) the largest segment of the market, and has the least amount of penetration. So, one could ask the question, without a robust financing solution for the C&I market, how can California hope to reach their new 100% RPS target? The answer is, it is likely impossible.
Defining the C&I Space
To put some bounds around this problem, most would define the C&I sector as both for-profit and non-profit entities with solar PV system needs in the 50 kW to 5 MW space. However, the vast majority of systems needed in the C&I space are in the 50 kW to 500 kW range. Think of schools, churches, municipal buildings and local businesses. Just like the residential sector, without a financing mechanism, the total available market may drop from 50% of the total to less than 10%. The number of companies offering financing for solar PV systems below 500 kW is incredibly small, with most offering short and medium-term loans (which reduce the borrowing capacity of the off-taker), and some offering 7-10 year operating leases (which are economically challenging). What is truly needed to get this huge chunk of the market jump started is a third-party ownership model that offers Power Purchase Agreements (PPAs) and/or Solar Services Agreements (SSAs), targeted directly at the smaller end of the C&I segment. If this is such a large percentage of the market, and such an obvious target for financing companies, why aren’t there more solutions? The short answer is credit, and soft costs.
Determining the credit quality of an unrated off-taker is a labor intensive process. The way the residential sector was able to overcome this was by adopting the FICO score which has been used for decades by those providing personal credit and home loans. Everyone has one, so it was easy for residential giants like Tesla Solar and Vivint to adopt this. However, for the C&I sector, no such rating system exists. Some small percentage of entities in the C&I space do have public credit ratings (think Walmart, most municipalities, and some schools), but the vast majority do not. Determining a systematic and efficient methodology for assessing credit is the first major hurdle to solving the C&I financing puzzle.
The second major challenge for the small end of the C&I market is soft costs. These include legal fees for contract review, real estate expenses (like title searches and land surveys), accounting expenses, independent engineering costs, and many others. To get a financing institution comfortable with any project requires a lot of due diligence and documentation. Financiers want to make sure that all of the legal documents that are being implemented have been reviewed and verified by legal experts with a strong competence within the solar PV arena. They also want to know that systems are built with quality components (Tier 1 solar modules, for instance), and that systems are built to meet National Building Codes like the NEC. They also want to know that the owner of the property where the system will be installed has clear title to the property. All of these services can be expensive because they are labor intensive and need to be performed by high-paid professionals. Many companies spend between $30,000-100,000 (possibly much more) to process a PPA project, regardless of the size of the system. If you were to look at financing a 100 kW system that cost $2.50/watt to build, the total cost of that system would $250,000. If you needed to add another $40,000 in soft costs to that system, you are essentially adding $.40/watt or 16% to the build cost, and in most cases, are killing the deal. To truly solve the issue of soft costs requires a standardized approach to the C&I sector. Financiers that want to pursue this space need to push the same level of standardization as we are seeing in the residential market. Here is a short list of items that will need to be standardized before soft costs will begin to come down:
- Standardized Contracts – first and foremost, projects in the C&I sector need to start using a standardized set of documents including PPAs, EPC agreements, Site leases, and an assortment of other documents. The C&I sector needs to take a page out of the residential playbook by using repeatable documents rather than the “one-off” approach that most Developers and EPCs follow. Throwing legal dollars at a new set of contracts, or incorporating major overhauled revisions from a counter party, for every project is a recipe for disaster.
- Verification tools – another key aspect of financing solar PV projects is being able to verify key metrics like system production and avoided cost analysis. Choosing industry accepted tools like PVSyst to verify system production, for instance, and getting everyone to standardize on these tools is vital to creating efficiencies and lowering costs.
- Design – system design is becoming a hot topic in the online software market. There are a handful of new companies that are supporting online design services that not only provide the ability to quickly and accurately design systems remotely, some also provide production analysis, shading analysis and even avoided cost analysis. To the extent that these tools become accepted by the general industry, there will be a strong push to choose a standardized approach to the design aspect of the process to improve overall efficiency in design review.
There are many additional areas that can be improved by standardization, but these are some of the key areas that will need to be addressed. In essence, the goal of financiers that want to pursue the C&I sector should be to make small C&I look as much like the residential space as possible. Without a substantial and systematic financing solution for the C&I market, I believe that California will struggle to meet its 100% RPS goal.
SCF, with EPC services provided by Vista Solar, recently completed several new solar PV systems for the City of San Joaquin, in California. The project is comprised of three separate systems on three unique parcels located within the city. The installs include a ballasted roof mount, a ground mount and a carport, with an aggregate system size of approximately 200 kW. The project serves as another example of SCF’s commitment to support municipalities, and the C&I marketplace.
As solar has continued to mature into a viable asset class, new investors have entered the marketplace. This influx of capital has increased the number of viable financing/investment options available to developers, and has created new structures for capital deployment.
Investors are deploying capital earlier in the project life cycle, looking to provide liquidity to small and mid-size developers while justifying higher returns. Dependent on the long term goals of a developer, this capital can come in both, debt and equity structures.
Developers can now access debt capital through development/construction hybrid facilities. These structures allow developers to recapitalize and “draw” upon their margin or equity, during development and construction. This is a great benefit for small to mid-sized developers who need to fund working capital and may not have access to other means of financing. Most debt structures will commence draw schedules effectuated by a signed PPA or equivalent revenue contract.
With an increased risk profile, these structures will often have increased security requirements and costs. Investors will likely require a belt & suspenders approach to security, requiring a pledge of project assets, project co membership interests, a corporate guaranty and even a pledge of corporate assets. These facilities often use a multiple approach to cost of capital (as opposed to an interest rate) which can be seen anywhere from 1.5-2x.
For Developers looking to recapitalize their projects due to longer than estimated project life cycles, growing budgets, or increasing working capital needs, partnership “bridge” capital is available. Investors with development expertise can offer a “cashout” scenario whereby their investment gives them control of the project, while the developer continues to develop through COD. A takeout party will buy the project pursuant to the existing take out agreement, thereby paying the bridge investor. This can be a huge benefit for developers who need to cash out and redeploy capital on the next opportunity.
As with the debt structure, this bridge equity comes at a hefty price. Most structures will see multiple based returns sized at 1.5-2x+.
Both structures are being utilized by Private Equity firms looking for higher returns in the solar market, than those of long term ownership. In either structure, the relationship between the investor and developer needs to be one of trust and transparency, as the investor is taking on a great deal of development risk. If developers have access to this kind of capital, they can aggressively pursue a greater number of projects knowing their origination efforts can be met with liquidity early in the project life cycle.
For developers looking to sell their projects, but monetize their efforts prior to commercial operation, SCF can provide a milestone based payment schedule. This is not unusual in the solar market, however, SCF will also engage with developers during the early stages of development, in order to provide the developer a firm takeout and development assistance, ensuring a bankable project.
With the solar market’s exponential growth and ascension as a viable asset class, project and growth capital will continue to be available for developers, in a variety of structures.