By Casey McGrath
Some see renewable energy as the most recent fad, embraced by hippies and environmentalists, but the reality for many self-storage owners is solar just makes economic sense. Climate-controlled units that produce obscene electricity bills mixed with an abundance of roof space create an ideal environment to invest in solar energy. Throw in federal, state and utility-based incentives, and you can generate a pretty nice return on investment.
The hurdle for many, however, remains the upfront capital costs and the question, How am I going to pay for this? With costs in the hundreds of thousands of dollars, occasionally approaching millions, its difficult to imagine funding such a project with cash. Alas, not to worry storage owners, there are several ways to either forego capital expenditures completely or finance the installation using traditional debt and equity.
Power Purchase Agreements
The most common structure for storage owners is to set up a power purchase agreement (PPA), a contract by which the property owner agrees to purchase all the electricity produced by the system at a set price. Under this structure, a third-party PPA developer/installer funds the installation in full and is entirely responsible for the maintenance of the system. From an owners perspective, this situation is nearly ideal because no capital is being deployed to install the system, and theres no production risk if the solar panels do not produce electricity as advertised. In a PPA structure, all of these risks fall on the developer.
A typical PPA structure will price the solar-generated electricity below the retail rate charged by the local utility. This is a win-win for self-storage owners. Not only do they avoid any capital expenditures, theyre able to decrease their monthly utility expense, however subtle that may be. Of course, the rate offered by the developer is dependent on varying factors including local solar incentives and the level of competition among PPA developers.
Some states such as New Jersey offer generous incentive programs that allow PPA developers to aggressively compete for business. Furthermore, because PPAs must compete against local utility rates, states with expensive electricity ratesCalifornia, Hawaii and the northeast United Statesare prime territory for PPA developers. In other parts of the country where electricity is particularly cheap, such as in the South and Midwest, its more difficult for PPA developers to compete.
Generally, PPA contracts include an annual rate escalation of 1 percent to 2 percent. This is in line with historical retail electricity-rate inflation so, theoretically, PPA rates should parallel retail electricity increases. Its important to note that most local utility rate structures are very complex, sometimes with tiered rate structures or region-specific rates, and its necessary to have a good understanding of your current electricity rates before signing a PPA contract.
PPAs are long-term contracts, varying from 10 years to 25 years, with the norm being 20 years. There are several areas of negotiation to consider when signing the PPA including but not limited to annual rate escalators, early purchase options, and minimum kilowatt hour (kWh) production limits by the developer.
Some of the largest PPA vendors are SunEdison Solar Electricity (who created the PPA structure in 2003), MMA Renewable Ventures, SunPower Corp., Regenesis, Solar Power Partners, Tioga Energy and Recurrent Energy. Generally speaking, there are more active players in markets where solar typically works including Arizona, California, New Mexico, the Sun Belt states, Utah, and the Northeast (especially New Jersey). Finally, for owners contemplating a PPA structure, its critical to shop around, since per-kWh prices can vary dramatically among PPA contract providers.
Solar leases are similar to PPAs in that they fully eliminate any up-front capital costs. Under this structure, the property owner leases the solar installation from the lessor at a fixed monthly cost, and subsequently collects all the offset electricity benefits. The major difference under this structure is the owner is now liable for the electricity production of the solar system.
More important, if the system doesnt perform as well as was anticipated, or if it is particularly cloudy in a given month and the system doesnt generate the energy expected, the offset electricity costs may not be sufficient to make up for the monthly lease payment in that month. On the flip side, in months when production exceeds expectations, the benefits should more than offset the monthly lease expense.
There are two distinct types of operating leases prevalent in the market, both of which create different tax implications for the owner. A capital lease is structured such that the property owner (lessee) is effectively considered the owner of the system. Under this lease structure, the owner collects all the federal and state tax incentives, however, he must also list the solar array as an asset and the lease payments as a liability on his balance sheet.
The second and more common type of lease is an operating lease. Under this structure, the lessor owns the system, therefore, the property owner doesnt book the installation on his balance sheet, but rather treats the lease payments as an operating expense. Its critical to understand the tax consequences when deciding which lease is best for your facility. Its recommended you seek the counsel of a qualified CPA when contemplating between these two lease structures.
Traditional Balance Sheet Financing
For self-storage owners with adequate cash on hand, financing the installation with equity would certainly be an option. However, given most self-storage owners may not have that kind of equity ready to be deployed at a moments notice, its also possible to use traditional debt financing to fund the installation.
Yves Bienvenu of Global Infrastructure Asset Management LLC is an intermediary who specializes in arranging capital structures to finance large-scale renewable energy projects. He suggests that If your local bank is your current lender, they are likely the best option for solar financing as they are already familiar with the property. Having a single lender finance both your real estate and your solar project avoids any priority lien situations on your solar installation.
Financing a solar installation is similar to financing traditional real estate as lenders will want to perform a credit analysis to determine the financeability and structure the rate and terms accordingly. If the lender is comfortable with the project, leverage can reach as high as 80 percent of cost.
Unfortunately, however, many local lenders are not familiar with renewable-energy projects, neither from an investment nor technology perspective. Because of the general lack of knowledge about renewable projects, debt financing at the commercial scale is sometimes difficult to achieve, often making PPAs and solar leases a more attractive option.
Property Assessed Clean Energy
The newest financing vehicle for solar energy is the PACE (Property Assessed Clean Energy) program. PACE financing allows property owners to borrow money from their local government to fund the cost of renewable-energy projects. Under PACE, the amount borrowed is then repaid via a special assessment on property taxes. The major benefit of PACE is the assessment follows the real estate and not the owner, eliminating any complications upon a sale of the property.
As with other forms of solar financing, the first lien holdergenerally the lender if the property has an existing mortgagemust approve the additional debt to be incurred under the PACE project. Residential PACE programs face obstacles because Fannie Mae and Freddie Mac refuse to purchase mortgages from homes with PACE assessments, citing priority lien issues. Fortunately, however, this doesnt apply to non-residential properties.
The commercial PACE program is currently only available in a few communities in California (Palm Desert, San Francisco and Sonoma County) and select communities around the nation. To see if a program exists in area, visit www.dsireusa.org. While PACE is still in its infancy, its anticipated the success of these programs will be the catalyst for expansion into communities across the nation.
If all of this seems too complex, it may be worthwhile to engage an advisor who can create a project rate of return based on energy usage, local electricity rates, and state and local incentive programs among other factors. He can present an array of options from local PPA developers, solar lessors and potential bank financiers. As with any business decision, the focus is on profitability and return. For some self-storage operators, an investment in solar just might make good business sense.
Casey McGrath is an associate vice president with The BSC Group. The Chicago-based firm arranges debt and equity financing for commercial real estate investments nationwide with a focus on self-storage. Hes experienced in renewable-energy financial modeling, solar-policy research and electricity-rate analysis. To reach him, call 800.605.7880; visit www.thebscgroup.com.