Sponsor equity is in abundance. There are a number of bankers, real estate professionals, and others interested in deploying capital into projects. This is tremendous for solar developers, but the overall supply of sponsor equity is large enough that it has started driving yields downward for many investors.
To remain competitive, investors are focused on lowering their cost of capital or investing in smaller or more complex solar projects that have not traditionally attracted investment. Even with a competitive, low cost of capital, investors will also need reliable access to tax equity (or their own internal tax appetite) in order to establish a competitive advantage to do solar deals.
To play seriously in the solar market, equity investors need a minimum of ~$3-10 million of annual tax liability. These investors are likely best suited to be take-out financiers (the single purchaser of a project) because of the relative simplicity and lower transaction costs vis-à-vis tax equity investing. Take-out solar investments are (generally) relatively straightforward because the investor provides the sponsor equity and makes use of their own tax appetite to monetize the Federal Investment Tax Credit.
Investors who have $10+ million in tax liability may choose to act as a take-out investor, or as a tax equity investor. While tax equity returns are generally more attractive, these transactions are complex. Tax equity investors use heavily structured vehicles that focus financial investments on securing tax credit and depreciation benefits alongside cash benefits. These deals require much more time and attention than deals that are financed with a single take-out financier.
There are also significant factors limiting the pool of solar tax equity investors. Individuals, LLCs, partnerships, and closely-held corporations are all limited by IRS passive activity rules as well as at-risk rules. There is also a significant hurdle in the complexity of the structures themselves. To the extent you are an investor considering tax equity investing, we urge you to reach out to us to explore these questions.
For all the attempts to reduce solar industry soft costs, there are still significant costs associated with finding good solar projects and undertaking tax structured investments. For example, each tax equity transaction typically requires a legal opinion from a tax attorney stating that it adheres with IRS provisions and tax laws. These opinions come from the most senior partners in law firms, and their time is not cheap. Legal fees from $200,000-400,000 per deal are common, and smaller projects simply cannot bear these costs.
In other words, economies of scale mean that multi-megawatt projects have a significant advantage in attracting tax equity compared to projects less than 2 MW. In most cases, smaller projects are typically poor candidates for attracting tax advantaged equity, but are better suited to take-out investors.
Bottom line: Solar is increasingly viewed as a strong asset class, and more investors are waiting at the sidelines with sponsor equity. However, unless an investor is able to provide tax advantaged equity, they will find a very competitive environment. Even take-out investors who have some tax appetite will need a competitive advantage in obtaining low cost capital if they want to be able to compete for good projects.
About Sol Systems
Sol Systems is a boutique financial services firm that offers investor clients direct access to the renewable energy asset class and provides developers with sophisticated project financing solutions. Founded in 2008, Sol Systems focuses on meeting the most critical needs of the industry, including SREC monetization, capital placement, tax equity, and New Market Tax Credits. To date, the company has facilitated financing for thousands of projects and hundreds of millions in investment on behalf of Fortune 100 companies, private equity, family offices and individuals. For more information, please visit www.solsystemscompany.com.