Sol Systems’ CEO, Yuri Horwitz, and Dan Yonkin, Director of Regulatory Affairs, were published in the September 2012 issue of the Novogradac Journal of Tax Credits. In the article, New Markets: Tax Credit Equity and Solar Energy Development, Horwitz and Yonkin detail the tremendous investment opportunity that solar energy can provide for tax credit investors.
New Markets: Tax Credit Equity and Solar Energy Development
By Dan Yonkin and Yuri Horwitz, Sol Systems
Solar energy is a lucrative and untapped line of business for tax credit investors. Commercial sized solar projects, specifically offer investment opportunities for those active in other investment tax credit markets. In value, the solar tax credit makes up nearly 20 percent of the big four tax credit markets, and is set to grow during the next several years as the industry matures.
The relative lack of equity supply in the solar market coupled with industry growth provides a compelling investment opportunity.
Finding and securing viable and profitable investment opportunities requires significant time and capital, particularly for commercial solar projects because of the industry’s fragmented nature. High transaction costs and the absence of a stable development partner can undermine a promising opportunity. Identifying efficient and profitable networks (and partners) in the solar marketplace is critical to an investor’s success.
Supply and Demand of Tax Credit Equity for Solar
For the past three years, the solar industry has witnessed staggering year-on-year growth. In 2011, the industry grew by 104 percent, with 1.8 gigawatts (GW) of solar capacity installed. Or, to put in a more material term, in 2011 more than 7 million solar panels were placed in service. Estimates for 2012 indicate that nearly 10 million more solar panels will be installed and energized before year end. This growth has been a direct result of falling commodity prices for polysilicon, a glut in the supply of solar panels and relatively simple financing opportunities. The single largest limiting factor for the continued growth and development of commercial solar projects is a lack of access to tax credit equity.
The solar industry relies on an investment tax credit, namely Internal Revenue Code (IRC) Section 48, which offers a 30 percent energy investment tax credit for solar projects. The credit, combined with depreciation benefits, is available to the solar industry until December 31, 2016, when it declines to 10 percent.
However, Section 48 did not drive the past three years of growth in the solar industry. Instead, Section 1603 of the American Recovery and Reinvestment Act did, by offering a cash grant in lieu of the tax credit. The turmoil in the financial markets at the time and a general lack of tax appetite from many banks and corporations, made Section 1603 a more streamlined source of “tax equity” to ensure the solar industry did not falter.
Section 1603 expired December 31, 2011, however, and certain hang-over provisions for projects are quickly disappearing. The end of this era means that the solar industry needs to figure out how to transition to a world in which tax credit investment vehicles and sources are paramount. It is a huge opportunity for companies, banks and others that wish to participate in the solar tax equity market.
In 2008, the last calendar year in which tax credit equity played a central role in the market, the U.S. solar market installed 0.34 GW, or 1.36 million solar panels. Even though panel and installation costs were much higher in 2008 than they are in 2012 ($9/watt versus $3.50/watt), the solar industry in 2012 needs to raise roughly 275 percent more tax equity than it did in 2008. This needs to be done from a standing start, as gateways to tax equity investors have grown rusty during the past three years. The roughly 10 million solar panels installed this year could generate over $3 billion in tax credits. A central question facing the industry is who will step up to make the tax equity investment necessary to monetize the credits.
Solar Credits : How Do They Compare?
Solar tax credit transactions correspond in many respects with transactions in other investment tax credit markets. In size, the solar credit market ranks third, behind the low-income housing tax credit (LIHTC) market ($8 billion in 2011) and new markets tax credit (NMTC) market ($3.6 billion in 2011). In aggregate, the solar credit market comprises 19 percent of the four major tax credit markets, and its proportion will grow as the industry itself continues to expand and the NMTC market disappears. (At press time, Congress had not reauthorized the program for 2012.)
The financial structures utilized for solar equity investments are similar to models utilized by the LIHTC, historic tax credit and NMTC industries. But substantive differences, such as a five-year vesting period, depreciation schedule and exit payment rules, do exist.
The Fragmented Market
Solar projects are categorized into three classes: residential, commercial and utility scale. Utility scale projects are typically projects larger than $60 million. These projects have been prime targets for conventional tax equity investors, as they allow for a large equity deployment in a single transaction, typically through a flip structure. Residential projects secure tax equity through innovative third-party ownership structures. In these models, the tax equity investor enters the deals at a fund level, typically through the inverted lease structure. The facility is leased to the homeowner. Commercial projects are the projects in the middle and range in value from $250,000 to $25 million or more.
Commercial solar is the largest, and by far the most diverse market segment within the solar industry. It is the segment with the greatest promise (more solar can be built profitably on commercial rooftops than just about anywhere) but also the most complex, largely because its fragmented nature.
Commercial solar projects generally have some of the most compelling economics because they have fewer transaction costs than residential but generally the power that they generate qualifies for retail electricity rates. .Commercial projects, however, have generally not been large enough to attract a tax equity investor at the project level. And creating a portfolio of commercial projects, as is done in the residential solar market, has proven difficult due to the lack of document standardization and a variety of counterparties.
This gulf between the difficulties these projects have in securing financings and their potentially compelling return on investment presents a tremendous opportunity to conventional tax credit investors.
Creating Networks to Place Equity
The inability to access the commercial solar sector efficiently through networks of qualified developers and project opportunities is the biggest pain point for potential investors.
Hundreds of solar developers are actively shopping their commercial projects to the conventional solar investor community right now. These developers vary significantly in experience and quality. Some developers have minimal transaction histories, but have exclusive development rights to extremely profitable commercial projects, and a number of other developers only have marginal or sub-marginal projects.
For tax equity investors considering a solar investment, the solar market can seem frenetic. It is often difficult to discern whether a project is financeable or if the developers actually know what they are doing. New investors can find themselves spending inordinate amounts of resources on due diligence only to learn that an opportunity will provide a marginal return on investment.
Navigating through the commercial arena poses significant risks for tax credit investors, but is feasible. If an investor is able to identify qualified networks through financial intermediaries, the sector holds tremendous untapped value where a whole new book of business can be built.
Sol Systems is seeking 1 MW+ solar projects on behalf of our tax equity partners. Project developers with sponsor equity and have access to term and construction debt to utilize tax equity are preferred. If you have projects that seeking a tax credit investor, please contact email@example.com.
About Sol Systems
Sol Systems is a solar finance firm and a leader in financial innovation in the renewable energy industry. Since its inception in 2008, Sol Systems has partnered with 350 solar installers and developers to bring over 3,200 solar projects from conception to completion by offering innovative financing solutions for residential, commercial, and utility-scale projects.
Sol Systems’ financing programs catalyze investments for a broad set of solar projects by simplifying their origination, diligence, and financing processes. Developers seeking financing for solar projects can access over $2.5 billion in capital through the Sol Systems investor network.
In addition to providing financing, Sol Systems also offers project due diligence, deal structuring, and asset management services – all designed to reduce overhead and transaction costs and quicken project development timelines.
For more information, please visit www.solsystemscompany.com.