By April Zhong
Investors had traditionally shied away from solar due to the long investment period, high risks, and modest returns. However, as solar is gaining in popularity, investors are taking notice, and a variety of financing mechanisms have arisen to meet the boom in demand. Investors are usually most interested in utility-scale projects because of the economies of scale it provides, and until recently there were very few unique financing options for homeowners and small commercial businesses looking to go solar. Solar leasing helps to fill this gap, and also provides an attractive option for investors looking to minimize their risks and gain the unique benefits of owning a small solar system.
Large solar projects (1 MW and above) are typically financed through Power Purchase Agreements (PPAs). Under a PPA, a third party (often a group of investors or banks) owns the solar system and sells the power produced by it back to the client, who is either a commercial entity with large energy demands or a utility company. The client pays for power produced by the system at a pre-arranged rate for the length of the PPA term, usually 20 years or longer. This enables the client to pay no capital cost for the system and has allowed many projects to be built that would not have, otherwise, been possible. However, this also means that much of the project risk is placed on the third party owner and, in turn, the project investors. In contrast, a solar lease provides a much safer option for investors by leaving much of the system risk on the shoulders of the client, and in the meantime, allows investors to enjoy the same or even higher financial returns than those of larger systems do.
A solar lease is similar to a PPA in that the system is third party-owned. The business concept is the same as any equipment leasing or automobile leasing. The solar equipment is leased back to the client, who pays a monthly lease payment over the lease term, and has the option to purchase the system outright for a residual value at the end of the lease period. One immediate difference between leases and PPAs is that the monthly lease payment is a flat rate, while under a PPA, payments are production-based. If the system has particularly low production during a month, PPA payments will drop in turn, while lease payments will remain steady regardless of any weather conditions or system performance problems. Additionally, under most current PPAs, there are penalties for underperformance, under which if a system performs a certain percentage below expected, the owner of the system has to pay a penalty to the client. If the owner is not able to bring the performance up to the contractual level within a certain period of time, the client no longer needs to pay for electricity produced during the low performance time period. Because leases are not production-based, these kinds of risks do not apply to leased systems.
Under a PPA, the third party system owner is responsible for all system operation and maintenance. They are also held accountable for panel theft or damages, and it is the owner’s responsibility to purchase annual liability insurance against such. Under a solar lease, the client assumes these responsibilities and costs, protecting investors from such liabilities. System operation and maintenance is considered to be in the range of 5 to 8% of annual system revenue. Under a PPA, this cost lies with the investors, in a lease it is absorbed by the client. Investors in leased projects are similarly protected from risk because leased system clients must usually provide a form of collateral on the system, while no corollary exists for PPA projects. This makes leased projects very low-risk while still providing attractively high returns.
Leases also provide far more flexibility than PPAs. Lease terms can cover any range of time periods, from 7 years up to 30 years. At the end of the lease period, there is usually a mandatory buyout term where ownership passes over to the client. Under a PPA, there is rarely a similar clause, leading to the potential investor liability of needing to disassemble the system at the end of the PPA term. Leases also often have a higher escalator built into the payment structure than PPAs, leading to better ROI for the system owner. For example, most current lease clients accept an escalator rate of 3.5% or greater, whereas most PPA escalators have a fixed market rate of less than 1.5%. Large utility companies like PG&E rarely accept any PPAs with escalators.
Renewable Energy Credits (RECs) provide an additional financial advantage for investors in leased systems. In general, PPA clients are entitled to receive RECs produced by the solar system, however, the investors of a leased system usually reserve the right to receive RECs. Trading RECs can be a profitable side income for the investors. In New Jersey, the price of each REC can be as high as US$250 to US$300.
Commercial-scale solar systems can be developed under a much more rapid timeline than utility-scale systems. Under a typical 200 kW system, investors can start receiving rent payments within 30 to 45 days of providing funding. In contrast, the development process for a utility-scale project usually takes two full years to complete. Investors in a portfolio of leased commercial-scale projects will see a return on their investment much more quickly than investors in a utility-scale PPA project.
In addition to the benefits provided to investors, leases are an attractive financing structure for commercial system clients. Small commercial businesses usually do not qualify for a PPA program because the financial terms cannot satisfy potential investors. The leasing structure is a perfect fit for small business owners who cannot afford the upfront investment for a solar system.
SilRay, Inc. offers leasing options for small commercial systems as an alternative to self-financing. This leasing structure proved to be of huge benefit to a local organic farm looking to green their operation and strengthen their environmental branding. The farm was eager to add solar, but needed financial assistance. SilRay was able to design a lease structure that met the client’s needs and enabled the project to move forward. Within 35 days, SilRay was able to not only finalize the leasing agreement, but also complete the system design, product procurement, and final construction. This project led to high satisfaction levels from both the customer and system investors, and can provide a model for other commercial solar leasing projects.
April Zhong has spent nearly two decades perfecting her expertise in technology management, with more than seven years focused specifically on solar solutions. Prior to founding SilRay, Inc.(http://silray.com) in 2007, Zhong served as Senior Vice President at publicly traded Solar EnerTech (SOEN.OB), a developer and manufacturer of solar cells and modules. Zhong left Solar EnerTech to launch SilRay. She holds a Bachelor‘s of Science in Molecular Biotechnology from Beijing Agricultural University, a Master‘s of Science in Biotechnology from Northeastern University in Boston and a Master‘s of Business Administration from the Graduate School of Business Management, Boston University.
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