Financing for Mid-Sized Renewable Energy Projects

19 january 2013

Between the residential and utility sized RE projects, there are more and more distributed generation projects in the $100,000 to $1 million range. Rather than paying cash, many customers would prefer monthly lease payments as this reduces the capital requirement and often increases the return on their investment. As an example, a $500,000 rooftop solar PV install for $500,000 would have monthly payments between $4,000 and $6,000 over a 7- to 10-year lease term.

Most RE projects carry a 30 percent Investment Tax Credit, plus other tax benefits for the owner of the system.  A customer that is paying taxes may decide to take advantage of these and use a Finance Lease, also known as a Capital Lease or Conditional Sale, for financing.  Customers with limited tax appetites, or those more concerned about keeping their monthly lease payments low, would be more interested in an Operating Lease, also known as a Tax Lease or True Lease.  The Lessor will then claim the tax benefits and pass back much of that value in the form of lower monthly lease payments, typically 25 to 40 percent less than what they would be under a Finance Lease with similar terms and conditions.

Sample Financing Alternatives

Using the solar PV system listed above as an example, let’s assume that it will produce 225,000 kWh of net energy worth about $45,000 per year ($3,750 per month) in avoided costs and/or incentives.  A loan from a bank at 6 percent over five years means payments of $9,843 per month. Although this preserves the tax credits for them to use, the negative $6,093 per month may not be attractive.  A Finance Lease over seven years at a 7 percent rate drops the payment to $7,502 and over a 10-year term down to $5,772.  The latter figures are more manageable but still represent some sizeable negative cash flows between energy value and lease payments.

Transferring the tax benefits to a Lessor under an Operating Lease should result in payments of $4,000 or so over a 10-year term, comparatively close to the value of the energy produced.  For customers with very strong credit, an Operating Lease can be done over 12 years, and the payment of $3,250 makes the project $500 per month cash positive immediately. In situations with a cash rebate, another technique is to use that rebate a security deposit.  Since the Lessor is getting ITC and depreciation on the entire system cost but only financing the amount net of this deposit, the monthly payment will go down even faster, making the project even more affordable. As an added bonus, this deposit can often be used at the end of the lease term to purchase the system.

Questions, Issues and Other Considerations

Credit Quality

Just as it is difficult to get a loan for a house without both the credit rating and the income to qualify, it is important to be sure that the credit quality of a customer is appropriate for the RE project under consideration.  Basic rules of thumb would be (1) at least 5 years in business, (2) tangible net worth at least three times the project size, (3) gross annual revenues at least 20 times the project size and (4) operationally profitable (or at least positive EBITDA).  While it might still be possible to secure financing for a business which doesn’t quite meet these basic hurdles, it will require some additional paperwork and may involve co-signors or other guarantees or credit enhancements.

Tax Status of the End User

If the customer is a municipality, school, charity, etc. then taking the 30 percent ITC is more difficult.  The Tax Code is confusing (imagine that) but the consensus of opinion is that the “user of the equipment” cannot be tax exempt.  The easiest solution to this is to find a “for profit” company into the equation, or to form one if possible to act as the initial Lessee.

Failing this, some funders believe that an Operating Lease can still work, but many are of the opinion that only a Power Purchase Agreement will suffice.  Unfortunately, there are comparatively few funders for PPA transactions less than $5 million. There are a couple of funding pools which may address this in 2013, but in the meantime, keep in mind that there can be difficulties in retaining the 30 percent ITC and the more rapid depreciation when the end user is tax exempt entity.

Transaction Size

Within reason, the larger the transaction the better, subject to the credit quality of course.  If the transaction is less than $150,000 or so, it can be difficult or impossible to find someone interested in an Operating Lease structure and therefore a Finance Lease may be the only practical option.  If possible, try to keep the total transaction size at or above $250,000 even if this means multiple locations for the same Lessee.

End of Lease Options

In a Finance Lease, there is a nominal end of lease purchase, typically ranging from $1 to 10 percent of the project cost.  Under an Operating Lease and to qualify as the owner for tax purposes, there has to be some element of residual risk for the Lessor, which usually equates to a “Fair Market Value” purchase option.   Since RE systems have a long useful life and can retain their value well, it is wise to have some defined purchase alternatives such as FMV to a capped maximum amount or some early purchase options.

Sales Tips as to Financing

Offer Return on Investment Analyses

Focus on the Return on Investment over the lifetime of the asset, rather than how fast it pays for itself initially.  In most cases, a lease option will show a much higher ROI, since the cash investment itself is much smaller so you may want to present the economics for all cash purchase as well as one or more lease scenarios.

Do Your Research as to Incentives

Make sure that whatever financing option your customer elects, that they lose incentives by doing so.  As usual, the DSIRE database is an excellent place to start.  In most cases a lease can be structured so that incentives can be taken by either the Lessor or the Lessee.

Try to Improve on any Existing Financing Options

Don’t assume that your prospect doesn’t need financing or that they know the best options to pursue.  In many cases, a Lessor that is comfortable with RE assets will offer better terms than the customer’s own bank.

Don’t Over Promise

Lifetime Return on Investment for RE projects can easily be 15 percent or more.  While everyone likes the idea of buying a system with the money that would otherwise have gone to the utility company, unless the credit is very strong and/or energy costs high, this is challenging.  Disappointed prospects that would have bought the system with modest negative cash flow but attractive ROI may back away when they thought that they “could get it for free.”