Tom Konrad CFA
The last day for a solar
developer to submit an application for the Treasury’s
1603 grant program was September 30th, and only for
grandfathered solar projects which broke ground before the end of
2011.
Solar panel prices have continued to drop this year, but solar
project development remains a capital-intensive business.
The 1603 program allowed solar developers to monetize the
solar investment tax credit (ITC) much more quickly than they
could otherwise, and this essentially reduced their cost of
capital. As the rush of projects begun before the end of
2011 are completed, developers are looking for new ways to finance
their next projects, especially since traditional forms of
financing have been harder to come by since the financial crisis.
Jan Schalkwijk, CFA, a portfolio manager with a focus on
sustainable investments at JPS Global Investments based
in San Diego, CA says, “Any solution that further improves
financing of solar projects should be of interest to investors;
especially if returns come in the form of dividends, from
financial structures that are collateralized.”
The Solar REIT
Currently, the only way a small investor can invest in solar is
by buying stock in solar manufacturers. I have long
argued that solar manufacturers are unattractive as an asset
class because of the fiercely competitive
nature of the solar industry. The massive decline of
solar stocks over the last several years has convinced most
investors of the danger of investing in solar manufacturers, even
when solar installations are skyrocketing. Since inception
in April of 2008, the Guggenheim Solar ETF (NYSE:TAN) has fallen
93%, while solar installations have risen
six-fold with rapidly falling costs.
While those rapidly falling costs destroy solar manufacturer
margins, they improve the opportunities for profitable solar
farms. Yet stock market investors find themselves shut out
of this opportunity. The two layers of taxation for public
companies make common stocks a less than ideal investment medium
for solar farms, unlike the private equity investments and LLCs
used by large investors.
What sort of structures might be attractive? Master
Limited Partnerships, or MLPs come immediately to mind,
since they combine the tax structure of a limited partnership with
the liquidity of public exchanges. MLPs allow the investor
to avoid the two layers of taxation by passing their tax
liabilities (and benefits) through to their limited partners
(shareholders), which leads to a level of tax complexity most
small investors are unaccustomed to.
In addition, MLPs are limited by law to specific businesses,
mostly fossil energy extraction and transport. While
extending MLPs to solar and other renewable energy has a certain
appeal on the basis of fairness, such an extension would require
an act of Congress.
Sen. Chris Coons introduced the
Master Limited Partnership Parity Act on June 7th
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Senator Chris Coons (D) of Delaware introduced The
Master Limited Partnership Parity Act to
allow MLPs to invest in renewable energy on June 7th, and
Representative Ted Poe (R) of Texas introduced identical
legislation in the House September 19th. Unfortunately, the
chances of these bills becoming law seems low. Govtrak.us
puts their chances at only 4%.
A second appealing structure is the Real Estate Investment Trust
(REIT). Like
MLPs, REITs avoid the double taxation of traditional corporate
structures, and are limited to investing in certain asset classes,
which in the case of REITs means real property. REITs pass
through their income, rather than their
tax liability to investors: REIT dividends are treated as
ordinary income to the investor.
As Jim Hansen, a financial consultant at Ravenna Capital
Management in Lake Forest Park, Washington and publisher of
the Master
Resource Report notes, “for retail investors the REIT
would be the simplest and could be used in IRA’s which MLP in many
cases cannot” because a certain portion of MLP income may be
taxable, even if the MLP is held in an IRA. Indeed, Congress
first enacted the REIT model in the 1960s to enable small
investors to “secure advantages
normally available only to those with large resources.”
Garvin Jabusch, Cofounder and CIO of Green Alpha Advisors in
Boulder, CO and manager of the Sierra
Club Green Alpha Portfolio also thinks REITs would be a
good structure for solar investments.
“Making PV [photovoltaic solar] a REIT eligible asset
class will give investors access to what is currently the best
value in solar, the annuity of electric power sales agreements.
Currently investors can mainly invest in panel
manufacturers (and to some degree BOS [balance of system]
providers such as converter manufacturers), which is not these
days the most profitable way to play solar. Buying a piece or
pieces of solar PV projects on the other hand is profitable
right now but is currently the province of private equity
investors. Utility scale solar on a project basis is very
attractive because, unlike a coal or other fossil-fuels based
plants, once the solar plant is running it produces electricity
which can then be sold essentially indefinitely without risk of
the price of its fuel increasing (or indeed ever
costing anything at all), with very low risk of plant failure
(and if it does fail, it’s likely only offline for a short time,
no risk of explosion), and relatively low overhead in terms
of maintenance.
Legal Considerations
“The IRS could declare that solar assets were REIT-safe
with a stroke of the pen.”
Joshua Sturtevant has done
extensive research on the legal requirements to allow
REITs to focus on solar investments.
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The other potential advantage of REITs as an solar investment
structure is that it would not require an act of Congress for PV
to become a REIT-qualified investment class. Joshua L.
Sturtevant, an Associate with solar aggregator, financier, and
developer Distributed
Sun of Washington, DC, has done extensive research on the
changes which would allow REITs which would generate all or most
of their income from solar generation.
He found that “the IRS could declare that solar assets were
REIT-safe with a stroke of the pen. Because of the broad
authority it has been granted to regulate REITs, it could bring
solar assets into the fold simply by issuing a ruling to that
effect. … [I]t wouldn’t require legislation or huge changes to the
tax code.” Getting a favorable IRS ruling might not be easy,
but it would almost certainly be easier than getting legislation
through Congress.
Sturtevant says that an IRS ruling might take the form of a
“private letter ruling” or through a “revenue ruling.”
The IRS grants a private letter ruling in response to a
taxpayer asking for clarification on an aspect of the tax code
applies to them. A private letter ruling does not have
broad applicability, in that it is only binding on the requesting
taxpayer and the IRS. However, private letter rulings “often
end up having some trickle-down influence on business decisions as
they are generally accessible to tax lawyers and accountants.”
A revenue ruling is ”often issued at the prompting of a
government official. To the extent that an issue might be a close
call, it is better for the request for clarification to come from
within the government as there is a better chance of obtaining a
favorable (from the perspective of the requestor) outcome.”
The Wheels of Government Turn Behind the Scenes
No one was able to tell me anything definite, but there are
rumors that a request for an IRS revenue ruling is imminent.
In June, the National Renewable Energy Laboratory (NREL)
issued a report, ”The Technical
Qualifications for Treating Photovoltaic Assets as Real Property
by Real Estate Investment Trusts (REITs).” The report
concluded that PV
meets many of the important criteria to be considered “real
property” and hence a proper asset class for investment by
REITs.
The fact that NREL issued this report suggests that someone in
the government is working to prepare the way for a favorable
revenue ruling. David Feldman, an NREL analyst and co-author
of the report, said ”We’re not trying to make the decision —
the Internal Revenue Service will do that. We’re giving them
the technical information they need to make the decisions.”
But somebody asked them to write the report.
Sturtevant says, “My pulse of the situation suggests that there
are parties who are moving to place a request to the IRS by
election time. If such a request were successful, it could be less
than two quarters before a company claiming REIT status is
developing solar.”
Jabusch has also heard rumors predicting everything “from year
end this year to Q2 2013.”
UPDATE: The Renewable Energy Trust
Capital, Inc., a San Francisco, CA based mission-driven
company founded in 2011 to “facilitate the transition to a clean
and sustainable economy” apparently already has ruling
request “on file with the IRS.” I’m seeking an
interview with RET to determine if this is a request for a
private-letter ruling (most likely since this is not a government
entity) and when the request was filed. 10/12: I’ve
published an article about
Renewable Energy Trust’s request based on my interview here.
Will the IRS Rule in Favor of Solar REITs?
If there has already been a request to the IRS for a
revenue ruling on PV as real property, the the odds are good that
the ruling will be favorable for those of us who would like to see
Solar REITs. According to Sturtevant, enough political
will would be sufficient to guarantee a favorable
ruling. The political will is likely to depend on the
outcome of the election on November 6th.
Giving solar a similarly advantageous investment structure
to the MLPs enjoyed by investors in fossil fuels should be a
“politically neutral concept,” as Sturtevant puts it.
Obama has long been in favor of leveling the
playing field between alternative energy and fossil
fuels, while allowing Solar REITs is seemingly in line with
Romney’s expressed belief that alternative
energy should sink or swim on its own merits: Investors
would evaluate each deal on its investment merits, as
both Hansen and Schalkwijk implied above. On the other
hand, Romney
has repeatedly called green jobs “fake” or “illusory” while
championing the fossil industries, and has plans to sharply cut
funding for clean energy: He may have already concluded that
PV has no “merits,” and hence might see little point in giving it
similar privileges to the extractive industries he
promises to promote in the name of
energy independence.
The First Solar REITs
Even if there is a favorable ruling, it may take a while for the
first REITs dedicated to solar to emerge. The first movers
are most likely to be traditional REITs that are already thinking
about renewable energy investments.
A few REITs have dabbled with solar already as a revenue
enhancement. IRS rules allow them to generate up to 25% of
their income from sources other than real property, and this
allows some scope for solar on REIT-owned buildings, for instance.
Some solar developers are even specifically targeting
the traditional REIT market. However, few REITs are
likely to use this option to obtain more than a few percent of
their income from solar because “ the IRS tends to be very
wary of anything that doesn’t smell right in the context of REITs”
and “ leads to wariness and conservatism by many REIT
managers,” according to Sturtevant. REIT managers
generally feel that a little extra revenue is not worth risking
greater IRS scrutiny.
ProLogis Global Headquarters,
Denver, Colorado (Photo credit: Wikipedia)
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The conservatism of REIT managers has most likely already proven
a barrier to some potential solar installations on REIT property,
and a positive revenue ruling would have the added advantage of
giving a green light for existing REITs to install solar
on their property.
ProLogis, Inc. (NYSE:PLD)
is one of the few REITs not waiting for a ruling.
ProLogis had installed 75
MW of solar on its buildings by the end of 2011, and claims to
be “just getting started.” According to my
calculations (using aggressive assumptions of a 20% capacity
factor and $0.10 per kWh electricity price), even 75 MW of PV
would generate only $13 million in annual revenue, or 0.85% of
ProLogis’s 2011 total revenue.
![pwlogo5[1].jpg](http://www.altenergystocks.com/archives/pwlogo5%5B1%5D.jpg)
Another REIT which might
be expected to take advantage of a positive revenue ruling in a
big way is Power REIT (NYSE:PW). Power REIT invests in the
embedded real estate of transportation infrastructure and
renewable energy installations. PW currently owns only
railroad real estate, but its CEO, David Lesser plans
to acquire real estate underlying renewable energy
generation (most likely a wind or solar farm) in the near future.
Talking ‘Bout a Revolution
ProLogis and Power REIT will undoubtedly continue investing in
renewable energy in any case. Lesser says, “We believe that
that there is an attractive investment role for Power REIT to play
in the renewable energy space with or without a clarification of
PV being included as a real estate asset for REIT purposes.”
But for both investors and solar developers, the IRS could
completely revolutionize the solar investment landscape by
classifying PV as real property. That revolution could be
upon us before year-end.
Disclosure: Long PW
This article was first
published on the author's Forbes.com blog, Green Stocks on
October 9th.
DISCLAIMER: Past performance is
not a guarantee or a reliable indicator of future results.
This article contains the current opinions of the author and
such opinions are subject to change without notice. This
article has been distributed for informational purposes only.
Forecasts, estimates, and certain information contained herein
should not be considered as investment advice or a
recommendation of any particular security, strategy or
investment product. Information contained herein has been
obtained from sources believed to be reliable, but not
guaranteed.
On April 18th,
U.S. long-term mutual funds experienced $105.8
billion net inflows over the quarter. Despite appetite for risk
has made a come back, investors in aggregate continued to move out
of equities and into bond funds, with $10.0 billion coming out of
equity funds and $93.7 billion of net inflows to bond funds over
the period.
Developments in the low-carbon corporate
bond market
Each company had one senior unsecured bond, with
the rest of their debt financed through banks in the form of term
loans and revolving credit facilities.
In the author’s opinion the bond documentation
carries weak covenants, more in line with investment grade bonds,
rather than the high yield bonds. Further, the companies do not
provide information regarding financial covenants provided to the
bank lenders (and not the bond investors), which cedes control to
the banks and creates uncertainty for bond investors (and even
more so for equity investors).
While wind turbine manufacturer bonds have
outperformed their equity counterparts, they have underperformed
the broader bond markets. Charts 3 & 4 illustrate how the
Nordex and Vestas bonds have risen in yield and credit spread
versus the Merrill Lynch Eur High Yield B-BB Bond Index (an index
of higher risk European corporate bonds) and the Merrill Lynch EMU
Non-Financial BBB Bond Index (an index of lower risk European
corporate bonds).
Neither bond has an official public credit rating.
However, 4 gives us an indication of how the market
perceives the credit worthiness of the bonds. The higher the
credit spread, the higher the credit risk is perceived.
