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A Sunny Day for REITs

REIT and renewables financing

Demand for solar energy has outpaced the private sector’s current ability to finance it.

This is a problem.

Renewable projects are still financed based on the expectation of higher-risk investments yielding potentially higher returns rather than lower-risk, income-oriented investments yielding steady returns. This makes conventional financing very expensive. One small tax reform the Obama Administration could make today, without the help of Congress, could reduce the cost of financing and accelerate the deployment of solar. All that’s required, as Third Way (among many others) have advocated, is making a relatively small clarification to the definition of “real property” to include solar as qualifying property for Real Estate Investment Trusts (REITs).

Created in 1960, REITs let the average individual investor buy shares of commercial real estate assets from offices to shopping malls to communications towers. More like buying a stock than buying a house, REITs provide shareholders with the net rents, but also allow shareholders to easily sell their shares they choose to do so. REITs are attractive to many investors because they are required to distribute virtually all of their net earnings to shareholders, and to the extent they do so, they are only subjected to a single level of tax.  

So why REITs and why now?

The price of solar panels dropped far more rapidly than industry analysts expected. This has fueled 76% growth in installed solar capacity in the US from 2011 to 2012 and a market that grew 34%, from $8.6 billion to $11.5 billion over the same time frame. According to BNEF, this growth is expected to continue through 2020, requiring an average of $6.9 billion each year  to finance the installation of new solar panels in the US.

The liquidity, transparency and tax treatment of a REIT could lower the cost of capital for solar. This would make it a much more attractive way to raise money to help finance large-scale installations. With financing as the bottleneck and the solar investment tax credit set to decrease by 2/3rds by 2017, solar REITs could make up for the growing capital deficit. This is also a rare idea that has bipartisan support. Twenty-nine Members of Congress have expressed their support for including clean energy assets in REITs. Richard Kauffman, chairman of energy and finance for New York State and former senior advisor to the U.S. Secretary of Energy described this change as opening the door to a “wall of money” seeking the kind of stable rate of return that solar REITs would provide.

A growing sector of the American economy needs more affordable capital. And there is an answer that doesn’t require an act of Congress. The Obama Administration has an opportunity today to make a small tweak to the tax rules that could help. Opening REITs to solar would enable the private sector to meet demand without the hurdle of Congressional gridlock or incurring new government spending.

Photo Credit: REITs and Energy Financing/shutterstock

Content Discussion

Elias Hinckley's picture
Elias Hinckley on November 6, 2013

No question access to cheap capital (and lots of it) is vital to support growth in the deployment of renewable energy assets. And REITs could be a good vehicle for doing this. There are, however, a couple of important hurdles that won’t easily or clearly be overcome.

1. Treating solar as real property for internal revenue code purposes means it is no longer property that qualifies for the Investment Tax Credit (which excludes real property) – it’s a nuanced issue, and while a solution is possible it isn’t easy (and it’s not 100% it can be done w/o a legislative change – nothing good happens when Congress gets involved).

2. The general push around REITs is to tighten the application of REIT rules as there is some view that the conversion to REITs by non-core real estate businesses is an expansion beyond the intent of the REIT rules (I don’t necessarily agree with this, but it is the current landscape). The upshot is that it’s more likely that REITs get narrower, rather than broader in scope.

Securitization and yieldcos (which have their own challenges), and I think at some point soon MLPs, are actually more likely to be the new capital vehicles that drive growth for solar and other renewables over the coming years – but agree it would be great to add REITs to the list as well.

 

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