An Investment-Driven Solution to Green Development Problems: The S-REIT (Part 2 in a Series)

This post is Part 2 in a series and is excerpted from a recent thesis on the applicability of the REIT tax structure to large-scale solar development. Part 1 can be found here. Parts 3-5 can be found at the following links: Part 3, Part 4, Part 5.

 The Solar Development Framework of Today

Solar development is not a new idea. Many companies already exist that build solar projects, and there are financiers dedicated to funding solar and other renewable projects. Additionally, the government, both at the federal and state levels, has put measures into place in attempt to stimulate further solar development. These facts are evidence of the idea that there is both an economic appetite to invest in renewable energy technologies and a political appetite to change the energy mix that exists today. However, solar development has not advanced at a level commensurate with the potential production capacity of the US. This is due largely to two problems with the solar development framework that exists today. First, the potential pool of investors is limited due to the types of investment vehicles that are currently available. Second, the current solar incentive regime has not succeeded in stimulating large-scale PV developments. Both of these current difficulties are addressed below.

The Investment Framework

Investors interested in solar development currently have a few different avenues into the sector. A non-exhaustive list of the most common vehicles currently available includes limited liability corporations (LLCs), private-equity structures, master lease partnerships (MLPs) 1 and publicly traded solar development company stocks. 2 All have benefits as well as limitations.

The first two forms, the LLC and private equity investments, both, to some extent, stimulate solar development and provide investors with access to the solar market. However, both vehicles lack the inclusivity required to be considered tools for common investors. This is due to a number of factors, including minimum investment requirements, limited knowledge regarding these vehicles, and a dearth of options. Because of this, the common retail investor is not able to use these vehicles to gain access to solar projects. Investors in both forms face additional risks ranging from illiquidity to lack of transparency and valuation conflicts. Private equity investors can face the additional risk of long lock-up periods with reduced or limited access to cash as well as what are often high fees. 3 Because of these issues and the risks of investing in these vehicles, they cannot accomplish the goal of attracting new sources of capital to the sector.

Investors in the latter two forms, the MLP and publicly traded solar stocks, don’t necessarily confront the same risks as investors in LLCs and private equity vehicles. For example, these publicly traded options are more accessible and liquid and grant investors greater insight into operations due to the availability of SEC filings. However, both MLPs and stocks can be volatile. Though higher returns often accompany a greater appetite for risk, investor attitudes coming out of recent financial market crises have reduced the effectiveness of these vehicles as tools to broaden the investor base of solar development. Going forward, this trend toward lowered risk appetite could become ever more prominent as a large segment of the US population looks forward to asset protection rather than appreciation ahead of the retirement of the baby boomer generation. Both vehicles are also rather limited in their available options, and the MLP investment has the additional downside of not necessarily being allowed in retirement accounts.

For the right investors in the right situations, each of the above investments offers opportunities, and often very lucrative ones. However, the risks and barriers to entry of these vehicles reduces their ability to act as conduits for large-ascale investment into the solar sector.

The Incentive Structure

As noted above, the current vehicles for solar development are insufficient to meet the capital needs of the space. However, an argument could be made that even larger problems exist with the incentive structures currently in place to stimulate solar PV development. The imbalance between potential capacity and America’s energy demand on the one side and the lack of solar development on the other is the best evidence that the incentives currently in place are not sufficient to meet the needs of the industry. Though strong arguments can be made by either side in the energy subsidization debate, the fact is that it has long been the policy of the US federal government to provide subsidies to the energy industry as a tool to supplement research as well as production. 4 Because it is unlikely that the basic policy to provide incentives for energy production will change anytime in the foreseeable future, it makes sense to put into place the most efficient and effective incentives possible. Unfortunately, the history of PV incentives has proven that new ideas are needed.


Prior to the financial crisis, the PV incentive regime placed the emphasis on investment tax credits (ITCs), most notably the 30% Business Solar Investment Tax Credit 5 which was due to expire in 2016. 6 The ITC regime produced mixed results. 7 For one, the lack of certainty before the renewal of the credit in 2008 stifled new development as many potential projects were put on hold. Even after the extension of the credit to 2016, it was unclear that companies were being stimulated to develop new arrays. In other words, the credit didn’t sufficiently address the tax appetite of potential investors. 8 During the financial crisis, Congress amended the Federal tax code to allow eligible companies to receive cash grants but set a termination date for this authority which is approaching at the end of the year. This has seemingly led to even more uncertainty as many tax-motivated investors have since left the market. 9 In addition to the uncertainty that the current regime has caused there are other criticisms. Among these include the idea that incentivizing initial investments stimulates the wrong kind of behavior. For example, it may incentivize smaller-scale, and therefore more expensive, solar array projects. 10

Because of the failures of the structure outlined above, new strategies must be explored if the goals of a cleaner, more sustainable and more secure economy and environment are to be met. One such solution would be to take a well established and successful tax regime and allow solar developers to adopt it. For example, if solar developers were allowed to adopt, with minimal changes to existing laws, the REIT regime, it would both stimulate retail investment into the field and provide the proper incentives for developers to expand operations. 11



 
1. Kinder Morgan manages one of the best-known examples of the MLP structure in the energy world. However, this vehicle does not focus on renewables. For more information on Kinder Morgan Energy Partners see http://www.kne.com/.

2. Interview with Jigar Shah, CEO, The Carbon War Room, in Washington, DC (Mar. 23, 2010).
3. Notably, some in the private equity field are attempting to reduce some of the inherent risks of the typical private equity model, including Green Power Funding. However, the inclusion issue will always count as a downside for the typical retail investor in private equity instruments. For more information on alternative private equity models, see http://www.greenpowerfunding.com/index.html. Special thanks to John Cravenho for taking the time to discuss his model. Telephone Interview with John Cravenho, CEO, Green Power Funding (Mar. 19, 2010).
4. These are often supplemented with state and local incentives. See, The Database of State Incentives for Renewables and Efficiency, available at http://www.dsireusa.org/ for a listing of current state and federal incentives for solar development.

5. I.R.C. § 48.
6. The Solar Investment Tax Credit Frequently Asked Questions, available at http://www.seia.org/galleries/pdf/ITC_Frequently_Asked_Questions_10_9_08.pdf .
7. Interview with Joe Cordes, Associate Director, The GW Trachtenburg School of Public Policy and Public Administration (Apr. 14, 2010).
8. Cordes Interview.
9. See, Collapse of Tax-Motivated U.S. RE Investor Market, .ppt presentation slide provided by Hudson Clean Energy Partners, which estimated that tax-motivated investor based dwindled from 25 to 6 investors from 2007 to 2009.
10. Cordes Interview.
11. Going forward, all analysis of REITs and discussion of the S-REIT structure will deal exclusively with publicly-traded vehicles. Though the current REIT regime allows and facilitates private real estate investment trusts, these entities create some of the same problems noted above with the current vehicles currently available in the solar sector, notably transparency and liquidity.