The Solar REIT: A Vision for the Future of German Solar Development

Frequent visitors to the site may be familiar with our proposal to allow solar developers to take advantage of the real estate investment trust (REIT) tax structure to stimulate development in the US (an unabridged copy can be found here). It is our belief that providing the tax benefits of the REIT regime and the broader investor base that would come with it would help to conquer certain existing up-front hurdles and allow the solar sector to grow even in a world of rapidly changing political and economic realities.

For example, it is not always clear that government created rebates and incentive schemes will be available indefinitely, adding certain risk factors to the calculations of potential investors. Additionally, it has been noted that during economic downturns, and particularly in the US, investor appetite for funding solar development declines substantially. In light of such factors, our proposal was an attempt to facilitate market-based incentives for solar development simply by affording solar developers the opportunity to use the same tax structures as commercial real estate developers. Though it is unclear whether this is currently possible under US tax law, clarification from the Internal Revenue Service (IRS) would help overcome any doubt.

As part of that proposal, we suggested that developers in other countries might eventually take advantage of such schemes as well, and since the initial posting we even posted a small blurb about the potential for a solar real estate investment trust (S-REIT) regime in Italy (albeit with little to no analysis on how such a change would be facilitated). Today our attention shifts slightly north of the Italian peninsula to Germany, another very logical candidate for S-REIT adoption. Germany currently has a comparatively robust renewables sector, greatly aided by current government regulatory schemes, most notably feed-in tariffs. However, feed-in tariffs are not permanent, and may outlive their useful lives. In this light, and based on the desire of Germany to continue to increase its percentage of energy mix from renewables, developing a more permanent means for facilitating solar development might be an attractive solution.

Though this article will not address the exact changes to the German code that would be required to facilitate such a development, it is possible that, similar to the US, all that would be required is clarification from tax authorities. Indeed, as is noted below, the German and US REIT systems are quite similar, as many of the German REIT regulations are borrowed directly from the US model.

Of course the political realities of the two nations are vastly different, and it is always tricky business to make broad generalizations (particularly as your author admittedly has limited experience with the German system). However, it is at least possible that any changes adopted in the US would be considered favorably by German officials, particularly with the existence of a poweful green lobby in the latter nation. In any case, with an established and growing REIT structure combined with a clear appetite for solar development, the pieces are already firmly in place if the political will for such a change were to develop.

Future development may require further innovative thinking

First, a brief description of Germany’s REIT system. German REITs, or G-REITs have only recently come into being. The establishment of the structure was meant to facilitate more tax-effective property ownership. According to the Deutsche Börse Group (the group that runs the main stock exchange for Germany, the Frankfurt Stock Exchange, which is the equivalent to the New York Stock Exchange in America) 73% of German companies own property while only 25% of companies own property in the US. Also according to Deutsche Börse, the largest 65 listed companies in Germany have property reserves of over €80 billion. REITs may allow some of this locked-up value to be realized, a potential boon for German companies and their shareholders. Following are some basics on G-REITs:

• Companies pay no corporate income or trade tax. Earnings of G-REITs are paid to share holders and taxed individually. In other words, dividends paid are taxed as investment income for the shareholder.
• At least 75 percent of the capital of G-REITs must be invested in property.
• 90 percent of earnings must be paid out to share holders
• 75 percent of revenue must be from fixed assets.
• G-REITs must be listed in an organized market such as the General or Prime Standard.
• G-REITs must have their headquarters in Germany.
• Finally, G-REITs must have an initial capital of at least 15 million Euro.

Those familiar with the REIT structure in the US will undoubtedly recognize that many of the general rules governing G-REITs mirror their American counterparts. While German REITs were only introduced in 2007, foreign REITs have been listed in the country for some time, and over 150 currently trade on the Frankfurt Stock Exchange. There now currently appear to be three German property companies trading as REITs on the Frankfurt including an office REIT, a diversified REIT and a retail REIT.

It is clear that the trade of foreign REITs on the Frankfurt has created a familiarity with the structure in Germany. Meanwhile, the recent laws have facilitated the creation of Germany's own REIT structure. This familiarity as well as the proper legal framework indicate that the nation is fully comfortable with the idea of publicly listed firms owning income-producing property, opening the door for broader use of the REIT structure in the future. 

We now turn to the appetite for solar development in Germany. Incidentally, it is enormous, and it is claimed that Germany is one of the top nations, if not the top nation, for solar development. It is generally accepted that the reason for Germany’s rise as a solar power is a result of its government subsidization scheme, heavily reliant on feed-in tariffs, which has stimulated developers to provide an ever-increasing proportion of the state’s energy mix.

The most simple explanation of a feed-in tariff (FiT) is that it is a policy providing for grid access, long-term contracts and methodological pricing via government set compensation rates ( under contracts which usually last from 15-25 years). The goal of such policies is to stimulate development of solar and other renewables in the short-term, and push pricing of these sources toward levels comparable to fossil fuels (a concept referred to as grid parity) in the long-term. This long-term goal is facilitated by technological improvements made by the industry during the subsidy stage.

There are several features which make FiTs possible. First, the set prices are usually maintained by passing costs through to consumers, whether directly or through taxes. Though it often takes some political capital to establish this initially, these costs are not typically prohibitive for reasons including the natural decrease in the FiT over time (a concept referred to as tariff digression), technological improvements, and the caps that many jurisdictions place on how much energy can be priced at the set compensation rate. There are also typically government mandates for utilities to provide a certain percentage of their energy supply from renewable sources, similar to renewable portfolio standards. Finally, it is important to note that feed-in tariffs are typically phased out over time as technology is presumed to improve over the life of the scheme, and as grid parity hopefully comes closer to being a reality.

In Germany, FiT law underwent a restructuring in 2000 under the Act on Granting Priority to Renewable Energy Sources ('Erneuerbare Energien Gesetz').  Some have claimed that this revamped structure has created the world's most effective policy framework at accelerating the deployment of renewable energy technologies. The major features include:

• purchase prices which are methodologically based on the cost of generation from the various renewable energy sources, leading to different prices for different sources and sizes to account for economies of scale;
• purchase guarantees which last for a period of 20 years;
• the ability for utilities to participate, and;
• tariff degression

In Germany and elsewhere, such mechanisms have proven necessary in the past as a lack of grid parity has made it difficult for solar developers to achieve solid returns otherwise. Indeed, according to a European Commission report, ‘well-adapted feed-in tariff regimes are generally the most efficient and effective support schemes for promoting renewable electricity.’ According to at least one source, feed-in tariffs are used in one form or another in nearly 60 jurisdictions worldwide, indicating their popularity and possibly proving their worth.

FiTs have shown the tremendous appetite many nations, including Germany, have for solar development. However, despite long-term contracts, feed-in tariffs don’t last forever. In addition, political winds change direction often enough that developers, particularly in emerging fields like solar, should rightfully be weary of government-run schemes. Finally, economic developments can often impact the decisions of investors even if tax incentive schemes prove popular and effective. This has been seen in, for example, the US as tax equity investors lost appetite for solar development during the economic downturn. How then, can Germany, and other countries with a desire to continue growth in the renewable sector, ensure that development continues? As noted in the admittedly conclusory introduction above, such nations could use existing REIT laws to help stimulate solar development. Quoting our earlier post on such a proposal in the US:

One potential solution would be to use tax structures which already exist and benefit the commercial real estate market to stimulate large-scale solar development. Similar to the benefits that real estate investment trusts (REITs) have brought to both commercial real estate owners and investors, solar real estate investment trusts (S-REITs) could bring solar development to the masses, increase capital flows to the space and incentivize lawmakers give the solar industry the same treatment as fossil fuel counterparts.

The S-REIT structure should not be viewed as the exclusive domain of solar developers either. Indeed, Germany's wind sector is, perhaps, even more robust than its solar counterpart, and developers have managed to make wind more cost effective than in the US. Therefore, and particularly in nations with well-developed wind sectors such as Germany, it is possible that other renewable sources could benefit from gaining access to the REIT structure as well. This broader vision would lead to the potential formation of Renewable Energy REITs, providing diversification for investors  based on the various geographic, technological, pricing and reliability differences between the various production methods.

In the US, the creation of an S-REIT structure unencumbered by tax risk requires clarification on a particular section of the tax code dealing with REITs, §856 of the US Code. Once the IRS moves to clarify this section, and if it grants the proceeds of electric sales contracts the same status as rents under the REIT laws, solar developers will be entitled to benefit from the same tax status as commercial real estate developers. This will ensure start-up capital and a wide investor base of individuals seeking steady returns, allowing the solar sector to survive any storm, whether politically or economically generated.

It is possible that similar clarification would be required in Germany (further research is needed on this point, which may include discussion with the appropriate tax authorities). However, despite some hurdles, it is clear that the S-REIT could potentially provide a way for Germany and other states currently relying on feed-in tariffs to continue the ambitious global push toward maintaining a self-sustaining, secure, and environmentally friendly energy sector in the future.