As the solar industry prepares strategies for dealing with the investment tax credit (ITC) step down, there is a silver-lining in that tax equity will become a smaller part of the capital stack, making more room for debt to fill that gap and enabling developers to own more of their assets.
By owning more of their assets, developer's business model will shift from that of a service provider to asset owner.
RadiantREIT is aiming to seize this opportunity by being the first-ever mortgage REIT offering loans to the solar energy market. The company uses a model that finances solar like real estate, offering long-term loans to project developers that match the operational life of the project and lower the cost of capital for developers. By lowering the cost of capital, project developers are able to increase project cash flow and maintain ownership of their asset portfolios, instead of having to sell their projects to aggregators to secure debt finance.
REM talked to Jeff Just, CEO of RadiantREIT in order to discuss this in greater detail.
Please tell me a bit more about Radiant REIT and what it does
RadiantREIT is the first solar mortgage REIT in the US. Mortgage REITs exist in the US specifically to finance structures like this, where you have long-term, stable, secure cash-flow at relatively low interest rates. You take that, bundle it into a portfolio, put some leverage on it and get a return that’s attractive to the equity markets. Then you can go to the public markets, raise a lot of capital and invest it into this solar development industry. That’s what mortgage REITs do. It has not been used before for solar or other renewable energy projects. We think it is an ideal structure to help bring capital to the markets. We are providing long-term, fixed-rate debt to solar projects under terms that are more flexible and favorable than what is currently out there.
A typical debt right now for solar projects, particularly for the smaller to mid-sized developers who we are targeting, is called mini-perm debt. It is five- to seven-year terms and seven- to 15-year amortization. It has high fees, onerous debt service coverage ratios, swap risk and refinance risk. It’s like equipment financing for infrastructure -- like buying a house with a car loan. It just doesn’t really work for the projects. It’s really been a problem for the market. What we’re doing is providing long-term debt for the full length of the project life, so, if you have a 20-year project, you have a 20-year amortizing loan. We’re providing it at no fees, debt service coverage ratios of 1.1 at P50, instead of the 1.25 and 1.3 the banks are doing. There are no fees, no swap risk and no finance risk, so these are really straightforward loans that take you through the entire length of the project.
We’re also providing construction debt and tax equity because the folks we’re targeting, that have portfolios between $10 to 200 million a year, don’t have the ability often to get tax equity or construction debt because they’re too small. Typically, these developers right now aren’t able to own their own projects; they’re forced to sell them because of the way solar financing is run in the States. They’re effectively sales people. They have a high-paying job but it’s a job -- they don’t have a business. We’re empowering them to have a business where they can own assets, build a portfolio and have something to retire on and leave to their kids at the end of the day.
The industry is preparing strategies for a step-down in the Investment Tax Credit (ITC). Can you give me a bit of background about this and why it’s important.
Currently, there are two sorts of tax advantages to investing in solar projects. One is the solar ITC, which is a 30 percent credit from investing in a project, so, if you invest a million dollars in solar projects, you can deduct $300,000 directly from the taxes you owe. That’s a pretty valuable credit. Then there’s accelerated depreciation. Currently, with the new law this year there’s a 100 percent bonus depreciation: you can depreciate the entire project in Year 1. More typically people use Modified Accelerated Cost Recovery System (MACRS), which effectively is depreciating an advanced rate over five years. Those provide some great tax incentives to invest in solar.
Now the issue is most developers don’t have the tax appetite to be able to monetise those credits. You can give them all the credits in the world, but they don’t have enough taxes to turn that into cash to invest in projects. What’s happened here is there is an industry that’s built up called tax equity investment, where a bank or some corporation like Google will invest in a solar project and, in exchange, get all those tax credits. Typically, right now, they might cover forty percent or so of the cost of the project and in exchange they get all the tax credits and all the depreciation. The typical structure is called a tax equity flip. The bank would come in, invest in the solar project entity, they will get, almost all, 99 percent of the tax credits and some of the cash for five years. Then after five or six years, it flips, and then the solar developer gets 95 percent of the income and the bank gets 5 percent. At that point typically they're bought out. That’s the way the industry has developed to monetise those credits in order to offset the costs of the project.
Right now, equity could be anywhere between 40 to 60 percent of the project depending on how it’s structured, so that’s a pretty substantial amount of equity going into these projects throughout the US. As the ITC steps down, from 30 percent down to 10 percent, that tax equity is going to be a smaller and smaller piece of the project. There’s not enough equity in the US to offset all that tax equity. It just doesn’t exist. What’s going to have to happen is debt is going to need to make up that difference. This isn’t necessarily a bad thing; debt is cheaper overall than tax equity, but the problem is that banks, because of the regulation and how they look at things, generally can’t make up that difference. They can’t grow the loan to value of their debt on the project enough to make up that difference. However, we can.
Being that we are a non-bank lender, we’re not faced with those restrictions, so we can step up the debt level as the tax equity declines. We can make up that difference and we can support the industry so that they don’t have to slow down the rate of growth. If we or someone like us doesn’t step up to do this, the industry is going to take a bit hit as the tax equity steps down. That’s why it’s urgent for us to get this up and going before that happens.
How do you see the sector developing over the next few years as a result of this?
Without taking into account the fact that we can help the industry continue to grow, they are expecting to be about $65 billion or so required in solar loans over the next five years in the US alone. That’s just the amount of debt, not the project size, they expect will be needed. The point of this mortgage REIT structure is that it allows us to tap into the public markets, institutions, the public pension funds, all these ESG (environmental, social and governance) funds globally for folks who want to write checks in the hundreds of millions of dollars and then break it down and get it to the people who really need it, which is the small to mid-sized developers throughout the US -- and actually throughout the world because there’s really no limitation to where we can lend.
In effect, we would have access to an unlimited amount of capital to get into the market at a time when it’s going to really need that capital. It can have a substantial effect on the growth of the solar systems in the US. This is also tied into how many states in the US have recently come out with requirements mandating up to 100 percent renewable energy in their states over the next few decades with step up requirements between now and then. That’s going to be encouraging a lot of solar development in their states also, so they need a way to support that. There is going to be more financing required to meet those goals and hopefully we’ll be there to pick up that need.
Have you got any plans to offer this elsewhere, outside the US at some point?
Yes. Right now, we’re just in the US for simplicity’s sake and keeping the story simple. We do expect to add to the team and get international folks working on this to be able to expand. Mexico is a big market right now for debt. Europe obviously is, so we think there is a lot of opportunity there for growth.
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