REITs & Securitization
Real Estate Investment Trusts are a financing method in which individual investors invest in a fund that buys property or makes loans for real estate assets or invests in other “good assets” applicable to real estate. As long as the REIT annually pay its investors at least 90% of the REITs profits, the REIT itself isn’t taxed. Instead, only the individual investors are taxed on their REIT dividends, thus avoiding double taxation.
Recently, the IRS made a so-called “private letter ruling” that—under certain conditions—allows solar equipment to be a “good asset” as part of a REIT.
To comply with IRS regulations, NREL has outlined three strategic options:
I - Utilize a taxable REIT subsidiary (TRS) to own PV projects
REITs can create a TRS that can develop, finance, and own rooftop solar PV systems. The TRS can then receive the benefits of the 30% Investment Tax Credit and also make income by selling the power generated to the building tenants. The TRS then returns this after-tax income to the main REIT fund.
II - Utilize a TRS to develop and construct PV projects
A REIT can utilize a TRS to develop and construct PV projects, but instead of owning the project after construction, the TRS can sell its ownership interest to an investor or utility. Electricity generated by the project is retained by the utility or is sold to an offtaker under the conditions of a long-term power purchase agreement (PPA). In this case, the TRS only acts as a construction contractor, and the parent REIT collects rent for leasing the rooftop space to the project owner, which is considered good income by the IRS
III - Lease space to solar developers and project owners
In this case, a REIT owns rooftop space or land but does not form a TRS to construct or develop the PV project. Instead, the REIT will lease the rooftop or land to a PV project developer, which will pay the REIT monthly rent. This rental income is considered good income by the IRS
The introduction of solar asset-backed securities, commonly referred to as “solar securitization,” has been “the next big thing” in energy finance for the past three to four years. Whether the first real solar securitization happens this year or in the near future, securitization is coming to solar finance.
As state and federal support for renewables shrinks, the industry must find ways to continue to reduce costs, and access to less expensive capital will be a vital piece of this process. Securitization will enable the solar industry to access a much larger and more diverse investor base, which will eventually help to reduce the long-term cost of capital to a likely range of 3% to 7%, compared with the 8% to 20% rate required by some project finance equity and tax equity investors in the current market.
In the most basic form of a solar securitization, the holder, or “originator,” of a portfolio of solar assets identifies and isolates contracted revenues from a series of solar projects. The originator then bundles the contracted revenues into a “reference portfolio,” and sells the revenue stream (but not the physical solar asset itself) to an issuer, typically a special purpose vehicle. The SPV then issues a tradable, interest-bearing security to investors in the capital markets. The revenues generated by the reference portfolio fund a trustee account that passes through payments, either fixed or floating, to the investors in the new security. These investors are senior to equity investments and for stable income producing assets like solar projects represent a relatively low risk investment.
Sources: NREL & Power Intelligence