A Powerful Duo: When Solar Leases Meet PACE Finance

SI Staff
Written by Jessica Lillian
on November 06, 2012 No Comments
Categories : E-Features

In September, California's first statewide commercial property assessed clean energy (PACE) finance program, CaliforniaFIRST, debuted in 14 counties and 126 cities.

CaliforniaFIRST drew immediate attention for not only its immense size, but also for its ability to take advantage of a compelling piece of new state-level legislation: A.B.44 allows PACE to be used with projects owned by third parties under leases or power purchase agreements (PPAs).

Given the popularity of third-party ownership for commercial PV installations, opening up this segment of the market to PACE offerings could create a statewide wave of newly financeable projects.

But can PACE and PPAs peacefully co-exist in a single solar project from a legal and financial standpoint? According to the industry experts who spoke at a recent webinar sponsored by Vote Solar, the two mechanisms can absolutely be compatible, but problems can crop up if solar installers, lenders and property owners are not careful.

‘Both of these finance tools are incredibly powerful and incredibly complex,’ said Michael Wallander, founder and president of Demeter Power Group.

PACE, which allows property owners to finance the installation of solar projects and other building-energy improvements through their property tax bills, is currently on hold in the residential solar sector due to regulatory obstacles. In July 2010, the Federal Housing Finance Agency (FHFA) stated that PACE loans pose a threat to mortgages held by government-sponsored enterprises Fannie Mae and Freddie Mac and the U.S.' 12 Federal Home Loan Banks.

As residential PACE's issues are sorted out, the tool remains available for commercial buildings, including multifamily units. Coupling PACE with a PPA or solar lease for commercial PV installations delivers sound benefits to both property owners and solar providers, the webinar panelists explained.

For instance, property owners gravitate toward third-party arrangements because they eliminate upfront costs and place risks – including technology risks and operations and maintenance risks – on the side of the solar provider. PACE, meanwhile, can streamline financing, allow building owners and tenants to more equitably split costs and benefits, and provide a favorable tax structure for the solar provider.

‘Because PACE is backed by property value, the credit analysis is much simpler,’ said independent consultant M.K. Lynch. ‘You're not trying to figure out the cashflow from individual businesses,’ she said, noting that for small-scale commercial PV projects in particular, excessive transactional costs can often sink a project.

‘Many small commercial customers have limited or no access to capital,’ she added. With PACE, these customers can find attractively priced long-term finance due to the seniority of the PACE lien.

For project integrators, the combination of third-party ownership offerings and PACE can be a boon for project sales, as the offering can be easily integrated into the sales, finance and marketing infrastructure.

Caution
As residential PACE's regulatory woes make clear, the tool is not without potential complications. Adding another mechanism with potentially murky legal issues to the mix can create additional problems – especially now, as municipalities and state legislatures are still trying to work out some details.

‘You need to structure the deal to allow both PACE and the third-party financing to work fully efficiently,’ warned William Spring, counsel at Bingham McCutchen.

One sticking point could be the legal status of the PV installation itself. PACE rules require that the array be considered ‘permanently fixed’ to the property. However, third-party finance programs have historically considered PV arrays to be ‘equipment’ placed onto real property. This classification allows for a more advantageous depreciation rate.

Over the course of a 20-year PPA or lease, conflicting obligations in case of trouble could also cause headaches.

‘If the lease holder has obligations under the lease, their obligation to pay that – assuming it's not prepaid – are not necessarily related to their obligations to the city,’ Spring explained. ‘If something were to happen to the city or something else, the owner could be stuck in a difficult situation.’

System integrators, property owners and financiers also need to consider what will happen during the course of the agreement certain other situations arise – e.g., if the roof under an array needs to be replaced, if the system doesn't perform as designed or if the property owner goes into default on its mortgage.

Some solar net-metering laws could also be problematic, Spring added. This would not cause the entire deal to collapse, but the benefits from excess energy generated could be limited under a PACE/third-party structure.

None of these issues is insurmountable, the panelists agreed. Moreover, parties involved with both PACE and third-party finance already tend to be well accustomed to finding solutions and workarounds when getting their projects done.

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