Despite Promise, Clarified REITs Fail To Yield Additional Solar Financing Benefits


President Barack Obama made waves throughout the solar sector last week with a speech emphasizing the importance of solar power to realizing his climate change initiative.

One of the more eye-catching elements of Obama's solar program was his indication that the U.S. Treasury Department and Internal Revenue Service (IRS) would clarify how real estate investment trusts (REITs) relate to renewable energy installations.

According to the White House, this is important because REITs, ‘a key component of many retail investors' portfolios, generally hold only real property. The new guidance will provide clarity regarding the treatment of renewable energy installations in REITs, thereby helping to promote investment in the sector.’

The role of REITs as a source of funding for renewable energy development is constrained by the requirement that the bulk of its assets must be"real property."

Kelly Kogan, a senior attorney in the project finance and tax practice at Chadbourne & Parke, points out that the definition of that term came out in 1962 and up to now had never been updated. This has led to uncertainty in the industry over which assets meet that definition. In addition, a REIT cannot not use those any of its assets in the active conduct of a trade or business and must distribute at least 90% of its taxable income annually to its shareholders as dividends.

‘My prediction is that the regulation will identify those aspects of renewable energy property that clearly fit within the existing definition of real property (i.e., property that is 'inherently permanent'), such as wind towers, and make calls on those types of property that have raised questions, such as solar panels,’ Kogan said in the wake of the president's announcement." Hopefully, in the latter case, the IRS will come down on the side of treating such property as real property.’

The prediction came true. Alas, the hope part turned out to be in vain.

The REIT clarifications cover solar installations as ground-mount sites that serve the grid and as ground and roof mounts intended primarily to serve buildings on the site, even if grid connected.

Mounts affixed to the land in foundations are considered real property, as is the ‘exit wire’ for connecting the array to the grid. However, the PV modules, which can be removed and still function, are not. In the case of arrays that serve buildings on the site as a utility, these are considered real property if they are permanently attached to the building that they serve – or nearby land – and the owner of the land, building and the solar array are the same.

‘Significantly, these rules are extremely consistent with how the IRS has been interpreting the definition of 'real property' to date,’ Kogan says of the clarification. ‘This means that they don't really expand the category of solar assets that are good REIT assets beyond those that were eligible before this proposed regulation.’

In a sense, the president promised more than the IRS delivered. Kogan is quick to point out that the agency does not really have that much freedom of action in this area. The clarification confirms that the types of property REITs can hold are probably not going to be subjected to a radical revision.

She says the notion some people hold that all the IRS has to do is issue a ruling to open up REITs for renewables ‘with the stroke of that pen’ has never been correct.

‘One positive from the rules, however, is that they do create some certainty in terms of what the IRS would have issued in a ruling, which means that developers can begin to run numbers in proposed structures to see if they are viable without having to go through the time and expense expense of requesting a letter ruling,’ Kogan says.

Andrew Redinger, managing director and head of KeyBanc Capital Markets' utilities, power and renewables group, says any disappointment over REIT rules should not come as much of a shock given how venerable they are as financial instruments.

‘The reason you have yieldcos is because there are limitations in REITs,’ Redinger says. ‘Renewables developers still have access to capital.’

While noting that it would have been beneficial to be able to bundle the entirety of a solar asset into a REIT from a convenience standpoint, not being able to do so does not prevent developers from getting financing at comparable rates.Â

‘The fact is, we have found another structure,’ he says. ‘While yieldcos are still in their infancy, they still enable access to the same type of capital.’

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