Strategically Green: Solar's Sweet Spot

Spring 2010

The solar energy industry is currently in a "sweet spot," created primarily by the combination of low material costs and relatively high financial incentives. This creates a unique opportunity for developers to increase the scope of their projects while adding significant value. There are several reasons why now is a great time to go solar.

First, prior to the economic downtown, the solar industry was growing very quickly, which led existing solar manufacturers to significantly increase production capacity while many new manufacturers entered the solar arena. The economic meltdown slowed industry growth, leaving the world with a large oversupply relative to demand. This precipitated a rapid decrease in solar equipment pricing throughout 2009, leveling off in the fourth quarter. Now the industry is bouncing back, with equipment costs stabilizing at levels of about 20-30 percent lower than pre-recession prices.

Second, the economics of solar are partially driven by time-sensitive federal and state government incentives. There is a federal investment tax credit of 30 percent for installing solar until 2016. However, if the system is installed by October of 2010, the credit can be replaced by a cash grant from the Treasury Department. The federal government also provides a five-year accelerated depreciation schedule for solar assets.

In addition to federal incentives, there are state, utility and other local incentives which are also designed to decline over time. California, for example, utilizes a rebate program called the California Solar Initiative (CSI), which is a partnership between the state and the three largest publicly owned utilities. Currently this program pays a significant rebate based on the power a system produces over the first five years of operation, but the total amount of rebate dollars available is limited and is expected to be significantly depleted by allocation within the next 18 months. Other states have recently developed their own versions of a solar rebate program. Pennsylvania recently launched one and the system in Massachusetts has now been fully dispersed, evolving into a Solar Renewable Energy Credit (SRECs) program. The SRECs plan allows the owner of the solar system to sell SRECs for as high as $600 per credit, depending on market conditions, with a floor minimum of $300 per credit for up to two years.

A third reason why developers should strongly consider implementing solar energy now is that many utilities have recently introduced rate schedules that magnify the impact of solar. The application of demand and consumption charges is performed in such a way to make the impact of the utility cost savings much larger. All three of the large public utilities in California, for example, have introduced renewable schedules, and many utilities in other states are preparing to follow suit.

The Bottom-Line Benefits of Solar Energy

There are many ways a developer can structure a project to leverage solar benefits to their advantage. For example, if a merchant builder is developing a 100,000-square-foot light industrial building at an estimated cost of $12.5 million and they opt to add a 500 kW solar system at a gross cost of $4.50 per Watt, the total project capitalization is now $14.75 million—an 18 percent increase. After all subsides—including federal cash grant, accelerated depreciation, rebates based on state programs, annualized incentives discounted at seven percent and assuming a three percent annual increase in utility costs—are taken into account, the net cost of the solar system is just over $500,000. The system will offset approximately $100,000 per year in utility costs, resulting in an ROI of 20 percent annually and an IRR of 13 percent over seven years.

The savings generated by the solar system will also greatly reduce the overall cost of ownership of a building. The value of those savings can be easily quantified to justify a higher per-square-foot price as well as differentiating the asset in a very competitive commercial real estate market. This same logic can be applied to build-to-suits and fee development projects justifying higher developer fees along with a larger scope of work.

Developers also have the option of partnering with third-party system owners, either leasing rooftop space to solar project developers, joint venturing on solar projects and sharing returns, or even partnering with tenants who have an appetite for solar and structuring their lease provisions around the cost savings.

The next 18 months will be the best time to implement solar energy, and there are many ways developers can add value to projects, create competitive advantages to differentiate their assets and realize higher-than-average returns by integrating solar power into their portfolios.

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