Guest blog by Jim Jenal, founder and CEO of Run On Sun
Installing a solar power system is a major investment, and part of what determines your return on that investment is how the system is financed. In this three-part excerpt from our upcoming book, Commercial Solar: Step-by-Step, we explain the most common methods for financing a small to medium-sized commercial solar power system.
In recent years a great deal of creativity (some would say perhaps too much creativity) has been brought to bear on the subject of how to finance solar systems resulting in the introduction of myriad financing schemes from the terribly simple (straight cash purchase) to the terribly complex (e.g., flips and swaps)—and as the amount of money at stake grows, the more complex the schemes become.
Fortunately or unfortunately, in the realm of small to mid-sized commercial solar systems, the options are more limited and include cash purchases, loans, various types of leases, Power Purchase Agreements (PPAs) and a handful of more novel approaches. In Part 1, we will look at the pros and cons of cash purchases and loans. Part 2 will explore leases and PPA and Part 3 will conclude with a handful of novel approaches and overall limitations.
Cash or Self-Financed Purchases
The simplest financing method is the cash purchase—simple, that is, if you have the cash on hand and it isn’t needed elsewhere.
When a company self-finances through a cash purchase, they own the system outright and receive the rebate payment from the utility and all of the tax benefits. For those entities with the cash on hand, a cash purchase may be the best possible option since, unlike all of the other methods available, there is no added cost to the price of the system. Instead, a solar power system that is purchased outright should be looked at in terms of its opportunity cost. That is, what advantage/disadvantage does the solar investment provide compared to where the same capital could have otherwise been invested.
These days, with interest rates at historic lows, capital invested in traditional savings instruments—savings accounts or certificates of deposit (CDs)—provide safety, but returns in the 1 to 2 percent range—not terribly attractive. On the other hand, investments with higher returns—individual stocks or stock funds—come with substantial risk, as the crash of 2008 painfully reminded us.
As a result, a solar power system—with next to no risk and an IRR of 12 to 19 percent—compares quite favorably. Put most simply, a safer investment will provide a far, far worse rate of return whereas an investment with a higher yield will be far, far riskier.
When viewed through such a lens, a solar power system becomes a very attractive investment indeed. In fact, when analyzed in that fashion, investing in solar even makes sense as a way of employing endowment funds designated for the maintenance of non-profit organizations like private schools and churches.
Unfortunately, not every entity that would like to add solar is in a position to self-finance. For those who must seek other financing sources, a conventional loan is the obvious alternative—if it is available. While interest rates remain at historic lows, many banks are historically reluctant to make loans at all, let alone for “exotic” projects like solar power installations. Or if they are willing to consider it at all, they may impose onerous terms or prohibitively restrictive conditions that keep solar loans more of a theoretical option than a practical one.
Bankers are focused on collateral and cash flow considerations, with solar being strong on the latter but notoriously weak on the former. Normally a loan for an equipment acquisition could be collateralized by the equipment itself—if you don’t pay on your car loan, for example, the bank simply repossess the car. But repossessing a solar power system is a complicated project and, unlike a used car which has a known resale value, the resale value of used solar equipment is uncertain, at best.
On the other hand, solar power systems significantly enhance the cash flow situation of the loan customer since the combination of remnant electric bill and loan payment will be substantially less than the old electric bill, with that difference only improving over time.
In the end, it comes down to a question of the banker’s comfort level with solar. Does the reduced risk that the customer will default thanks to the improved cash-flow prospects outweigh the downside increased risk of poor or no collateral? Some banks are starting to emerge with a specialized practice in solar loans but for the moment, loans for small to mid-sized commercial solar projects remain painfully hard to come by.
The original article was posted on the Run on Sun blog.