The SolarKal Quarterly 4Q22
The momentous Inflation Reduction Act (IRA) – passed in August and covered by my colleague Cole Petrillo in this fantastic article – is the most significant climate bill in US history and is a huge win for everything clean energy.
Clean energy winners range from low-income communities (bonus 10% credit), solar and storage owners (Investment Tax Credit [ITC] expansion to 30%), nonprofits and governments (cash monetization of the ITC), and domestic manufacturing (Make it in America provision), but there is a lesser-known section flying under the radar that is a complete game-changer for a key segment of potential solar owners: Real Estate Investment Trusts (REITs).
REITs are real estate companies that operate under a special tax-advantaged structure where the company pays zero corporate tax if it satisfies a list of criteria; chief among those are the requirements that the REIT generates at least 75% of its Gross Income from real estate and that the REIT pays a minimum of 90% of its taxable income in the form of shareholder dividends, annually.
That taxable income disbursement requirement meant that REITs often have almost zero taxable income, which means the ITC – again, a tax credit! – was almost always missed value for a REIT.
REITs historically had resorted to either eschewing the credit entirely, creating expensive and convoluted corporate structures like a taxable REIT subsidiary (TRS), or splitting the credit with a third-party tax-equity partner if they wanted to own their solar systems. Often, REITs would instead avoid ownership in favor of a complicated third-party ownership deal in combination with a site lease or a power purchase agreement (PPA).
These complicated workarounds meant that project IRRs were lower and fewer projects were built, which is a huge problem given that REITs own over 530,000 properties and are one of, if not the largest, real estate ownership segments at over 20% of the entire institutional-grade real estate market.
There are a lot of complicated specifics, but for the sake of brevity, the IRA’s Section 6418 allows for the transferability of tax credits (ITC, PTC, or other credits) from the owner to another taxpayer in exchange for cash. Key to this is that the cash payment will not be included in the gross income of the original recipient.
In essence, the IRA allows – for the first time – the easy transfer (sale) of credits from the solar owner to another entity. This is a huge win – REITs can now expect to monetize the ITC by transferring the credit to any taxable entity, even unrelated ones! Moreover, any proceeds from the transfer do not count against the 75% Gross Income requirement REITs have to meet.
(For more detailed information, here’s a great memo from Sullivan and Cromwell and here’s another great REIT-focused perspective from Mayer Brown.)
Assuming the full utilization of the ITC, it’s clear that Section 6418 unlocks a higher level for REITs’ solar ownership economics.
For example, using data from recent bids on SolarKal’s Marketplace, the REIT-specific payback period on a sample 1MW system in NJ shrinks from 7 years to 5 and the overall project economics see a boost of 5% to IRR:
(Note that REITs are still unable to transfer the depreciation benefit, and thus, we model that at zero for simplicity – should a company be able to harness the depreciation benefit worth an additional $350K-$400K, they would see an IRR of 25% – 27% with a 4-year payback.)
These numbers are incredible – the IRA just opened the door for REITs to become prolific owners of solar, and the additional gain also provides more room for real estate owners to offer their tenants meaningful discounts to power, a strong tool that can help improve retention and rents. The 5% boost from transferability is such a game changer that it dwarfs the 1-2% gain due to the “headline” ITC expansion!
At SolarKal, we work with dozens of REITs and real estate owners across the country to identify the best opportunities for their assets, and we have been working to re-evaluate portfolios since the IRA’s passage. We’ve already seen a massive increase in the number of potential projects from our REIT partners, and it’s abundantly clear REITs are about to be a big installer of solar over the next few years.
For more information and to work with the country’s leading commercial solar marketplace, reach out to us at inquiries@solarkal.com.
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