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Financing Details Matter

In an earlier blog, various scenarios that might require a solar equipment appraisal were identified. In all of the scenarios, some type of third-party ownership and/or financing of the solar equipment is involved, which calls for the solar equipment to be appraised by an accredited equipment appraiser, separately from the underlying real property (e.g., home, commercial building, plot of land, etc.). This equipment appraiser must not only be competent to understand the continually evolving equipment technology, but also the particular details of the many third-party financing options associated with the solar equipment. In some cases, the financing terms and conditions for a solar installation can significantly impact its value. Examples of common third-party financing models and contract options, and their potential impact on solar equipment value, are discussed below.

POWER PURCHASE AGREEMENT

One type of solar financing is referred to as a power purchase agreement (PPA). According to the SEIA, a PPA is a financial agreement where a developer arranges for the design, permitting, financing and installation of a solar energy system on the property of a host customer, at little to no cost to the host customer. The developer sells the power generated by the system to the host customer at a rate that is typically lower than the retail rate of the local utility. In some cases, the customer is the local utility, and the PPA rate is effectively a wholesale rate. For a non-utility customer, the PPA rate is intended to provide an economic advantage over purchasing electricity from the grid. In all cases, the developer receives the income from the sale of the electricity to the customer, as well as any tax credits and other incentives associated with the system. PPAs typically range from 10 to 25 years, and the developer remains responsible for the operation and maintenance of the equipment for the term of the agreement. At the end of the PPA contract term, the system can be removed, the PPA can be extended, or the system can be purchased from the developer. In some cases, the developer will provide a buyout table to facilitate a buyout of the system by the customer at certain points during the PPA term.

For such buyout events or other events, such as refinancing the solar system, an appraisal of the solar equipment comprising the system is likely needed. For example, an appraisal value can provide a benchmark against which a buyout price can be compared. Appraisal values, including forward-looking estimates of value, can also be used by a financial institution to underwrite the financing or refinancing of the solar equipment associated with the PPA. While the rate and term specified in the PPA are certainly key to determining such estimates of value, other PPA terms and conditions can also impact value. For example, PPA terms often specify the responsible party for certain operational tasks, which tasks result in operating expenses incurred by the respective responsible party. Based on the particular event, some or all of these expenses need to be considered when determining the value of the solar equipment. The ownership and market value of any solar renewable energy credits (SRECs) associated with the PPA can also impact value. SRECs from the energy generated by the solar system are often owned by the developer in a PPA, but at least future generated SRECs may be owned by a buyer (e.g., host customer) following a buyout event. In either case, the appraiser must ascertain the market value of the applicable quantity of SRECs to determine their impact on the value of the solar system.

EQUIPMENT LEASE

Various types of leases can also be used to finance solar equipment. Generally, a solar equipment lease is established by a contract between a customer (e.g., lessee) and an installer or developer (e.g., lessor) that allows the customer to receive the benefits (e.g., energy production) of the solar equipment in exchange for periodic payments over a certain period of time (e.g., 20 years). The lessor, however, remains the owner of the solar equipment. Similar leasing structures are commonly used in many other industries, including automobiles, office equipment, high tech equipment, and industrial equipment. In most cases, the lessor is responsible for maintenance of the equipment, but the lessee may also have some ongoing operational responsibility (e.g., maintaining an Internet connection for a monitoring system). Such leases are often structured so the lessee pays no up-front costs and has one or more buyout options over the term of the lease. The buyout prices might be predetermined by the lessor at fixed moments in time, or based on some lease prepayment formula that can be applied to any moment in time during the lease term (e.g., at the sale of the underlying property). Depending on the specific lease contract, the lessee may also face other options and decisions, such as end-of-lease renewal and/or upgrade choices.

One approach to selecting from multiple options is to compare them to one another. However, this approach could result in merely selecting “the best of the worst” of the options. A better approach is to compare the options to a then current appraised value of the solar equipment. For example, at the end of lease, a lessee might be offered a 5-year renewal at some payment rate, or an upgraded system under a new lease contract. The only way to accurately compare these options is to develop estimates of value for the two scenarios based in part on their respective energy production and operating expenses (e.g., lease payments, etc.). In this case, the technology, economic useful life, and, of course, the lease terms of each option will be considered when determining the respective values, facilitating an accurate and normalized comparison.

BOTTOM LINE: DETAILS MATTER

The foregoing third-party financing examples barely scratch the surface of the numerous variations and nuances of today’s solar financing options. The bottom line is that the details of a particular third-party financing contract matter when appraising solar equipment. Beware of using metrics such a “average home sales price premiums” produced in the back office by a data analyst. Such metrics are compiled in aggregate and therefore do not reflect your specific solar installation, which may lead you to making a wrong decision when faced with multiple options. Instead, engage with an accredited equipment appraiser, like those at Solovar, to help guide you to the right choice for your specific situation. Like Steve Jobs, we believe “details matter“.

Who Needs Solar Appraisals Anyway?

Even if you’re convinced your solar equipment should by appraised by an accredited equipment appraiser, you might still wonder, who needs a solar appraisal anyway?

Stakeholders associated with commercial equipment procurement and financing might already know that answer, but many residential solar system users might not. Specifically, in commercial equipment financing, appraisals performed by accredited equipment appraisers are commonplace. As an example, during my tenure at GE Capital managing a portfolio of equipment that we financed (e.g., leased) and received to inventory (e.g., returned from lease, purchased for trade), the value of that equipment was appraised often for various purposes.

COMMERCIAL INSTALLATIONS

For example, at GE Capital or any commercial equipment-backed lender, a current value and various forward looking values had to be determined before a lease could even be proposed or originated or renewed. Even when offering finance leases (e.g., loans), value trends are desired to identify any collateral gaps that may occur over the term of the lease or loan. Such leased assets would further be appraised periodically (e.g., quarterly) using then current market conditions and inputs in a process often referred to as a mark-to-market process.

Appraised values might also be required at certain events associated with a financing product, such as an early buyout (EBO) event or an end of lease (EOL) event. If the equipment is returned at the end of lease, various valuations are needed from time to time for remarketing purposes. The lender (e.g., lessor) might participate in all the foregoing valuation events, while the borrower (e.g., lessee) might only care about the value associated with some purchase event (e.g., EBO and EOL events, inventory purchase event).

RESIDENTIAL INSTALLATIONS

Fundamentally, the leased solar equipment on the roof of a residential home will have appraisal requirements similar to that of the commercial installation. Like the commercial equipment-backed lender, the residential equipment-backed lender (e.g., installer, developer, lessor, etc.) still assumes the risk of return on the invested capital pertaining to the equipment and installation, and therefore has an interest in knowing an estimate of the value of the equipment over time should a negative credit event occur.

Residential homeowners with financed solar equipment, however, might have more occasions to have their equipment appraised than the commercial borrower. For example, the EBO and EOL purchase prices established in a residential solar lease agreement are not necessarily based on an estimated fair market value (FMV) for the event date. Rather, such prices from the lender might be established based on a formula that determines the price based on some target return for the lender. The homeowner desiring to purchase the solar equipment at one of these events therefore should have the solar equipment appraised to determine the then current FMV of the equipment.

In addition to EBO, EOL, or other lease purchase events, homeowners with financed solar equipment more often transfer ownership of the underlying property associated with the equipment (e.g., sell their home). Whether selling or purchasing such a residential property with financed solar equipment, an appraisal of that equipment by an accredited equipment appraiser is prudent. Even when the lease is merely transferred to the new owner, the value of the solar equipment is still vital to the overall value of the property, which can impact the purchase price. As an example, while the value of a solar installation is often viewed as insignificant as compared to the value of the underlying property, a relatively small investment in a solar equipment appraisal can have significant returns as pertaining to the overall value and purchase price of the home.

ASK SOLOVAR

Solovar is here to help the commercial or residential lender or borrower with any of the foregoing appraisal scenarios and more. Check out our portfolio of services, all provided by accredited senior equipment appraisers, and structured and priced to fit your particular need.

Everyone’s An Expert

I think it was about the time I was pursuing my undergraduate degree in electrical engineering at the University of Michigan (go Blue!) when I first realized just how many more people out there are smarter than I am. I always had good grades, and put the work in to get them, but there was one guy in my class that seemed to consistently be above and beyond the rest of us. I wasn’t surprised to learn later that he went on to become a very successful entrepreneur.

I also would say there are many that know more than I do about solar equipment and even solar equipment appraisals. I try to learn as much as I can from such experts. I have also discovered others, perhaps not so qualified, that seem to be compelled to address certain topics pertaining to solar appraisal, often missing the mark on various basic appraisal concepts.

One example that caught my attention was from a July 2015 article in Solar Industry Magazine outlining a solar energy plant fact sheet published by the Vermont Department of Taxes. The fact sheet, among other things, promotes the use of a discounted cash flow (DCF) model to determine the fair market value (FMV) of solar equipment for property tax purposes. Specifically, the model is said to be based on algorithms developed by Sandia National Laboratories, such as those included in the PV Value tool, which can be useful in estimating future solar equipment income streams. Like all models, however, the quality of the output depends on the quality of the inputs.

In this case, some of the inputs specified in the model are such that the result is effectively not an indication of FMV at all, but rather just a number that can be used to calculate property taxes. The authors of the article, from law firm Akin Gump, correctly identify some of the more questionable inputs:  a fixed discount rate of 13.3%, an exclusion of federal investment tax credits, a fixed estimated life of the equipment, and a “gratuitous” 30% valuation reduction!

I can appreciate the state’s interest in lowering associated taxes to encourage more solar energy investment, but please don’t call the output of that model a “valuation” result (e.g., FMV). What happens when the solar energy plant owner needs financing backed by the solar equipment or wants to sell the plant? An accredited appraiser will likely be called in to make a true assessment of FMV and may have to expend energy discrediting the self-proclaimed “FMV” derived from the property tax model. The authors of the article specifically cited a need to adjust the “inappropriately repressed” valuations from the model when determining a value for income tax purposes. Such adjustments, and all inputs to a valuation model and/or approach, should be determined by an experienced and accredited equipment appraiser.

Just remember, while there are indeed different types of FMV for equipment assets, they all should be based at least in part on the following definition from the American Society of Appraisers (or similar):

An opinion expressed in terms of money, at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts, as of a specific date.

Practicing the Fundamentals

At the risk of overusing baseball analogies (see “If You Build It, …?“), I’ll use another in this post to illustrate an interesting dynamic in the solar appraisal world. Picture the experienced second baseman about to field a grounder with a runner on first base. His team needs just two more outs to win the championship. In the excitement to turn the double play, he forgets all his training and fundamentals, lifting his eyes, head, and glove, as the ball skips between his legs into right field. When it comes to playing in the solar PV appraisal market, it seems many have also let their excitement distract them from some fundamentals.

FUNDAMENTAL #1:  PERSONAL PROPERTY IS NOT REAL PROPERTY

One of those fundamentals related to appraising solar PV systems, pertains to determining whether the solar PV system is real property or personal property.  Real property appraisers know there is relatively clear guidance for determining whether certain assets associated with real property can be considered a component (e.g., fixture) of the real property. Certainly, commercial real property appraisers and their clients deal with this determination quite often. In general terms, if the asset (e.g., solar equipment) is substantially fixed to the real property (e.g., residential home) and owned by the same owner (e.g., the homeowner), then the asset might be considered real property. However, some solar PV systems are not substantially attached (e.g., readily removed without damaging the real property), and further, most are owned by a third party (e.g. lessor). In such cases, the solar PV system should be considered personal property, and more specifically, machinery and equipment (e.g., as compared to other types of personal property, such as residential contents, art, antiques, gems, etc.). In fact, many lease agreements specifically classify the solar PV system as personal property.

FUNDAMENTAL #2:  PERSONAL PROPERTY SHOULD BE VALUED SEPARATELY FROM REAL PROPERTY

When the solar PV system is identified as personal property, certain appraisal reporting and/or competency rules can apply. For example, one reporting fundamental to apply in this case specifies that the value of the solar PV system should generally not be included in the value of the real property. Surprisingly, however, the more common practice seems to be to include it in the real property value (e.g., as a comp adjustment). This may be appropriate, depending on various factors (e.g., lease terms, etc.), but it is certainly not a given as generally assumed. When it is included in the real property appraisal, the real property appraiser should at a minimum identify and treat the solar PV system (e.g., or any personal property) separately in the appraisal, clearly stating the portion of the final value attributable to the solar PV system.

FUNDAMENTAL #3:  APPRAISER MUST BE COMPETENT IN APPRAISED PROPERTY

As is fundamental to any appraisal assignment, the appraiser must be competent to value the solar PV system. This is certainly true when the system is deemed to be personal property, but also applies when the system is classified as real property. In either case, the techniques, expertise, and approaches more familiar to the accredited machinery and technical specialties appraiser might be needed to properly value the solar PV system. Such competency must cover not only the equipment, but also any related contractual terms (e.g., a PPA, lease transfer terms, etc.) that may affect value. For certain assignments, accredited appraisers might need to abide by the competency rules and/or policies from many agencies and institutions (e.g., USPAP, Fannie Mae, Freddie Mac, FHA, HUD, etc.).

These and other fundamentals have been established over many years to largely protect appraisal clients. While one might be safe with a ballpark appraisal of a residential solar PV system from a non-equipment appraiser in some game situations (e.g., a small installation on a $1 million property), we appraisers must never forget to practice our fundamentals. (all puns intended)