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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“.

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.

If You Build It, …?

Solovar effectively started with a phone call. A local installer here in San Diego found my name in the American Society of Appraisers (ASA) web directory, and called with a question, “Do  you appraise residential solar installations?” The call was precipitated by a client of the installer asking if he knew of any appraisers that might help with an appraisal related to a lease buyout option. Of course, my answer was, “I can.” While I didn’t really answer his question, I was confident that my academic background (MSEE) and over a quarter century of working with high-tech semiconductor manufacturing equipment would enable me to satisfy the competency rule required of my appraisal accreditation to complete the assignment.

However, as I was answering, I was also contemplating how the typical homeowner might not have much experience pertaining to appraisals outside the occasional home value assessment. While such home appraisals might be in the $250 to $750 range, many high-tech equipment appraisals with inspection and a USPAP-compliant certified appraisal report might have fees with one or more extra zeros. But I also saw this as a growing unmet need, as residential solar installations continued to grow at a strong pace in California and other regions in the US and around the globe. I further recognized the need for more competent solar equipment appraisers in the growing commercial (e.g., non-residential, utility) installation arena.

Solovar was founded to address the foregoing challenges pertaining to appraisal affordability in the residential market, and appraisal expertise needs in both the residential and commercial solar equipment markets. Affordability can be addressed by limiting the scope and improving the efficiency of the appraisal assignment, among other things. More specifically, residential assignments might be limited to a single value standard and premise, with a single valuation approach being implemented at least in part using custom software. The expertise aspect can be addressed by, well, developing the expertise. As with all the classes of high-tech equipment I appraise, continuous learning is a must. Such learning is effectively the only way any appraiser can stay aligned with the latest technology such that competent and meaningful valuation results can be determined.

I acknowledge there is a notion of an “if you build it, they will come” strategy with Solovar. But if only a few come, I will still appreciate the knowledge and experience gained. By the way, I did not get an assignment from that original call.