This is a summary of How REITs are Already Investing in Renewables article that appeared in the June 2013 issue of Project Finance NewsWire. Interviewed were Jeff Eckel of Hannon Armstrong, Bill Hilliard of CleanREIT Partners, Arun Mittal of Power REIT, Pavel Molchanov of Raymond James, Will Teichman of Kimco Realty, and Drew Torbinof Prologis.
While the industry awaits ruling from the IRS classifying solar and wind as real property certain groups are already using existing REIT structures to develop solar projects.
Renewable energy companies are looking into Renewable Energy Investment Trusts (REITs) as a way to lower the cost of capital. REITs are required to mostly own real property, with 75% of its assets required, at a minimum, to be real property. Beyond the land and buildings below wind farms and solar panels (both on the ground and on rooftops) it is unclear what qualifies as real property. When it comes to income, REITs are required to have at least 75% of its income come from rent or mortgage interest from real properties.
The dividends an investor would receive from a REIT vary, the results are hard to determine as it depends on which metric you use, and they aren't comparable. One project portfolio, says Bill Hilliard of CleanREIT Partners, that generates 10% cash return over 20 years, can have a 12% Internal Rate of Return (IRR) or an 8% IRR depending on an augmentation of the cash flow by a 30% investment tax credit (12% with augmentation, 8% without).
Different REITs generate different returns and their methods of generating cash flows can vary and depend on their focus. Arun Mittal of PowerREIT says: “The renewable energy market is highly differentiated... it depends on the projects assets as well as other attributes.”
Kimco Realty, which owns roughly 900 shopping centres in 46 states and Puerto Rico, and is involved in Canadian and Mexican markets. They became interested in renewable energy in 2009 when they were considering how to use their rooftop space on their shopping centers. Their larger tenants wanted to lower their electricity bills by using solar energy. Kimco decided this was a good business opportunity, and looked into it. An important part of their considerations was the 1603 Treasury grant, which was available to taxable REIT subsidiaries (TRS') but not REITs themselves.
Kimco used a wholly owned TRS to manage the solar systems and facilities, which includes selling Solar Renewable Energy Credits (SRCs). The TRS now produced approximately 3 megawatts(MW) of energy in New Jersey, which it sells to several tenants under PPAs.
Prologis had similar reasons to Kimco for entering renewables, and their methods are partly similar. They wanted to develop addition value for the assets they already have, and they use a TRS to develop and construct the project.
Beyond that, their similarities end. After the project is constructed, Prologis sells its' interest to an investor or utility, then acts solely as a leaser of roof space and constructor. After the sale energy is usually either kept by the owner of the project or sold to an energy off-taker. Most of the roughly 100MW of electricity Prologis' TRS produces is in southern California with some in Europe and Japan.
PowerREIT has an unusual history and method. It pursues properties that don't require a PLR (Private Letter Ruling) from the IRS. In 1967 they restructured after receiving a PLR saying the railroad and associated assets (eg buildings, tracks and superstructures) qualified as real properties under REITs. The PLR they received was later turned into a broad ruling that applied to all taxpayers. This ruling wasn’t used by PowerREIT for about 40 years until they decided to start acquiring good REIT properties, though they are willing to jump on the bandwagon when the IRS declares a renewable energy property a good REIT property. They also focus on the land and what can be bundled with it.
When it comes to good properties for REITs, they don't have to be solely in the US, as solar energy is a global business. Prologis, for example, has properties in France. Kimco, though it has no projects outside the US yet, are looking into projects in Mexico. One important aspect to keep in mind when going outside the US is getting local help to assist in the projects. These local advisors have insights into the market that may elude companies not from the area.
In the opinion of Pavel Molchanov, of Raymond James, there would be more demand for REITs and other similar structures, if they could get past the legal and political challenges.