Installing solar panels on commercial building rooftops can become a revenue-generating opportunity for REITs as they seek to harness the power of the sun to produce clean energy. However, contrary to popular opinion, the value does not always outweigh the risks, due in large part to low rooftop lease revenue and hidden operational impacts. In response, the solar industry and utility companies have begun to work together on solutions that make it possible for property owners to unlock the value of rooftop space.

 

A Dearth of Investment Models

AMB Property Corporation (NYSE: AMB) has been active in defining the benefits of using solar panels. As such, we have taken a measured approach toward investigating and selectively pursuing opportunities. One of our early observations has been that despite the rapid evolution of the solar industry, there remains a dearth of investment models that work well for REITs. Property owners are asked to take on potentially costly financial risks far out of line with expected revenue. In short, the risk and reward equation remains unbalanced.

 

However, we are beginning to see the rewards side tip the scale as the industry quickly matures; evolving technology and greater construction efficiencies are leading to higher revenue and more equitable risk-sharing. At AMB, we are evaluating the merits of opportunities as they emerge, rather than rushing headlong into fledgling markets. But we are encouraged by what we see.

 

For example, rooftop lease rates have risen by 50 percent in the past 12 months alone in Southern California, one of the country’s largest solar markets, and rates could go even higher in response to the low supply of suitable space. We are also seeing new equipment—tailored specifically for rooftop applications—that reduces weight and simplifies installation, which in turn reduces costs and construction time.

 

Not All Buildings Are Created Equal

Rooftop solar is currently an option for certain buildings, as related subsidy programs often target a subset of the commercial property universe; only the newest and largest rooftops are eligible—in many cases only those less than three years old and at least 200,000 square feet.

 

It’s also important to note that very few existing properties were built with solar in mind. Therefore, they may not have the excess structural capacity needed to support additional roof loads. This can be problematic, as the typical one megawatt project today can mean up to 1 million pounds of added weight on the roof. In California, this weight affects a building’s seismic performance. In some cases, the cost of seismic upgrades can render a possible project economically unfeasible. This is a major consideration as 90 percent of industrial buildings were built prior to the latest structural codes. Similar concerns exist with snow loads in colder climates and high winds in coastal locations.

 

Early Incentive Programs Did Not Work for REITs

Solar projects require both federal and state-level subsidies to be cost-effective. The IRS offers a 30 percent investment tax credit (ITC) and some states offer cash rebates through local utilities. However, REITs cannot receive the ITC without creating special-purpose taxable entities. This alone has prevented many REITs from investing in solar projects.

 

Alternate solutions such as the power purchase agreement (PPA) exist, but they are not a panacea. A PPA typically requires that a property owner purchasing power from a solar facility has an investment-grade credit rating and commits to buying all of the power produced for 20 years. PPAs also rely on the tax equity market to monetize federal tax benefits—a market that has largely dried up over the past 24 months.

 

For REITs, the PPA is even more challenging, as most tenants under triple-net leases buy energy directly from a local utility and not from the landlord. This means a REIT would have to become a reseller of solar electricity. As most multitenant building leases are for between five and 10 years, REITs could face exposure to the cost of unsold energy every time they negotiate leases and energy sales agreements with new tenants.

 

Utilities Entering the Market to Provide Alternatives

The solar and REIT industries are finding new ways to work together. Utilities in particular have begun to seek development opportunities to meet renewable portfolio standard obligations.

 

Earlier this year, AMB inked an agreement with Southern California Edison (SCE) to install a one megawatt pilot facility on the roof of our 436,000 square foot building in Rialto, Calif. The system will be connected to SCE’s local grid so that its customers can receive the clean energy. This solution maximizes the use of rooftop space because a large industrial roof can produce several times more energy than the building beneath it needs.

 

A unique aspect of this project is that AMB neither owns the panels nor purchases the electricity. We instead lease rooftop square footage in return for rental income from SCE. As utility companies explore the distributed market, solutions like this are becoming more common. Leasing rooftop space allows property owners to do what they do best—lease and operate real estate.

 

A Unique Opportunity to Mature with Industry

While PPAs and direct investment are the primary solutions in many markets today, utilities in Texas, Florida and elsewhere are looking closely at the SCE roof-lease model to formulate their own programs. This bodes well for REITs and others that are searching for the right fit for solar projects.

 

The solar industry is maturing and there is still work to be done before industrial real estate owners fully embrace rooftop solutions: The supply and demand of rooftops in each market must be better understood; the effect thousands of solar panels can have on a building must be better quantified; and incentives, programs and technologies must continue to adapt to the reality of building rooftops not necessarily constructed with solar in mind. We remain confident that these issues will be addressed as solar companies, utilities and property owners continue to communicate and collaborate.

 

In the meantime, we believe that REITs willing to adopt a strategic approach to using their rooftop space will be in a position to enhance the long-term value of their portfolios and support the long-term growth of the renewable energy industry.

 

Author Credit: Aaron Binkley is director of sustainability programs at AMB.