Happy 2014 everyone. The deep freeze here in the Midwest is making me wish I was in California this week. By the way, how much better do solar panels perform when it is 15 degrees below zero? (Assuming they aren’t covered with snow?)
We’ve had several organizations ask us over the last few months about the returns for financing residential solar. Before we get there, however, let’s make sure we understand what’s included in the returns.
Essentially, there are only two places to earn returns in residential solar: from installation or financing. Installation (or “dealer”) businesses earn profits much like any contractor does, by finding customers and getting them to pay for an installation of equipment. Financing businesses earn money by investing money in solar systems up front and collecting fees over a long period of time.
Some companies, like SolarCity and Vivint, are vertically integrated in these business. Others, such as Sungevity, acquire customers and provide financing but rely on others to do installations. However, these variations don’t create new profit pools, they are just different ways of splitting up the profit pie.
We’ve discussed the profits in the dealer part of the business before. But how much profit is there in the financing part of the business? This depends on a few key factors:
The financier’s cost for the solar system
This is often called the “turnkey price”. It is what the financier pays the dealer/installer for the completed solar system. Some states are more expensive to operate in that others, some houses are more expensive to build on than others. Financiers also pay installers more when the installer does the customer acquisition. There are a variety of federal and state incentives that can effectively reduce this cost. Taking advantage of the federal incentives is complicated and done with so-called tax equity. (We described this in Tax Equity 101.)
Revenue the financier collects over time
As part of PPA or lease agreements, each month consumers usually pay something like 10-30% less than they would have paid to their utility if they did not have solar. Therefore, what they pay varies a lot between states like Hawaii, where utility prices are over $0.30 / kWh, and Texas, where there are about one quarter of that. In addition to customer revenue, financiers also may be entitled to performance based incentives or to earn SRECs, which they can then sell.
The financier’s cost to operate the solar assets
These are costs like billing, repairs, and insurance for the solar systems. Technically, the solar systems are often owned by joint ventures between the financier and tax equity investors, but the financier usually takes operational responsibility for items like those above. The JV’s typically pay the financiers somewhere around $25 / kW / year to take responsibility for these activities and their costs. We have seen these payments range from $10-50 / kW / year, but note payments from the fund are not necessarily the same as the financier’s cost to perform the activities.
The financier’s cost to run its business
Finally, we have the cost the financier has to run its own business. These include the cost of project finance professionals who can source and negotiate investments for project financing, such as from tax equity, cash equity, or debt providers. These are the same folks who will work on any sort of securitization.
The legal expenses of such a business are significant, too. First, there are the expenses associated with negotiating and structuring investment deals. Then there are the fees associated with making sure leases and PPAs are legal in the various jurisdictions where the financier wants to operate. Third, many of these business are not wallflowers when it comes to government relations.
Companies like SunRun, SunPower, and Clean Power Finance also have significant expenses associated with marketing to and working with a number of partner organizations, each of which has their own preferred way of doing business. Some finance companies do consumer marketing as well.
We think people often underestimate these costs. SunRun and CPF each employ on the order of 100 people. If the fully loaded cost of each of these employees is $150,000, that suggests at least $15M per year in such expenses.
Performing these tasks is probably somewhat less expensive for SolarCity, Sungevity, and Vivint, who don’t have to deal with the complexities of working with several dozen partners. However, even if the expense is 50% of that at independent finance companies, the cost of running such an organization is substantial.
Financing returns in residential solar
Using the above information, one could calculate the financier’s return on its investments in solar systems. We estimate these IRRs to be around 8-11% today. These have been decreasing over the past few years.
Whether 8-11% is a good deal for the financier depends on its cost of capital. If a financier’s cost of capital is 10%, the net present value of its investment is essentially zero. On the other hand, if its cost of capital is 5-7%, the NPV of each solar system is several thousand dollars.