Solar PV: Shedding light on the opportunities. Commercial roof solar PV valuation methodology and property asset performance October 2014

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1 Solar PV: Shedding light on the opportunities Commercial roof solar PV valuation methodology and property asset performance October 2014

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3 Contents 1. Executive summary Solar PV overview Introduction How solar works Types of PV technology Reasons to install Rooftop solar PV installation process Geographical implications Regulatory environment Planning Legal Current market context Global market context UK market Current transactional evidence Property owners/occupiers that have adopted PV Rooftop solar PV asset/portfolio transactions Parallels with large-scale ground-mounted solar market Implication for commercial property valuations including solar PV Ownership structures Overview Commercial structures Commercial ownership structures Valuation methodology Valuation methods Valuation scenarios South East distribution warehouse Midlands manufacturing facility Key attributes and risks Introduction Key attributes Risks Conclusions Solar PV: Shedding light on the opportunities 3

4 University of East London installed by Solarcentury 4 Solar PV: Shedding light on the opportunities

5 1. Executive summary This paper has been prepared by JLL with Solarcentury for the purpose of considering the impact of rooftop solar photovoltaic (PV) installations on the financial performance of commercial property. The aim is to explain the use of solar PV in the context of commercial property and then principally consider the relevant valuation methodology that can be used to ascertain the impact on property values. The paper explains how solar PV works, the current market context, relevant valuation methods with case studies and key attributes and risks. We highlight key points below:- There has been significant expansion in the use of solar PV due to the positive developments in legislation, increased efficiency in technology, tenant demand and quick payback periods. Commercial property offers larger roof space areas compared to residential property in particular distribution warehouses, factories, multi-let estates and shopping centres. These properties will be able to host and generate high levels of renewable energy. Greater understanding of how solar PV works, its income generation possibilities, the legal implications, and management, needed is required within the property industry to increase the deployment levels for commercial installations. Greater consistency and sophistication in the valuation approach for solar PV has been established but not commonly used. Discounted cash flow methodology providing a net present value of income generated by the solar PV is the most appropriate and explicit. Responsibility for the roof remains a key issue during the installation of solar PV with FRI leases being the most preferable for landlords. This maintains the liquidity of the asset. Insurance policies have predominantly remedied the issue. For multi-let estates and shopping centres, any excess income or cost savings generated from the solar PV installations can be used to reduce the service charge, contribute to a sinking fund and improve the lettability of units. Greater understanding is required of the impact on a property s asset performance. Sophisticated project management is required to provide analysis of what can be done and to deliver the best solution. Recent commercial property transactions benefitting from solar PV have continued to trade at premium prices demonstrating good liquidity. The recent surge in demand for solar PV on commercial roofs demonstrates a step change in the positive attitude towards this method of harnessing renewable energy. Solar PV: Shedding light on the opportunities 5

6 2. Solar PV overview Toyota / Lexus showroom installed by Solarcentury 2.1 Introduction We set out in our overview an explanation of how solar works, the technology involved, practical installation, geographical implications, regulatory environment, financial incentives and legal analysis. The aim is to demystify the world of solar PV and to provide a clear background to understanding how its operation impacts on the property valuation methodology. 2.2 How solar works Photovoltaics (PV) is a power generating technology that converts sunlight into direct current electricity using semiconducting materials that demonstrate this effect. A photovoltaic system employs solar panels composed of silicon cells to supply solar generated power. The solar panels can be easily attached to a range of commercial properties in the UK that vary in size and category. These include, but are not limited to, offices, industrial property, hospitals, schools, hotels, retail, farm buildings, and warehouses. Small commercial buildings can typically accommodate PV systems between 4kWp and 100kWp, while larger commercial buildings allow larger arrays, the largest in the UK currently being 5.8MWp. Figure 1 illustrates the process behind the technology: The solar panels are frames made up of solar (PV) cells (layers of silicon). The sun s radiation hits these cells and is converted to direct current (DC) electricity. This DC electricity travels to an inverter, which converts DC into alternating current (AC) electricity. The AC electricity produced is the same as the electricity supplied by a utility company. Excess electricity can be exported to the grid. Figure 1 - How solar works 6 Solar PV: Shedding light on the opportunities

7 2.3 Types of PV technology There are two main types of solar PV technology, these are Crystalline Panels and Thin-Film PV. Crystalline panels Most common type of PV technology used today. Most productive type of panel based on output/sqft. There are two forms, poly and mono which have varying efficiency ratings. Crystalline panels are generally more efficient than thin film panels. Thin film PV Thin film technology uses a different manufacturing process to crystalline modules and can be integrated with glass, plastic, fabric and metal. Not as efficient as other types of PV with the highest confirmed efficiency level recorded at 20.4%. 2.4 Reasons to install Solar energy is arguably the most environmentally friendly, clean and universally applicable form of power generation. Solar PV is becoming increasingly popular in the UK for both residential and commercial property. Reduce on-site grid energy used Make the roof a financial asset Reduction on CO 2 emissions We have identified the following drivers for both landlords and tenants to install PV as illustrated in figure 2. A number of these drivers are mentioned later in the benefits section of this paper, however we have identified two key drivers behind installation on commercial buildings in the United Kingdom, these are: changes in legislation and rising energy costs. Increased return from asset Increasing energy costs Solar PV Legislative need to improve EPC rating Help to fight climate change Contributes towards CSR objectives Figure 2 - Reasons to install Solar PV: Shedding light on the opportunities 7

8 In July 2013, the coalition government announced that by 2019 all new non-domestic properties must be zero carbon. This piece of legislation along with other rulings which are already or set to come into effect will mean sustainability and renewable energy will become important considerations for property owners. Below we set out key sustainability legislation rulings affecting commercial properties: 2016 Energy Act Requires landlords to accept reasonable requests for efficiency improvements 2018 Energy Act Illegal to rent out residential or business premises below minimum energy efficiency rating of EPC E % reduction in UK CO² emissions % reduction in UK CO² emissions Changes to Building Regulations L 2020 EU requires new buildings to be nearly zero energy (UK has 2019 zero carbon requirement for commercial buildings) % of UK energy consumption to come from renewable resources Emissions from all buildings to be as near to zero as possible. Figure 3 - Key upcoming legislation regarding sustainability. Rising energy prices will also be a factor behind the growth of PV in the UK. In the graph we have detailed the highest and lowest projected real price of electricity up to the year 2030 based on figures from a report published by DECC in The price for residential and industrial uses rises sharply from 2014 with residential prices reaching 23.3p per kwh in 2024 which represents an increase of 40% from the 2014 level of 16.6p. Industrial prices are forecast to increase by an even larger percentage over the next 10 years with prices projected to reach 15.9p per kwh which is a 60% increase on the 2014 level of 10p. In contrast, the cost of solar continues to decrease. The levelised cost of solar electricity for commercial and industrial installations is already at 10p per kwh. p/kwh Residential high p/kwh Residential low p/kwh Industrial high p/kwh Industrial low p/kwh Figure 4 - Projected price of electricity. Data: Department of Energy and Climate Change 8 Solar PV: Shedding light on the opportunities

9 2.5 Rooftop solar PV installation process The process behind the installation of a rooftop solar PV system is as follows: We believe it is crucial when looking to install solar PV on the roof of a commercial property that this is undertaken with a reputable company with a high level of expertise and an established track record. Survey Quote and Design Planning checks and DNO liason The installation Feed-in Tariff application Implement operation & maintenance strategy Survey Prior to going ahead with a solar PV installation, a survey must be undertaken to assess the suitability for installing PV on the building. The buildings orientation, roof pitch, structural integrity and potential capacity will be assessed and signed off. Quote and design Upon completion of the survey, the solar expert will design a rooftop solar PV system for the property in question. The design is crucial in order to optimise energy production. Planning checks & DNO liaison After the system has been designed, it must be checked to see whether the system will require planning permission or not. If it does, the planning application must be submitted and permission granted prior to installation. In addition, permission must be sought from the relevant District Network Operator (DNO) to connect a commercial PV system to the National Grid. This permission will be granted following the submission of a G59 ENA application form to the DNO, accompanied by a Letter of Authority. Installation Depending on the size of the system, installation can be completed in 2-3 months. Feed-in Tariff application This step should be completed as soon as possible in order to secure the best rate available. It is also possible to pre-accredit the project up to 6 months prior to commissioning if all permits are in place. Implement operation and maintenance strategy (O&M) This can be undertaken by either the installation owner or a third party (such as Solarcentury) via remote telemetry. Having a comprehensive operations and maintenance strategy in place, will minimise down time and optimise system performance. Solar PV: Shedding light on the opportunities 9

10 2.5.1 Installation methods There are a number of ways that PV can be mounted to the rooftop depending on the material it is made of. We have summarised these as follows:- Standing seam Concrete Asbestos fibre cement Quick and simple to design and install Non-penetrative as fixings clamp over the seam Reasonable on price, depending on roof manufacturer Upstand design installed onto concrete Requires strong design and installation skills due to high wind loads Elevated install costs due to design Possible to fix PV to this type of roof using careful install procedures Fragile roof requires strong design and installation skills Elevated cost due to install and design requirements Single ply membrane Composite panel profiled metal/ Trapezoidal metal roof Concrete with bituminous membrane Common on new builds and re-roofed developments Roofs are often lightweight which can be problematic for PV PV often ballasted to roof; structural sign off is essential Possible to penetrate and fix to roof if high wind load is an issue Light weight and simple design PV mounting can be penetrative or non-penetrative, depending on roof type Very common Mounting structure is simple in design and weighted using ballast Build up on roof must be investigated to sign off design 10 Solar PV: Shedding light on the opportunities

11 2.6 Geographical implications 900 One of the factors that makes solar attractive as a long-term, low risk investment is the reliability of irradiance modelling. Whilst that might seem counter-intuitive when you experience British weather day in and day out, the data is clear. Solar is highly predictable. The yield of solar systems very much depends on the geographic location and the orientation of the panels. The highest yielding geography in the UK is the south west Figure 5 shows the different irradiation levels in the UK. Solar systems work in the UK despite cloudy days as the technology responds to daylight. More electricity is generated when there is no cloud cover, but the system continues to work despite any cloud cover Orientation is just as important as location. The more south facing the roof is the better and the pitch of the modules will also significantly affect the amount of electricity generated. The chart below shows the percentage drop off from optimum as the system is pointed away from south or at more or less than 30 degrees pitch Figure 5 - Irradiance levels in the UK: Annual total solar irradiation (kwm/m2) across the UK Percentage of maximum output potential achievable with different orientation and tilt angles Orientation Compass bearing ( ) measures from North Horizontal West SW South SE East Tilt ( ) from Horizontal Figure 6. Source: Solarpv.co.uk Note: This chart is indicative and should not be used for the calculation of performance estimates. Solar PV: Shedding light on the opportunities 11

12 2.7 Regulatory environment Financial incentives There are two key incentive schemes used for commercial properties: the Feed-in Tariff (FiT) and the Renewable Obligation (RO). The FiT is typically used for systems up to 1MWp. The RO is typically used for large systems ranging from 1MWp to 5MWp. The Feed-in Tariff The FiT is a government programme introduced in 2010 to encourage the uptake of renewable energy in the UK. It rewards you for any energy you generate from a solar installation, regardless of whether you use the electricity or not. The income is guaranteed for 20 years and is index-linked. If electricity prices go up more than inflation which they have for the past decade your savings would grow even quicker. The financial model is based on: An inflation-linked payment for every kwh of electricity generated An inflation-linked payment for electricity that is exported Savings in payments of electricity for power that is consumed from the system rather than the grid. Levy Exemption Certificates (LECs) sold to suppliers from Climate Change Levy exempt generators and then sold on to consumers not subject to Climate Change Agreements. The FiT for new systems degresses in line with take up and is reviewed every three months. The Renewable Obligation The RO is the main support mechanism for large-scale renewable energy in the UK. Introduced in 2002, the RO requires electricity suppliers to deliver an annual proportion of electricity from renewable sources, or pay a fine. ROCs are traded separately to the actual electricity itself and work as a bonus premium on top of the price paid for the unit. Renewables Obligation Certificates (ROCs) are green certificates issued to operators of accredited renewable generating stations for the eligible renewable electricity they generate. Operators can trade ROCs with other parties. ROCs are ultimately used by suppliers to demonstrate that they have met their obligation. The financial model is based on: Renewable Obligation Certificates issued to generators and supplied to consumers under the Renewables Obligation. Levy Exemption Certificates (LECs) sold to suppliers from Climate Change Levy exempt generators and then sold on to consumers not subject to Climate Change Agreements. Renewable Energy Guarantees of Origin (REGOs) certificates which demonstrate that electricity has been produced from renewable sources. A Power Purchase Agreement (PPA) for the power supplied. It is possible to accredit PV systems as small as 250 kwp under the RO but the FIT is a simpler process. 12 Solar PV: Shedding light on the opportunities

13 Currently the solar PV Feed-in Tariffs are as follows:- 2014/2015 Description For eligible installations with an eligibility date on or after 1 July 2014 and before 1 October 2014 (p/kwh) For eligible installations with an eligibility date on or after 1 October 2014 and before 1 December 2014 (p/kwh) Solar PV (other than stand-alone) with total installed capacity greater than 50kW but not exceeding 100kW Solar PV (other than stand-alone) with total installed capacity greater than 100kW but not exceeding 150kW Solar PV (other than stand-alone) with total installed capacity greater than 150kW but not exceeding 250kW Solar PV (other than stand-alone) with total installed capacity greater than 250kW Stand-alone (autonomous) solar photovoltaic (not wired to provide electricity to a building) Higher Rate Higher Rate Middle Rate 9.31 Middle Rate 9.31 Lower Rate 6.38 Lower Rate 6.38 Higher Rate Higher Rate Middle Rate 9.31 Middle Rate 9.31 Lower Rate 6.38 Lower Rate 6.38 Higher Rate 9.89 Higher Rate 9.89 Middle Rate 8.90 Middle Rate 8.90 Lower Rate 6.38 Lower Rate Export Tariff The buyout rate for an RO Certificate is A commercial rooftop is eligible for 1.6 RO Certificates for every MWh of electricity generated. This is equivalent to 7.4p/kWh. Solar PV: Shedding light on the opportunities 13

14 2.7.1 Power Purchase Agreement A Power Purchase Agreement (PPA) is a contract between a generator and a PPA provider. The PPA defines all of the commercial terms for the sale of electricity between the two parties, including the schedule for delivery of electricity, penalties for under delivery, payment terms, and termination. Commercial terms in the PPA will typically refer to the sale price of electricity, and any associated items of value including: embedded benefits, triad benefits, Levy Exemption Certificates (LECs) and any future new benefits. The generator can enter into a PPA with a PPA provider to sell power exported to the grid at market rates. In addition where applicable the generator may be able to enter into a private wire direct PPA with an onsite energy user to sell power at a preferential rate Levy Exemption Certificates Levy Exemption Certificates (LECs) are used to provide exemption for business customers from the Climate Change Levy (CCL). The CCL is a charge placed on the use of fossil fuels by energy intensive users and is designed to encourage efficiency and use of renewable technologies. The value of the LEC is related to the level of the CCL rate is set at. The CCL rate for electricity as at 1 April 2014 is 0.541p/kWh. PPA providers will typically offer generators 80% of the LEC value in a PPA. Other embedded benefits refer to any benefit that accrues to a generator and/or a licensed electricity supplier as a result of the portfolio being connected to the local distribution network. These benefits include the avoidance of distribution and transmissions losses and are built into the export rate offered to the generator. 2.8 Planning It was previously announced that from April 6 th 2012, planning permission would not be required to install solar PV on nondomestic buildings, subject to meeting the following conditions: The solar PV array must not protrude further than 200mm from the surface that it is on, unless it is on a flat roof where the PV must not exceed 1 metre in height above the highest part of the roof. The solar PV array must be more than 1 metre away from the edge of the roof. Historically solar PV installations with a capacity of greater than 50kWp required planning permission. However, in a technical consultation on planning document which was published in July 2014, it was suggested that this planning regulation should be relaxed and the permitted development right to install solar PV on non-domestic buildings without the need for planning was extended to one megawatt installed capacity. As with all other types of property, planning permission is required for the installation of PV on a listed property. 2.9 Legal One of the most important aspects regarding solar PV on commercial roofs will relate to the legal aspects of the installation. The situation will vary depending on the ownership of lease structure in place with either a third party provider or standard landlord and tenant relationship. There are two types of lease that are commonly granted in the property market, these are FRI (Full Repair and Insuring) and IRI (Internal Repair and Insuring). The main difference between these two types of lease is an FRI lease requires the tenant in question to bear the responsibility for the repair and insurance of the whole property. In the case of IRI, the tenant in question is only responsible for the repair and insurance of only the internal accommodation. 14 Solar PV: Shedding light on the opportunities

15 The type of lease is also relevant when installing PV on a property as it details the party who is responsible for the upkeep of the roof after the solar PV array has been installed. This is detailed below: Lease type Responsibility for the roof Favourable for Remedies FRI Tenant Landlord IRI Landlord Tenant Landlord will take out additional insurance to realign the lease to an FRI basis From a number of discussions with property landlords, we understand that their preference lies with letting the property on an FRI lease meaning the tenant would retain the FRI liability for the roof space. However, should the tenant not wish to accept the liability for the rooftop upon installation of solar PV, it is possible to change the lease type with a Deed of Variation. This is a legal requirement for the lease agreement between a landlord and a tenant to be altered. In most cases, the tenant will pay the legal costs for both parties. IRI leases, which are less common in the UK, but dominant across the rest of Europe, can have a detrimental effect on the liquidity of the asset as the landlord has to account for the cost of maintaining the roof. We have established this is usually mitigated by solar PV owners taking out insurance to realign the lease to a FRI basis. Eden project installed by Solarcentury Solar PV: Shedding light on the opportunities 15

16 3. Current market context Bodyshop HQ installed by Solarcentury 3.1 Global market context It was reported in May 2014 that the UK is set to lead the European solar market for the first time, overtaking Germany, which was the leading country from 1995 to 2013 with the exception of This forecast was based on a number of factors including a plethora of MW-plus installations completed this year across the solar farm and large rooftop markets, and healthy demand in the residential and sub-50kw PV market. In addition to this, it was reported that in 2013, large scale PV installations grew by 600% year on year. Considering that at the end of 2009, installed PV in the UK was just a mere 0.3% of that installed in Germany, the UK PV market has shown strong growth and we anticipate that this growth will continue. Outside of Europe, China leads the non-european top three in terms of total cumulative capacity over Japan and the USA. It is expected that due to the nature of the PV business and its reliance on legislative reforms, markets in developing regions will see greater growth than a number of markets in Europe, where PV have been available for a number of years. Korea 1% Canada 2% Australia 3% India 4% Thailand 1% Others 3% China 43% USA 18% Japan 25% Total cumulative capacity outside of Europe 27,377 MW Figure 7: PV Market share outside of Europe in 2013 (Data: EPIA) 16 Solar PV: Shedding light on the opportunities

17 3.2 UK market The commercial and industrial rooftop sector is commonly associated with 50kWp 5MWp installations. As illustrated in the figure 8, the total number of commercial rooftop PV units installed to date in the UK remains small, and therefore both commercial property transactions involving solar PV and rooftop solar PV asset/portfolio transactions are limited. 3.3 Current transactional evidence Investment transactions The amount of comparable data in the UK is quite limited. We are aware of the sale of the following properties which have solar PV installed or are in the process of being installed by the tenant: In July 2014 the Sainsbury s Distribution Centre on Fleming Road, Waltham Abbey comprising a large modern cross-docked distribution warehouse extending to 704,780sq ft. was sold. The property was fully let to Sainsbury s Supermarkets Ltd until February 2030 which provided a term certain of years. We understand that Sainsbury s Supermarkets Ltd have significantly progressed in the installation of an extensive PV system which is incorporated into the roof. The property reportedly transacted above the asking price at approximately 107million which reflected a net initial yield of approximately 4.75% assuming purchasers costs of 5.8%. In May 2014, Standard Life acquired Hollywood House in Woking which comprised 43,440 sq ft of Grade A office accommodation across the ground and five upper floors. The property was recently refurbished by one of the tenants Skanska - to include sustainable elements including rooftop solar PV and rain water harvesting which earned a LEED Platinum rating for Commercial Interiors. The property was purchased for million which reflects a Net Initial Yield of 6.44% and equating to a capital value of 365 per sq ft assuming purchasers costs of 5.8% <=4kw kW >10-50kW >50-100kW > kW 1, > kW >250-5MW Standalones Figure 8: UK cumulative installed FiT solar PV capacity as at 31 July 2014 (MW) Solar PV: Shedding light on the opportunities 17

18 From the two transactions that we have identified, we understand that the installation of solar PV technology did not impact the liquidity of the assets and competitive bidding resulted in keen prices being achieved. The purchase price reflected the strong covenants present in both properties, the location of the asset and the weighted unexpired term across all tenants and the positive influence of the use of renewable energy sources. We anticipate that the use of solar PV on commercial buildings will become much more mainstream and as a result examples will become more common. 3.4 Property owners/occupiers that have adopted PV The number of corporate occupiers that are implementing PV is quite small at the moment, but we anticipate this will grow as solar PV become more mainstream. Segro has started to implement solar PV on a number of their industrial properties around the country. We understand that one of the latest properties to have this installed is at X2 in Hatton Cross, Heathrow. We believe the solar PV system was installed by Segro for the tenant, with all responsibility for the property being retained by the tenant. Sainsbury s has been installing solar PV on a large proportion of their portfolio including stores and distribution centres. In addition, it was reported by edieenergy that in July 2013, Sainsbury s had successfully installed 100,000 PV panels across 210 stores, making them the largest multi-roof solar panel operator in Europe. Skanska has also begun to install solar PV on their UK properties. We have seen evidence of this in the transaction for Hollywood House, Woking (3.3.1), but they have also installed solar PV on office properties in Bristol and works have started on a new development in the City of London called The Monument Building which will also incorporate solar PV. 18 Solar PV: Shedding light on the opportunities

19 50 Hanover Square installed by Solarcentury The Kingfisher group has installed solar PV in both Europe on their Brico Dépôt stores and in the UK on their B&Q stores. Notable examples in the UK include the installation of a 50kWp solar PV array on the roof of B&Q Taunton and the 168kWp solar PV array on the roof of B&Q Farnborough. B&Q are also now analysing the feasibility of installing PV on its freehold stores. Ikea has completed the installation of solar PV on all of their 18 stores in the United Kingdom. In addition to this, Ikea has started to sell residential solar PV systems for homeowners in their stores. Greggs the bakers has installed 10 solar PV arrays on their manufacturing sites across the UK to help meet their ambition of reducing its carbon footprint by 35% by In total Greggs installed 1.28MWp of PV. Solar PV: Shedding light on the opportunities 19

20 3.5 Rooftop solar PV asset/portfolio transactions To date we are aware of the sale of 24 rooftop solar PV assets in the global marketplace since 2011 as detailed in the table below. 19 of the 24 transactions (101 MWp) were for solar PV on commercial and industrial buildings while the remaining 5 transactions (56 MWp) involve solar PV on residential buildings. Country No. of transactions Installed capacity (MWp) Belgium Canada China France Germany Italy Spain Switzerland UK USA Total Transactions involving the sale of solar PV on commercial and industrial buildings include a variety of building types including: shopping centres, automobile manufacturers, cold storage warehouses, parking lots, and other commercial and industrial buildings. The five notable UK FiT rooftop solar transactions include: Aviva s c. 22m acquisition of an 11.4MWp UK residential solar PV portfolio from Zouk Capital in August Oxford Capital Partner s c. 16m acquisition of an 8MWp UK residential solar PV portfolio from Kingspan in May Aviva s c. 25m acquisition of an 8.6MWp UK commercial solar PV portfolio from Zouk Capital in July Aviva s 100m acquisition of a 23MWp UK residential solar PV portfolio from Homesun in August Aviva s 51m acquisition of a 12.3MWp UK residential solar PV portfolio from Ecovision Renewable Energy in July Solar PV: Shedding light on the opportunities

21 The limited number of transactions in the public domain, leads us to observe that the market for rooftop solar PV remains relatively immature and illiquid. However, we have noted that activity in this space is increasing as new developers and aggregators enter the market and the volume of funds raising capital on public markets or through closed funds increases. In addition we note a number of leading US rooftop installers have introduced innovative new financing structures to facilitate further deployment in the rooftop solar PV sector. The most recent of these was SolarCity s securitised rooftop Solar portfolio market offering including $201.5m of asset-backed notes secured by the cash flow generated by a pool of photovoltaic systems owned by SolarCity. The offering includes two tranches including $160 million of senior class notes with 4.026% interest and $41.5 million of junior notes bearing an interest of 5.45%. Both sets of notes will mature on July 20, Investor levels of interest vary depending on appetite for risk, stage of asset development and level of tariff rates available but we anticipate an increasing number of investors will seek exposure to this asset class as installed solar PV rooftop capacity rises and the number of aggregated rooftop solar PV portfolios increases. 3.7 Implication for commercial property valuations including solar PV In the current market context it is evident that while transaction data for properties with solar PV installed is scarce, investors recognise rooftop solar PV assets are valuable in their own right and should be valued accordingly. This approach to valuing rooftop solar PV assets is already evident in the transaction data for rooftop solar PV assets being bought and sold in isolation of a wider property sale. Investors purchasing these ring fenced rooftop solar PV assets will typically adopt a discounted cashflow valuation methodology when calculating individual asset values. Our view is this valuation methodology is the most appropriate means for valuing rooftop solar PV assets when transacted as part of a property sale. Under this approach the total value for a property sold with an accompanying solar PV installation owned by the seller will be the sum of a property valuation and a separate solar PV valuation. 3.6 Parallels with large-scale ground-mounted solar market While the commercial and residential rooftop solar PV market continue to develop, we are able to draw parallels with the large-scale ground-mounted solar PV market, which is more mature. Initially there were relatively few ground-mounted solar PV transactions, often led by niche industry investors. However, as deal volumes and market liquidity have increased, new investors, such as private equity, tax based and infrastructure funds have become increasingly interested in the sector. We are also now seeing low cost capital entering the sector via direct investments and through niche renewable yield based funds, albeit these investments are largely into secondary purchases of operating assets with a focus on larger portfolios. Solar PV: Shedding light on the opportunities 21

22 4. Ownership structures Agricultural buildings installed by Solarcentury 4.1 Overview Rooftop solar PV projects can have a variety of different ownership structures depending on who the landlord and tenant are and whether the installation is owned outright or by a third party. A typical project will involve contractual arrangements between the electricity consumer ( tenant ), the property owner ( landlord ) and the solar PV asset owner ( asset owner ). The figure below illustrates a typical flow of benefits for a rooftop solar PV project. The exact flow of benefits will depend on the relationships between these parties and the specific commercials relevant to the solar PV project. The weighting of the benefits flowing from the rooftop solar PV project is largely dependent on who has financed the solar PV project (tenant, landlord or third party) and the nature of the commercial risks relevant to each stakeholder. In determining a suitable commercial structure one must consider whether the solar PV project is owned outright or third party owned Purchase of system outright Where the solar PV system is owned outright the majority of benefits will flow to the property/asset owner through a return on investment without the need for a roof rental agreement. The property/asset owner will negotiate with the electricity consumer where relevant to agree a mutually acceptable PPA agreement. Electricity consumer Electricity payment Property owner Capital investment Asset owner Roof rental Solar PV lease Green power Return on investment Rooftop solar PV project Other power revenues Figure: Flow of benefits for a typical rooftop solar PV project 22 Solar PV: Shedding light on the opportunities

23 When purchasing the system outright, it is important to recognise that the responsibility of the maintenance and upkeep for the PV will be the landlord s Third party ownership In this scenario where the solar PV project is owned by a third party the majority of benefits will flow to the third party asset owner through a return on investment. However, the third party investor will also need to secure a roof rental agreement with the property owner or a mutually acceptable PPA agreement with the electricity consumer. The latter option will mean that the property owner/landlord of the property will not have to directly invest in the solar PV installations themselves but will also not receive any income. Instead the landlord will benefit through a preferential electricity tariff that can be passed on to future tenants improving the lettability of the property through both cheaper electricity that is available to the tenant and the opportunities for tenants to contribute towards their CSR objectives. The responsibility of the roof will be retained by either the Landlord or the tenant depending on the type of lease (FRI or IRI) however the installer will provide some form of guarantees for their installation on top of the guarantee from the manufacturer of the PV. This option will mean that the landlord is tied into a contract which can potentially impact the liquidity of the property and also day to day operations as the landlord will need to seek permission to remove/disconnect the solar PV installation if this were required for any particular reason. 4.2 Commercial structures In light of the possible ownership and contractual arrangements outlined above there are four typical commercial structures applicable to solar PV rooftop projects. Scenario 1: 100% client owned solar PV asset Purchase of system outright with all project returns accruing to asset owner Simple transaction Long-term warranties Up-front capital requirement Significant environmental statement On balance sheet Complete certainty on electricity pricing Scenario 2: Third party funded with roof rental agreement Property owner leases the roof in return for roof rental Standard documentation No up-front capital Rent approx 2.25 per sqm pa Tenant or landlord commits to market rate index linked PPA We note that there has been very little interest in the market place for this option due to the low returns generated for both the landlord and the third party operator. Scenario 3: Third party funded with direct PPA arrangement Property owner leases the roof in return for low-cost PPA Standard documentation No up-front capital Tenant and/or landlord benefits from a below average index linked PPA Scenario 4: Joint Venture Property owner co-invests in solar asset Asset co-owner receives either: - free electricity in return for investment (effectively pre- buying electricity for 20 years); or - a percentage share of project returns (assuming market PPA arrangement) Requires up-front capital input Solar PV: Shedding light on the opportunities 23

24 4.3 Commercial ownership structures We believe that there are a number of options available to a property owner when installing solar PV. These are illustrated below: Different options available for PV Installation Comments Option Landlord Tenant Sub-lease option Installation during construction period Acquires a sublease for the roof space in order to install the PV Puts in place a PPA in order to sell the energy back to the tenant at an agreed rate Insures the PV with installer roof warranty as a backup Pre-lets the property and agrees with the tenant to install the PV Retains FRI liability for the roof Pre-lets the property on an FRI basis Installation postconstruction Installs the PV for the tenant Puts a PPA in place in order to sell the energy back to the tenant at an agreed rate Landlord receives income from PPA and FiTs Retains FRI responsibility as originally agreed in the existing lease. We believe that the most attractive option to a landlord would be the installation of the panels during the initial property construction period or during refurbishment (new build or retrofitting) with the occupier retaining responsibility for the roof. 24 Solar PV: Shedding light on the opportunities

25 5. Valuation methodology Kings Cross Eastern Goods Yard installed by Solarcentury 5.1 Valuation methods Following our investigations and numerous conversations with fund managers and valuers, there appears to be a high level of inconsistency in the valuation approaches adopted in relation to solar PV. This relates principally to the lack of knowledge on the subject which results in an unsophisticated approach to the methodology. We consider the Discounted Cash Flow method to be the most appropriate method of valuation as this can analyse the value based on a number of sensitivities. We would use this method to ascertain the value of solar, by discounting the net present value of the projected income with relevant costs deducted at an appropriate discount rate. The method is advocated in the RICS information paper titled The Valuation of Renewable Energy Installations. The revenue consists of the FiT or ROCs (and associated certificates), power purchase agreement and/or exporting electricity to the grid. In our examples we adopt the relevant FiT, the on site electricity price (cost of electricity to the tenant) and LEC payment to arrive at the relevant revenue rate pence per kwh. The costs are the maintenance and insurance which are deducted to provide the net cash flow over the term. Generally solar PV installations are not considered to have a residual value at the end of the term. However, the system will continue to generate and save electricity as the lifetime of the panels which is approximately years. The term is generally considered to be 25 years in line with the term that the FiT or ROCs are receivable. Other assumptions adopted when appraising a solar PV array include degradation of 0.9% in year one, followed by 0.4% per annum thereafter which relates to how the efficiency for a panel deteriorates over time. Installation costs vary depending on whether the panels are installed at the time of construction or retro fitted, but the industry assumption is approximately 100 per sqm. We have adopted annual running costs of circa 15 per kwp and insurance of 5 per kwp in our examples. Following discussions with our renewable energy investment team, we have adopted a discount rate of 9% reflecting the return investors are demanding given the risk profile associated with the rooftop solar PV market and the government backed income from the FiTs and ROCs. The other important determinant of whether installing solar PV is viable is the payback period which typically ranges from 5-9 years depending on the level of incentive and whether the electricity is being sold to the tenant via a power purchase agreement or back to the national grid. 5.2 Valuation scenarios In order to demonstrate the approach to valuation we have considered a number of scenarios which we detail below Industrial property The preferred model from a landlord s perspective is to maintain a FRI lease with the tenant remaining responsible for the maintenance of the roof. Included within our valuation approach is the cost of insuring the roof against disruption to business arising from any problems from the installation which aligns the agreement to a FRI lease. Should the property be let on a FRI basis then the rental income from the property is capitalised using a traditional valuation approach and the solar panel income valued separately using the discounted cash flow approach and added to the property capital value to provide the total value. We set out our examples on the following pages. Solar PV: Shedding light on the opportunities 25

26 South East distribution warehouse Assumptions Property type: Distribution warehouse Location: South East Roof area: 100,000 sq ft Solar PV roof coverage: 25-30% Roof area ( sq ft) 100,000 PV installation system size (kwp) 249 Annual power output (kwh) 217,875 Solar PV installation costs 291,000 Power output (kwh/kwp) 875 Degradation (annual post 1st year) 0.4% First year degradation 0.9% Total revenue (p/kwh) Feed-in Tariff (July 2014) (p/kwh) 9.89 On site electricity price (p/kwh) 8.00 Export price (p/kwh) 4.77 Percentage consumed on site 100% LEC (p/kwh) 0.54 LEC term (years) 10 FiT term (years) 20 LEC & FiT (p/kwh) RPI 2.5% Energy price inflation 4% Installation costs ( per sq m) 117 Annual running costs ( /kwp) 15 Insurance costs ( /kwp) 5 Annual gross income 40,154 Nominal gross income over 20 years 803,000 Annual net income 35,374 Nominal net income over 20 years 703,500 IRR 12.85% Payback 8 years 26 Solar PV: Shedding light on the opportunities

27 Valuation Floor area 100,000 Indicative rent per sq ft 5.75 FRI? Yes Annual rent 575,000 Net initial yield 5.50% Value 9,900,000 Net income from solar 35,174 Solar income discount rate 9.00% NPV of solar income 419,400 Solar income yield 8.0% Solar value 415,600 Total income 610,000 Value 10,300,00 Net initial yield 5.6% We have adopted the investment method for valuing the rental income paid by the tenant which is standard market practice for an income producing warehouse property. We have therefore capitalised the estimated rental value at net initial yield of 5.50% to provide a capital value of 9,900,000. Using a discounted cashflow we have then valued the net income and operating expenditure from the solar PV installation at a discount rate of 9% providing a net present value of in effect the additional net income stream of 419,400. Reflecting the net income in the first year is 35,174, our equivalent capital value through the standard investment method means adopting a capitalisation rate of 8.00% for the term of the life of the solar PV to achieve the same result. The capital value of the whole property is approximately 10,300,000 reflecting a net initial yield of 5.6% overall. In summary, a modern industrial unit benefitting from 25-30% roof coverage of solar PV provides a payback period of 8 years and additional secure indexed income that adds value to the property asset. In addition, in the case of this example, the extra value created by the capital investment is significantly greater than the cost demonstrating the strong return on the investment. Solar PV: Shedding light on the opportunities 27

28 Midlands manufacturing facility Assumptions Property type: Manufacturing facility Location: Midlands Roof area: 750,000 sq ft Solar PV roof coverage: 45-50% Roof area (sq ft) 750,000 PV installation system size (kwp) 3,750 Annual power output (kwh) 3,187,500 Solar PV installation costs 3,750,000 Power output (kwh/kwp) 850 Degradation (annual post 1st year) 0.40% First year degradation 0.9% Total revenue (p/kwh) Feed-in Tariff (July 2014) (p/kwh) 6.38 On site electricity price (p/kwh) 8.00 Export price (p/kwh) 4.77 Percentage consumed on site 100% LEC (p/kwh) 0.54 LEC term (years) 10 FIT Term (years) 20 LEC & FiT (p/kwh) 6.92 RPI 2.5% Energy price inflation 4% Installation costs ( per sq m) 100 Annual running costs ( /kwp) 15 Insurance costs ( /kwp) 5 Annual gross income 475,575 Nominal gross income over 20 years 9,511,500 Annual net income 400,575 Nominal net income over 20 years 8,011,500 IRR 11.22% Payback 9 years 28 Solar PV: Shedding light on the opportunities

29 Valuation Floor area (sq ft) 750,000 Indicative rent per sq ft 4.50 FRI? Yes Annual rent 3,375,000 Net initial yield 5.25% Value 60,750,000 Net income from solar 400,575 Solar income discount rate 9.00% NPV of solar income 4,830,000 Solar income yield 8.00% Solar value 4,730,000 Total income 3,775,575 Value 65,500,000 Net initial yield 5.45% In the previous example the solar PV installation was installed on approximately 25 35% of the roof space and consequently the proportion of total income generated by the solar PV array was relatively small. In this example we consider the impact of a solar PV system covering nearly 50% of the roof. This enables a PV installation of 3.75MWp. We have assumed for demonstration purposes that the unit is let on sale and leaseback basis on a 15 year lease to the tenant on standard FRI terms. In this example, the property is situated further north than our first example and therefore the irradiation level is not as high. The Feed-in Tariff is also lower due to the large size of the system. This results in a lower IRR and consequently a slightly longer payback period. We again adopted the standard investment method for valuing the income created by the lease to the tenant and have applied a net initial yield to the distribution warehouse of 5.20% to provide a capital value of 60,750,000. Using the discounted cashflow model, we have then valued the net income and operating expenditure from the solar PV at a discount rate of 9% providing a net present value of 4,830,000. Reflecting the net solar income in the first year of 400,575, using the investment method our equivalent capital value of 4,730,000 is calculated through adopting a capitalisation rate of 8.00% for the life of the solar PV. The capital value of the whole property is 65,000,000 reflecting a net initial yield of 5.45% overall reflecting standard purchaser s costs. In summary, this example observes a higher impact on the overall yield due to the larger system size but provides an increase in value reflecting the substantial additional income provided by the revenue generated by the solar PV. As a result the significant investment in solar PV on this type of scale is of substantial benefit to the landlord and the tenant. Solar PV: Shedding light on the opportunities 29

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