www.pwc.com/cleantech Financing US residential solar: Owning, rather than leasing, will bode well August 2015
Executive summary Over the past few years, the third party ownership (TPO) model has served as the primary financing mechanism for the residential solar industry. However, we believe this is about to change: our financial models, which look at the net present value (NPV) of installations across the 50 US states, indicate that the industry is reaching a tipping point. Due to a confluence of declining hard and soft costs, changing public policy, and increasing availability and accessibility of capital, among other factors, solar loans are anticipated to offer consumers considerably more value than leases. As a result, in the coming years, we expect an increasing proportion of consumers will choose to own the photovoltaic (PV) systems on their roofs rather than lease such systems or buy power from third party developers. If the current residential system price trends continue, this shift in financing could be significant, with homeowner financed systems potentially dominating the financing landscape in 3-4 years. We suggest solar industry participants monitor the evolving landscape of the solar financing industry with increased scrutiny. Having a clear view on how regulatory changes will impact net metering, understanding the economic drivers of the industry, and being familiar with regional differences will help uncover significant business opportunities and help avoid potential disruptive risks to established business models. The rise of third party ownership Eager to save money on energy bills, protect the environment, and reduce reliance on fossil fuels as well as grid-supplied electricity, Americans have committed billions of dollars to putting PV systems on the roofs of their homes. As more residential consumers demand rooftop solar, the question of how those installations will be financed is on the minds of capital providers, policymakers, the solar industry itself, and, of course, US consumers. Cumulative installed residential solar capacity rose from 50 megawatts (MW) in 2003 to over 3.2 gigawatts (GW) in 2014, a compound annual growth rate of 46% 1. Strong demand is expected to continue, with the National Renewable Energy Laboratory (NREL) projecting cumulative residential solar installations to potentially total 20,000 MW by 2020, or roughly 5% of the US single-family home market 2. 1 U.S. Solar Market Insight. Rep. Solar Energy Industries Association, 9 June 2015. Web. 2 Drury, Easan, Paul Denholm, and Robert Margolis. Modeling the U.S. Rooftop Photovoltaics Market. Publication. Phoenix: National Renewable Energy Laboratory, 2010. Print. NREL/CP- 6A2-47823.
Over the last several years, third party ownership (TPO) financing has been a key growth driver of the residential solar market 3. In a TPO model, a third party provides the upfront capital to pay for the system while homeowners commit to paying monthly lease fees or a fixed rate per kilowatt-hour (kwh) based on a power purchase agreement (PPA). TPO financing has done much to help spur the adoption of solar energy in the US, making solar accessible to a larger portion of the population. An inflection point for TPO market share While the TPO model has been the go to financing vehicle for the past few years, it is being challenged by the increasing popularity of loans. Many solar developers and financing providers such as Clean Power Finance, Sungevity, SolarCity, and Vivint are offering consumers the choice between loans and leases. Their goal is to get more PV systems on rooftops and secure customers; whether it makes sense to finance these systems via direct ownership or TPO will be determined by the market, which seems to be moving in the direction of the former. According to the California Solar Initiative, leasing accounted for 13% of the residential installed capacity in California (the largest residential solar market in the US) in 2009; it then soared to over 70% in 2012 and 2013, before declining slightly to 66% in 2014 4. GTM Research confirms this trend: they forecasted that 2014 would be a peak year in terms of TPO financing in the US (72% TPO share) and expect direct ownership to surpass TPO by 2020 5. How sustainable is this trend, what is driving it, and how do regional dynamics impact the situation? To find out, we developed several models to evaluate the net present value (NPV) of solar rooftop installations in the 50 US states under direct ownership versus TPO (i.e., solar leasing or PPA). We ran sensitivity analyses applying a set of eight parameters: loan interest rates, amount of down payment, lease escalation rate, monthly lease fee, electricity retail rate, electricity retail growth rate, daily solar irradiation (kwh/m 2 /day), and assumed level of the investment tax credit (ITC). We then observed the fluctuations of projects NPVs when these key value drivers were modified in a range of scenarios. The results of the simulations suggest loans should capture a significantly higher share of the residential rooftop solar financing market over the next few years, potentially dominating the financing landscape as early as the end of 2017. At an aggregated level, the tipping point between loans versus TPO appears to be an installed cost of about $3 per watt not much different than current prices. At that price point, a 5kW PV system (the average size for a US home) would cost about $15,000 before incentives. It is important to note that the situation varies considerably from state to state and 3 Third-party ownership (TPO) designates a situation where the homeowner leases the solar system that was installed on his/her roof by a third party (and thus the homeowner does not own the system) as opposed to direct ownership, where the homeowner purchases the system in cash or uses a loan to buy it. Cash acquisitions have the best NPV in all configurations but are still pretty rare, as system costs average $20,000 (for an average 5kW system). 4 California Solar Statistics Current Working Data Set. Rep. California Energy Commission, Aug. 2015. Web. 5 Litvak, Nicole. "U.S. Residential Solar Financing 2015-2020." GTM Research. Greentech Media, Inc., 29 July 2015. Web.
sometimes within a state depending on the city or location due to the important impact of solar irradiation on the NPV. Our sensitivity analyses also revealed that loan rate, amount of down payment, and retail electricity rate are among the most powerful drivers of NPV differences between the two financing scenarios (TPO versus direct ownership). Therefore, an industry player interested in understanding the tipping point for a particular region needs to run a detailed simulation with the market conditions for that area. System costs still falling There are several reasons for the increasing attractiveness of the direct ownership model via solar loans. One of the primary drivers is declining cost: rooftop PV is simply becoming more affordable. Systems costs are typically broken down into hard costs, which are primarily driven by the price of solar modules, and soft costs which include a number of different project-related costs required to develop, finance, and install the system. Hardware costs have historically played a key role in reducing the average installed system price. While the US price of installed PV systems was about $10 per watt a decade ago, it fell to approximately $3.50 per watt in 2014 6. Much of the price reduction can be attributed to the price of PV modules, which experienced a significant decline due to a fierce competitive module manufacturing environment as well as improvements in the manufacturing process of solar cells. On the other hand, soft costs are still relatively high in the US, as evidenced by Figure 1, which illustrates the findings from a study conducted by the Rocky Mountain Institute with Georgia Tech in 2013 7. That study found that residential solar installed costs in the US were more than double the costs in Germany, essentially due to the gap in soft costs, which are almost four times higher in the US. Our extensive work in the solar industry corroborates that this gap is still significant today, and represents a key challenge to growth and higher profits. 6 Munsell, Mike. "Solar PV Pricing Continues to Fall During a Record-Breaking 2014." Greentech Solar. Greentech Media, Inc., 13 Mar. 2015. Web. 13 Aug. 2015. 7 Morris, Jesse, Koben Calhoun, Joseph Goodman, and Daniel Seif. Reducing Solar PV Soft Cost: Focus on Installation Labor. Rep. Boulder: Rocky Mountain Institute, 2013. Print.
Balance of Systems Financing US Residential Solar: Owning, rather than leasing, will bode well Figure 1: Solar PV installed costs for the U.S. and Germany 2012-2013 $4.93 $1.22 $1.22 Soft Costs $0.55 Installation Labor $2.21 $2.16 Margin Financing and other Costs* $0.19 PII** $0.44 $0.28 Hardware Inverter $0.48 Customer Acquisition $0.33 $0.83 Module German Average Residential System Price U.S. Average Residential PV System Price U.S. Soft Costs German Soft Costs Source: Reducing Solar PV Soft Cost: Focus on Installation Labor, Rocky Mountain Institute * Includes installer and integrator margin, legal fees, professional fees, financing transactional costs, O&M costs, production guarantees, reserves, and warranty costs ** Permitting, inspection, and interconnection costs The most significant soft costs are financing, customer acquisition, and installation labor. Leading installers understand this well, and are working hard to pursue initiatives that reduce such costs and push prices down, further contributing to the expansion of the market. Some installers are acquiring companies that make installation easier and faster, reducing balance of system costs. Others are partnering with retailers, car dealers, and cable providers as well as leveraging telemarketers and other lead generation companies to bring down the cost of acquiring new customers. Since the US market is still relatively immature, education is a critical component of the sales process, making the sales cycle longer and the actual cost of acquiring new customers more expensive than more mature markets like Germany. Finally, as installers offer consumers a broader array of solar financing options; the cost of financing should go down, as the risk profile of those who take out a solar loan is generally lower than a typical credit card customer. Just how far could prices decline? The US DOE s SunShot initiative seeks to lower the installed cost of rooftop solar to $1.50 per watt by 2020. In a recent interview, David Feldman, an analyst with NREL, indicated that while there is still considerable uncertainty as to how low PV system prices will drop in the next five to ten years, there appears to be an emerging consensus that SunShot s price reduction targets are within reach and are more and more likely to be realized 8. 8 Spross, Jeff. "U.S. Solar Is 59 Percent Cheaper Than We Thought It Would Be Back In 2010." ThinkProgress RSS. ThinkProgress, 22 Oct. 2014. Web.
Even if SunShot s goal is not fully realized, it seems highly likely that residential solar installation costs in the US will decline in the coming years. The diffusion of best installation practices, the use of innovative sales and marketing programs, and improved access to low-cost capital will all contribute to lower soft costs and therefore more affordable PV systems in the future. Macro forces supporting the rise of loans We expect TPO momentum to slow down as the value proposition for the direct ownership model becomes more compelling. At least five factors support this trend, which will significantly impact the industry for years to come. ITC decline: At the end of 2016, the federal tax credit for residential installations will expire and will decline from 30% to 10% for commercial and investor owners. This may make TPO models relying on tax equity investors less attractive and force developers to find alternative sources of financing. Tax equity financing, thanks to the incentives offered by the ITC, was a major factor in the dramatic expansion of the rooftop solar market under the TPO model. Loan accessibility: With minimum FICO scores required between 650 and 750 (depending on the amount borrowed), loan accessibility is not much different than that of solar leases, where a typical FICO score requirement is 700 according to various publicly available sources such as NREL 9. And as solar loans become more commonplace and gain the type of acceptance traditionally associated with consumer loans or automobile loans, their adoption rate should increase. Loans availability: Loans are becoming increasingly available. Several major solar developers (e.g., SolarCity, SunPower, and Sungevity, among others) now offer solar loans in partnership with banks; SunPower s co-marketing of solar loans with Admirals Bank is a case in point. Solar financiers such as Clean Power Finance also offer leasing as well as loan financing options. Finally, homeowners have the option of using a home equity line of credit to finance a solar system. Financial innovation: New business models related to loans are emerging and increasing the pool of available capital. In October 2014, crowd-funding platform Mosaic announced it raised $100 million to finance solar loans, backed by PartnerRe, a reinsurer 10. Other mechanisms such as PACE financing offer homeowners the opportunity to own a PV system by taking out a loan with their local government and paying the loan back via an assessment on their property tax bill. 9 Speer, Bethany. Residential Solar Photovoltaics: Comparison of Financing Benefits, Innovations, and Options. Rep. Parkway Golden: National Renewable Energy Laboratory, 2012. Print. NREL/TP-6A20-51644. 10 Goossens, Ehren. "PartnerRe to Fund $100 Million of Mosaic Home Solar Loans." Bloomberg.com. Bloomberg, 20 Oct. 2014. Web.
PV integration in new homes: Costs are dramatically reduced when residential solar systems are incorporated into new homes at the construction stage. Not only do customer acquisition and installation costs fall, but financing costs are lower, as mortgage lenders can roll the cost of the solar system into the homeowner s loan. In addition, homebuilders are forging partnerships with solar developers (e.g., KB Homes and SunPower) to market real estate already equipped with solar systems, encouraging consumers to buy homes with panels already on the rooftops. Another approach has been introduced by Lennar Corporation, where the homeowner has two options: they can either buy a home with a PV system installed or they can purchase a home without a PV system and sign a PPA with Lennar s energy affiliate. Such a PPA would allow the homeowner to receive a 20% discount off prevailing retail electric prices. Micro forces supporting the move to loans There is a second cluster of factors, which we will call micro forces, which boost the NPV of loans, and thus support the continued shift to loans and away from the TPO model. Below we have listed some homeowner-level financial forces accelerating this trend: Federal tax credit and other incentives: Under most lease terms, all the incentives go to the actual investors in the system. But in the case of a loan, incentives flow to the homeowner. In addition to the federal homeowner tax credit, which currently provides tax credits worth 30% of the installed system cost, there can be various state and city tax credits, rebates, and performance-based incentives that make ownership even more attractive. Full ownership of incentives lowers financing costs: Lower systems costs make ownership more affordable, reduce the cost of debt in absolute terms, and allow system owners to fully realize the gains on their bills. This is in contrast to TPO systems, where homeowners typically have to split the gains with a leasing company. Electric rates: Utilities across the country are facing large and rising capital costs for environmental cleanup, new generation construction, new transmission system construction, and distribution network expansion and reinforcement. These capital outlays will be recovered through higher retail electricity prices. In such an environment, a loan with fixed repayment terms is advantageous to a TPO system because it locks in power at a fixed price; leases, on the other hand, often come with annual rate escalations of 1% to 2%. Terminal value: When consumers lease a PV system, they do not own the asset at the end of the lease agreement. However, in the case of a loan, the user will own the system when the loan is paid off. Therefore,
the system s terminal value represents a positive NPV to the homeowner. When the loan is fully repaid, usually after 15-20 years, solar panels will typically have another 10 or more years of useful life. That added life constitutes substantial economic value, even factoring in system efficiency losses of 0.5% per year. What s ahead? While the aforementioned market forces provide impetus for the primary financing model to shift from TPO to loans, the overall growth of the residential solar market is highly dependent on net metering policies or some form of compensation for solar electricity production. At this time, several states are reassessing their tariff structure and net energy metering laws. For example, in California, the CPUC issued a statement in 2013 authorizing solar purchasers who commenced or will commence service by July 2017 to operate under net metering for 20 years. By the end of 2015, the Commission will decide what the rules will be for customers who net meter after July 2017 as well as for existing customers after the 20 year transition period has expired. The outcome of this process could seriously impact the solar residential market as a whole (loans and leases included), but at this stage, it is hard to predict what the CPUC will do. Given market conditions, we see rooftop PV loans capturing a significantly bigger share of the overall market from the TPO model in the coming years. However, solar TPO may continue to remain popular in select markets where conditions are not favorable for direct ownership, (e.g., where there is limited availability of affordable loans) or for more expensive systems (e.g., if PV is combined with storage and/or other systems). TPO may also remain attractive for large-scale residential developers who can aggregate enough rooftops to get to an investment tax credit (ITC) value that makes to sense to finance with tax equity, even with a tax credit of 10%. A shifting balance of power The shift from TPO to direct ownership has deep business implications which go beyond project financing. Business and profit models will have to be adapted. Compared to a market dominated by third party ownership, a direct ownership market should theoretically be more competitive when it comes to installation prices and customer acquisition. Plus, a wider availability of financing solutions will fuel market growth and accelerate sales, and financing will no longer be a differentiating factor for some solar developers unless they adjust their business model. As the balance of power shifts towards the consumer, traditional retail business success factors will be more prominent than ever brand, quality of service, value for money, customer reach, and capacity to innovate will differentiate the leaders from the rest of the pack. As a result, industry participants would greatly benefit from examining their current and potential financial partners, financing offerings, value propositions, and marketing strategies to ensure alignment with the significant market changes expected on the horizon.
Contacts Brian Carey US Cleantech Advisory Leader brian.d.carey@us.pwc.com 408 817 7807 Benjamin Cros Director benjamin.x.cros@strategyand.us.pwc.com 408 817 7871 Debi Gerstel US Cleantech Practice Chief of Staff debi.gerstel@us.pwc.com 206 398 3607 2015 PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.