Despite the scarcity of tax equity, the market-leading tax equity sponsors will continue to be successful in originating new pipeline and securing available tax equity capital.
The extension of the ITC and bonus depreciation continues to drive a strong solar market; however, it also exacerbates the tax equity “bottleneck” experienced by many developers and investors. Looking ahead to 2017, tax equity scarcity will likely grow. In January, we estimated that $10 billion in solar tax equity would be needed annually, on average, over the next five to seven years. Bonus depreciation limits the tax appetite of investors active in other infrastructure asset classes, and the prospect of corporate tax reform, depending on actions taken by Congress and the Trump administration, could create further shortfalls.
In the interim, as EPC prices continue to fall, tax equity investors will be asking themselves, “Where’s the upside?” Sponsors hoping for investors to accept lower returns in 2017 than 2016 will likely be disappointed. We expect pricing to be consistent or lower than 2016. As always, sponsors should be wary of offers that are too good to be true, asking tough questions about the source of the capital, the status of the commitment, and track record on execution with the proposed partner.
Nevertheless, despite this scarcity of tax equity, the market-leading tax equity sponsors will continue to be successful in originating new pipeline and securing the limited tax equity capital that is available. The secondary constraint on growth of sponsor portfolios may actually be their ability to adequately capitalize their daily functions while having enough to spare to seed the Sponsor portion of on-balance-sheet structured assets.
Sponsors must put in a limited amount of the capital stack, perhaps five to twenty percent, with exact numbers depending on the terms they receive from debt and equity versus the cost to build the project. Capital-constrained sponsors want to leave as little cash sitting in a project as possible, as the cash returns to the sponsor are usually minimal until the tax equity investor flips out of the structure, and perhaps not even then if the project is heavily leveraged. A sponsor without access to sufficient equity capital or financing may have to start selling a larger percentage of their pipeline to generate current-year revenue and keep the machine running.
Sponsors’ investments will certainly pay off in the long-term, but the fact remains that they must balance investing in their operational portfolios while also continuing to develop new assets. We will be watching closely to see how the industry’s most mature players evolve their business models to sustain this growth, and how others in the market will follow. In the meantime, Sol Systems is actively securing partners for 2017 tax structured transactions. Developers interested should send project details to finance@solsystems.com.
This is an excerpt from the November 2016 edition of The SOL SOURCE, a monthly electronic newsletter analyzing the latest trends in renewable energy based on our unique position in the solar financing space. To view the full Journal, please subscribe or e-mail pr@solsystems.com.
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