Friday, April 10, 2020

SolarInvest2020: Residential Solar is Good, but Commercial Solar can be Crazy Profitable!

Business/Commercial Solar can be crazy profitable.
Consistently three-fourths or more of people surveyed believe that renewable energy – especially solar – is good and that we should do more solar on the buildings where the sun shines consistently. But is doing the good thing of going solar a good financial investment?
Solar for residential can be a very good investment, but for businesses, solar can be crazy profitable. One reason it is such a good investment is the safety of producing your own power. If the home or business is to be used, you are already committing to the electric power to operate it. So, the decision to go solar is more like an own-verses-rent analysis: do you want to own your own power generation, or rent power indefinitely. You still need power either way.
In every case, even for the power utilities, the federal government offers a Solar Investment Tax Credit (ITC). Instead of paying taxes to the IRS, you save the amount of the investment tax credit. The ITC for 2019 was 30% of the qualifying investment which has been a wonderful incentive to install renewable power including solar, wind and qualifying battery backup. The ITC dropped down by 4% in 2020 to 26%; it drops again by 4% in 2021.* After 2021, the ITC drops off a cliff, to 10% for businesses and zero (0%) for residential.* Some states have renewable incentives as well, so the analysis might be even better than the profitability for residential and businesses described here.
* Update: As of January 2021 the ITC has been extended at 26% for 2021 and 2022. See Discussion at SEIA.

Residential, a Good Investment

For residential, a $30,000 system would have an investment tax credit of $7,800, meaning that the net investment is only $22,200 once the tax benefits have been realized. Savings each year might be about $1,560 ($130/mo) or 7% of the net investment. Stated differently, the savings that you do not pay the power company could be 7% or more of the net investment each year, assuming the power company does not raise rates. If the power company raises rates 1% per year, on average, the savings would be more like 8%+ per year. However, the solar investment is actually a better investment than the 7% to 8% return might imply.
The really big difference between buying a solar system to produce your own power and other things you might buy, say a car, is savings vs spending. As long as the house is being used, you (or your renter) are committed to paying for power. So, you are already committed to spending $130 to $200 per month, you simply wait for the bills to come in. If you could have a loan (for maybe 15 years), the payment would be less than what the power bill would have been; you would be cash positive compared to the utility power option that we have come to expect. Some loan packages for solar include interest only initially, let the homeowner apply the tax credit to the principle, and them pay off the loan in regular payment for 10 or more years; every month would likely be cash positive compared to utility power. Of course, once the loan (or home equity line of credit) is payed off, the power generated is free for decades.
Savings has another paradox. Going out and buying a car for $30,000 on loan, gives you a monthly payment of maybe $677 per month (4 years, 4%) or $8,265 each year. You use after-tax income to pay car loan payments, so your disposable income reduces by almost $700 per month for four years. If your marginal income tax rate is 23% (not average tax rate), you would need an additional $200 before taxes, for about $900 per month in gross income to cover the car payments.
One more point on the car example. The net asset value is what you can sell it for, after you pay off the loan. For several years, you will owe more on the car than you can sell it for. After the loan is payed off in 4 years (or more), the vehicle will probably be worth only about $10,000, just a third of what you paid. In the solar example, the house is cheaper to operate because of the free power generated, so it is reasonable to expect that the house will appreciate by more than the price of the solar system. Mortgage lenders account for the increase in purchasing power of the buyer because of improved operating costs. (TIP. When considering buying a house, call the utilities and ask about the operating costs associated with electric, water and gas.)
These same concepts apply as well to businesses, but with additional possible tax benefits.

Solar Example in 2020 for Business, Crazy Profitable

Let’s work an example for a business that owns their building and is considering a $100,000 solar investment that would save about $7,200 per year in utility power charges (a straight-forward case that does not have something called Demand charges). Assume that this is a limited liability (LLC) or S corporation where the marginal tax rate for the shareholders is 33%, and all profits and losses pass through to the shareholders for tax purposes.

First there’s the $26,000, 26%, tax credit that reduces the tax liabilities, dollar for dollar. This is $26,000 that you simply do not pay out to the IRS. Then there’s the possibility of 100% depreciation of an asset in the first year, so the $28,710 tax shield is based on the reduction in net income based on depreciation. (The tax shield is equal to the tax rate times the amount of depreciation; the asset bases is reduced by half of the ITC, or 33% of $87k.) Therefore, the actual investment is only about 45% of the solar system costs once all the tax benefits of the investment are realized. If the power savings are $7,200 yearly (assuming no increases in power costs), then there’s 15.9% return on net investment each year. Simple payback is about 6 years! Net Present Value (NPV) of the investment is $72k, almost double the net investment. (A positive NPV means that you get your money back, in present value terms, and then some.)
That is crazy profitable for a long-term investment. It is especially profitable when considering that the business is already committing to paying for utility power indefinitely. So, taking a loan for 10 to 15 years could result in loan payments that are lower than what the payments would be for utility power, especially when considering that the power company raises rates (you should figure at least the rate of CPI inflation). At 2% power inflation, the NPV of the investment jumps to $105k, and a massive profitability index of 3.33. (The profitability index is often the best measure for comparing investment alternatives because it is a multiple of the present value of the returns based on the size of the investment – in this case, the size of the net investment. Anything greater than 1.0 is a positive investment.)

Solar is a Different Kind of Investment

There are three major points, however, that make this different from most typical investment analyses. (Four, really, if you were to discuss the environmental savings, but that’s another discussion.) First, the money you’re spending is committed money for power as long as the business is open and operating. Taking a loan to buy the solar system might prove to be cash positive indefinitely. Take $100,000 loan; pay interest only of $4,500 (4.5%) for first year or two until you realize the tax benefits of the solar ITC and depreciation; apply the tax savings to the loan; and then make payments on the loan for 8 years. The loan payments should be several hundred dollars less per year than what you would have paid in electric bills, especially as the cost of power from the utility company increase over time. Once the loan is paid off, the value of the power that you generate for yourself is pure profit!
Speaking of profit, here is the second point. Every dollar you reduce your power bill is savings, which is better than profits – profits are taxable. Things like smart thermostats, insulation, weather stripping, adjusting habits/processes, etc. might result in reducing the power bill by 5% to 25% with little or no out-of-pocket costs. That could result in a perpetuity of savings. If the firm’s cost of capital is, let’s say 8%, then the present value of the perpetuity of savings of $1,200 per year ($100/mo) would be $15,000 in present value terms ($1,200 / .08). Plus, being more energy efficient means that a smaller solar system is required when going solar. (But, 2% power inflation makes the PV of the perpetuity up to $60k present value.)
An even more interesting concept related to energy savings is looking at the sales volume required to equal the $7,200 savings annually. If the firm has a 10% profit margin, the required sales to cover the power bill is $72,000 per year (once the loan is payed off). In the current loan example, cash flows (savings really) are positive every year and go up based on power inflation. When the loan is payed off in year 11 you start to realize huge savings.
By the way, someone buying this property would pay more for the business because it comes with “free” electricity. A Lawrence-Berkley study found that some properties would appreciate by as much as 20 times the annual electric savings. Therefore, the property might be worth about $144k more based on 20 times the $7,200 annual savings. Since the net investment after taxes in this example is about $45k, the property could appreciate almost $100k more than the net solar investment. That’s a property appreciation of about 2.2 times the net investment.
The last point is related to structure, or infrastructure. If the fixture or structure is necessary to put up solar, then some or all the structure might be subject to the renewable investment tax credit. Let’s add an additional $100,000 investment in carport/canopy to support the solar panels.  You talk with your favorite accountant and she agrees that the entire structure qualifies for the investment tax credit. That’s an additional $26,000 in tax credits to help pay for the solar system; these tax credits are only possible if you do the solar system. This reduces the net investment for the solar system from about $45k to about $19k. Payback is now less than 3 years; on a system that should still be producing power 30 to 40 years from now.

Solar: From Good to Great

Solar is a good investment for people and organizations that pay no taxes at all. Good for the environment, but not necessarily a great investment. Still, the investment is with money that you were already spending anyway, so that’s cool. The 26% Solar ITC improves the investment substantially for anyone who pays taxes. For businesses that are high tax brackets, solar can be a great investment, possibly even crazy profitable.
In many states and other countries, there are additional incentives for renewable energy. California and many New England states have a price on carbon, so there’s extra money to be made by selling Renewable Energy Credits (RECs). Most companies now report on their sustainability initiatives to investors. Being more socially responsible can be good public relations and great publicity. Doing good – like reducing your carbon footprint and helping to improve the world’s situation – is very rewarding all by itself. With renewable energy, it can be very profitable to do good. Even better!
Notes. There are a couple key points to keep in mind. You may want to produce only the power that you expect to use, the power utility typically pays only a small rebate per kilowatt hour if you overproduce beyond what you use. The business example shows 100% depreciation in the first year that some small businesses might be able to realize; the IRS has a 5-year accounting life for solar assets. Each state may have different incentives (or roadblocks) from the state Public Service Commission (PSC). Some solar companies offer a lease option which might be a good alternative is some situations. Not all solar companies and solar systems are created equal, nor are the warranties. Look for full warranty over at least 25 years for everything including parts and labor. Different solar panels have different depletion rates ranging from a tiny 0.25% to a high of about 0.60% per year (resulting in an estimated 92% to 80% efficiency by the 30th year, respectively).

* Update: As of January 2021 the ITC has been extended at 26% for 2021 and 2022. See Discussion at SEIA.

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