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Introduction: Our country is undergoing a major transition to a clean, sustainable energy ecosystem that is dependent upon the integration of renewable energy resources into our existing energy infrastructure. One
Industrial property owners in particular are increasingly turning to rooftop solar facilities to add value to their portfolios and maximize the profitability of their assets, as well as to increase renewable energy sources for the greater good. While the general principles of commercial leasing apply to rooftop solar leases, there are a few issues that are unique to solar rooftop leasing.
Property owners looking to investigate rooftop solar should be aware of the following issues.
Typical Deal Terms: Generally, the term of rooftop solar leases is between 15-25 years, and sometimes there are options to further extend. Rents can be fixed, but more commonly are calculated based on a dollar amount per megawatt of installed capacity, and sometimes may contain an escalation year over year if negotiated. Prior to commencing construction of the solar facilities, some landlords may require tenants to provide either a cash or letter of credit. The solar energy produced by the solar facilities may either be sold to an offtaker (sometimes a public utility company) or put into a community solar program, or the landlord could enter into a power purchase agreement with the solar tenant and provide the building with discounted electricity to reduce energy costs for building occupants. A decommissioning assurance provision is often required to secure the tenant’s obligation to remove the solar equipment at the end of the term, either in the form of a bond, letter of credit, or cash account, typically funded in the last five years of the lease term. The solar tenant will need several easements or license areas to support the installation of the equipment, including a ground area for a transformer pad, any necessary utility easements, and a construction laydown area to stage materials, the latter of which is temporary. One threshold issue to consider as a landlord exploring whether to enter into a solar rooftop lease is whether there are any third party approvals required, including without limitation consents needed from lenders or building tenants or joint venture partners; it is important to start a dialogue early on with any such stakeholders, including internal stakeholders at the landlord entity who may not be as prepared to take the risk of trying something unfamiliar with their asset management.
Ownership and Control of the Roof: Property owners need to be mindful of whether they have granted rights in the building’s rooftop to any of the building’s tenants. In multi-tenant buildings, generally, the landlord retains exclusive ownership and control of the roof, and in single-tenant buildings or ground leases, the roof may be under the tenant’s control, including maintenance and repair obligations. If the building tenant is responsible for the roof’s maintenance under the terms of the building lease, or if the building tenant leases the entire property (land and building), the landlord will need to amend the building lease to obtain control over the roof and take over the maintenance and repair responsibilities so that the landlord may legally lease the rooftop to the solar provider.
Age of the Roof: Many solar tenants are looking for a site with a brand new roof at the inception of the solar lease, since the term of the solar lease will be 20-25 years, and sometimes there are options to extend the term further. That said, however, the landlord will want to retain the option to replace the roof during the term of the solar lease in the case of emergency, and carve out opportunities to repair the roof during the term of the solar lease if that becomes necessary. If the roof is not new at the inception of the solar lease, but contains 10 or 15 more years of useful life, a building can still accommodate a solar facility, but landlords will need to negotiate with solar tenants in order to allocate the cost sharing of a mid-term roof replacement, as well as the mechanical and operational logistics of having to remove the solar panels from the roof and then reinstall them once the new roof has been completed. Additionally, some landlords may elect to pull forward roof replacements that had been planned for a few years away in order to accommodate the solar facility’s installation, which is also subject to negotiation.
Integration with Existing Users of Building and Potential Future Users: The solar tenant ought to accommodate any existing rooftop equipment, such as HVAC units, but landlords may wish to set aside additional areas for future equipment needs before the solar facility plans are set in stone. For example, landlords may envision future tenants requiring additional rooftop HVAC units during the term of the solar lease, and if so, it would be prudent to designate certain solar-free “reserve areas” in advance if a landlord wishes to plan ahead (though sometimes this is not necessary depending on the site specifics).
Interference is another area to consider. Landlords generally prioritize the needs of their primary building tenants as these tenants are landlords’ main investment and income source. It is important for the rooftop solar lease to contain provisions that require the solar tenant to remedy any interference it may cause with the operations of the building tenants; sometimes this comes in the form of parking lot disputes. Also, building access should be dealt with appropriately in the solar lease; generally, solar rooftop tenants are limited to accessing the exterior of the building only, and access to the roof is by exterior ladder, but sometimes landlords will allow the solar rooftop tenant to access through the interior of the building if it is able to do so. If there is a power purchase agreement, then the solar rooftop tenant will need access to the building’s electrical room to tie into the building’s electrical system.
Insolation (Let The Sun Shine): Solar tenants require a certain degree of insolation assurance, which means they need to understand that sufficient sunlight will reach their solar facilities for maximum energy production. It is common for solar leases to contain protective language that landlords will not do anything to impair the sunlight or cast shadows over the solar facilities. Landlords should work to carve out certain rights that would preserve their autonomy and flexibility for leasing out their primary asset (the building), including the right to carve out existing rooftop installations and landscaping. Landlords will also want the right to relocate and increase the size of rooftop HVAC units in the event that a new building tenant demands greater HVAC capacity, recognizing, however, that the landlord may need to compensate the solar tenant for decreased insolation.
Casualty Implications: Generally, if a building is materially damaged and the landlord does not have the obligation to restore it under other binding agreements (such as a building lease), then the landlord should have the right to terminate the solar lease. In some instances, and as a compromise, language can be inserted stating that the parties will use best efforts to find an alternative location for the solar facilities; however, landlords generally cannot guarantee that a new location will be available. If the landlord is obligated to rebuild the building, then it shall do so, and under this scenario, the solar tenant typically receives a proportionate abatement of rent during the time the roof is unusable. It is important for landlords to consider that they should not be forced to rebuild their primary asset (the building) just to satisfy the solar tenant.
Financing Friendly Provisions in Lease: Given that solar developers are making such a large-scale, long-term investment in the solar facilities to be installed, tenants generally obtain leasehold financing from traditional lenders and equity from tax credit investors. The federal investment tax credit is currently 30% of most of the costs of the solar facility (which can increase to up to 60% if certain requirements for adder credits are met, such as using certain domestic equipment, or construction of solar facilities in certain low income areas or sites where fossil fuels previously dominated), which credit is taken over the first five years of the solar facility’s operation. Solar lenders and tax equity investors require the solar lease to contain several lender-friendly provisions, including notice and cure rights, and other terms more likely to be seen in a ground lease than a building lease, including the right to obtain a subordination, non-disturbance and attornment agreement (SNDA) from any landlord lenders. This is different from traditional commercial leases in which most tenants request, but are unsuccessful in obtaining, an SNDA from the landlord’s lender.
Solar Tenant Owns The Solar Facilities: Solar leases generally contain an extremely specific delineation of who owns what. The solar facilities, though possibly considered “fixtures” under property law, are expressly and exclusively owned by the solar tenant. In addition, solar leases also specifically delineate who owns (usually the solar tenant) the various “Environmental Attributes” and “Incentives” that are allocated to or generated by a solar facility, including carbon trading credits, renewable credits, tax credits, accelerated depreciation, etc. It is important to ascertain each party’s ownership of the various assets, and Environmental Attributes and Incentives.
Interruption of Electrical Output / Lost Energy Revenue: The solar tenant generally will want assurance that it will be compensated for any time that the solar facilities are “down” due to an event caused by the landlord. The concept of “lost energy revenue” is often seen in solar rooftop leases. This represents the sum of all revenue that the solar tenant would have received from the sale of energy that would have been generated from the solar facilities, the revenue it would have received from solar incentive programs or rebates or assistance programs, and tax credits that the solar tenant would have received (or for recapture of the tax credits). It is not uncommon for the solar tenant to give the landlord a certain fixed number of days (or kilowatt hours of production) each year for the landlord to make repairs without having to pay the tenant the lost energy revenue. This is an important concept to protect the solar tenant from downtime caused by the landlord’s actions, as the solar tenant also has obligations to whoever is purchasing the power and to its financing parties and tax equity investors.
Conclusion: In conclusion, the risks and rewards of solar rooftop leases are many, but with an understanding of the various intricacies of the market and with the advice of experienced counsel, industrial property owners can undertake these transactions with confidence and contribute to the reduction of carbon emissions and make some additional income at their properties while they are at it.
A partner in the
Renewable Energy Group of the Boston law firm of Sherin and Lodgen LLP, Jennifer
Connelly possesses broad experience in real estate acquisitions, development,
leasing, and financing. In particular, Jen represents retailers, developers,
and institutions on all aspects of commercial real estate transactions. Jen’s
email address is JiConnelly@sherin.com.
This article was
originally published by the Massachusetts Chapter of NAIOP.
