How Much Is My Solar Lease Worth?

One of the most common questions we’re asked is “how much is my solar lease worth”? The pricing of a solar lease is actually pretty straight-forward. However, since there are a relatively small amount of property owners leasing their properties to solar farms, there isn’t a lot of information on how these properties are valued as compared to more traditional types of real estate. In this post I’ll delve into how we arrive at a price for your solar lease. Hopefully you will find the process much more transparent after reading this article.

The two main elements considered when valuing your lease are:

1. The cash flow
2. The discount rate

1. CASH FLOW

The first step in valuing your lease is to make assumptions about how much income we can expect to receive over the lease term. Some of the factors to be considered are:

a) Rent – rent is probably the most important consideration. The higher the rent the higher the purchase price

b) Rent Escalator – almost all leases have contractual rent escalators. These rent increases most often occur annually or every 5 years. The higher the rent increases, the more valuable your lease is. Inflation is on everyone’s mind at the time of this post. Leases with higher fixed escalators or CPI increases will be more valuable as a hedge against inflation

c) Property Taxes – ideally, your lease is triple-net. This means that during the lease term, the tenant is responsible for all the property-related expenses, including property taxes. If you are responsible for all, or a portion, of the property taxes, we will need to deduct property taxes from our rental income as part of our cash flow analysis. The bottom line here is that when a property owner is responsible for property taxes, this reduces the property’s income and its value

d) Closing Costs – we bear all customary closing costs when we acquire a property. Some of these costs include title, survey and environmental studies. These costs are relatively fixed, regardless of transaction size. This means that purchase multiples on smaller transactions are lower since closing costs make up a larger percentage of the price

e) Project Useful Life – most renewable energy investors consider the useful life of a solar project to be 35 years. When we buy a lease we assume the project will be active and we will collect rent for 35 years

f) Lease Monetization vs. Land Purchase – we have two ways of structuring a transaction. (1) we can just acquire your rent, but not your property. (2) We can acquire your entire property, including your lease. We pay more when we acquire your property because at the end of the lease term we own the property. When we buy a property, we make an assumption about the residual value of the property after the lease term and add it to our cash flow analysis.

Below are examples of how we would underwrite a lease paying $60,000 per year in rent with a 2% annual rent escalator. You can see that when we acquire the property (“Fee Simple” example) we make assumptions about what the property will be worth at the end of the lease term and factor this into our pricing.

2. DISCOUNT RATE

Once we create this model and make our best guesses about the cash flow we can expect to collect during our ownership period, we need to establish the present value of these expected future cash flows. It’s well established that if you had a choice between receiving $100 today or 35 years from now, you would choose to take the $100 today. Therefore, investors discount future income into its equivalent value today. Put another way, an investor would not pay someone $100 today for the right to collect $100 of rent in 35 years. Investors apply a discount rate (rate of return) to value these future cash flows in present terms. Discount rates and prices are inversely related – the higher the discount rate, the lower the purchase. The lower the discount rate, the higher the price paid today.

So what goes into determining the discount rate? There are a handful of factors:

a) Lease Term – the longer the lease term, the longer we can assume we will collect rent from the solar farm. Longer lease terms generally lower the discount rate

b) The PPA Offtaker – most solar projects have agreements to sell power via a long-term power purchase agreement (PPA). Longer PPAs make for a safer investment because the project has a more secure revenue stream which should enable it to pay rent. As a result, there will be a lower discount rates/higher valuations.

Not all offtakers are created equal. Many offtakers are large utilities and corporations (SoCal Edison, Amazon, etc.). Other projects may sell power to less recognizable offtakers. If the offtaker that is promising to buy power from the project located on your property has a strong, investment grade credit rating, this will lower the discount rate

c) Interest Rates – renewable energy ground leases are similar to bonds in that they are long-term, fixed income investments. This means they are highly susceptible to interest rates. Rising interest rates decrease values and lower interest rates increase values. Almost all real estate investors use debt when they buy property. Higher interest rates make those annual debt payments more expensive, despite annual lease payments staying the same

Hopefully this post gives you a better idea of how your solar lease is valued. If you’d like to have a site-specific discussion about your property give us a call today at (310) 266-9045 or email me at [email protected].