As photovoltaic solar costs have dropped, and with the support of renewable portfolio standards and incentives from federal, state, and local governments, rooftop solar installations on commercial properties have become more attractive.
From the solar developer’s perspective, rooftop solar photovoltaic (PV) projects have three key advantages over PV projects built on undeveloped land: First, since rooftop installations occur on previously disturbed land with minimal changes to the profile of the existing structure, these projects can avoid the lengthy, costly environmental analysis and land use approvals that can be required to develop new land. Second, as rooftop installations are located on existing buildings and in developed areas, such sites can take advantage of existing utility infrastructure. This advantage has not been lost on Southern California Edison, which has a program in place to bring up to 500MW of PV generating capacity online in its service area, largely from rooftop mounted systems located on warehouses. Last, where the utility is not the purchaser, the occupants or tenants of the building on which the rooftop solar project is built offer a natural market for the power to be generated at higher “retail” rates.
From the property owner’s perspective, rooftop solar installations allow the property owner to add a green feature to its property, making it more desirable to tenants. Further, as with cell tower and rooftop telecommunications license agreements, such installations can also potentially create a new (albeit modest) revenue stream for the property owner.
This article examines some of the key legal and business considerations in leasing commercial rooftop space to a tenant solar developer, who will sell that power back to the utility or to the occupants of the property where the installation is located. In cases where the property owner is purchasing the power from the solar developer, many of the same issues will apply, though some will be easier to resolve as incentives will be aligned more closely.
In negotiating the lease, the solar developing tenant may want to tie rent payments to its success in developing the rooftop solar project and obtaining purchasers for its power. Accordingly, it may offer to pay a certain amount per megawatt of solar capacity installed, with the amount of the payment depending on whether the power is being sold back to the utility at a lower “wholesale” rate or to another tenant of the property at a higher “retail” rate. The property owner or landlord will want some minimum rent payment to ensure that it is adequately compensated for tying up rights to the property’s roof. Further, if the property owner agrees to rent that is in part based on the installed capacity or production of the solar facility, it should consider whether it needs the right to take back rooftop area that is initially included in the solar lease if the solar developer does not build out within a reasonable period of time.
Allocating Property Taxes
Both the solar developer and the property owner will want the solar facility to be assessed separately from the remainder of the property owner’s property. If the facility cannot be separately assessed, the parties will need to agree on a method for determining the portion of the tax assessment which relates to the solar facility. Both parties will also want the ability to contest taxes related to their respective improvements, and coordination will be needed if a separate assessment isn’t possible. The solar facility developer will not want to pick up the cost of increased assessments that arise solely from a change in the valuation of the landlord’s improvements or new construction by the landlord. Similarly, the property owner will want the lease to clearly allocate to the tenant all costs attributable to the solar facility. The property tax allocation can be more important for a solar lease than a typical lease because in certain circumstances (for example, warehouse space) the cost of the solar facility may be quite high in relationship to the assessed value of the underlying real property. The property owner will not want exposure to a property tax bill for the solar facility that may be larger than the rent payable under the lease.
The solar developing tenant will want the flexibility to mortgage his interest in the solar facility and in the rooftop lease as collateral for financing, as well as flexibility for the leasehold mortgagee to assign the lease following foreclosure. The landlord should be able to provide this flexibility, but will want assurances that any foreclosing lender cures outstanding defaults under the lease. The landlord will also want comfort that if the lease is assigned following foreclosure, the assignee has the financial resources and technical expertise to complete and/or operate the solar facility.
Lease Due Diligence Period
The solar developing tenant in a rooftop solar lease will want sufficient time to investigate the site, obtain an interconnection agreement (if needed), negotiate power purchase agreements with other occupants of the site (if they are prospective purchasers of the power), and obtain licenses, before locking into a long-term lease. Consequently, the solar developing tenant will likely request a due diligence period (which may be from a few months to over a year) during which rent is reduced or abated, and during which it may terminate the lease if its investigations reveal problems with the site, or permitting and licensing or interconnection efforts are unsuccessful.
From the property owner’s perspective, a due diligence period should be expected. However, the landlord will want reasonable certainty of when full rent payments will commence, and will want an outside date for tenant’s due diligence to be completed. For example, the landlord and solar developing tenant could agree that the tenant will have an 18-month due diligence period, with rent payments commencing by the sooner of the 12th month or the commercial operation date for the solar facility, and with the tenant’s right to terminate expiring at the end of the 18th month of the due diligence period.
Leased Area and Rights in Related Space
The property owner and solar developing tenant should carefully consider what areas of the roof and related property will be affected by the solar lease. In addition to space for the rooftop facility, the solar developer tenant will likely need areas for (i) temporary construction staging and storage of equipment, (ii) permanent points of access for reaching the rooftop and performing maintenance, (iii) space for locating inverters, and (iv) flexibility to connect to existing building electrical infrastructure (if the power is being sold to the property owner or building tenants) or to connect the facility to the public utility lines. The solar developer may also need access to water for cleaning panels, and the ability to connect to existing telecommunications infrastructure on the property for purposes of connecting monitoring devices for the solar facility.
It will be to both parties’ benefit to reach rough agreement on these areas and rights early in the lease negotiations. However, both parties will want flexibility over the lease term to relocate or create new access, utility connection, or storage areas.
From the solar developer tenant’s perspective, it will also be important to ensure that the landlord’s maintenance activities and other development on the roof or on neighboring property do not interfere with the solar facility or the solar exposure (insolation) on the roof.
From the property owner’s perspective, it will be critical to ensure that the solar tenant’s facility, access and rights do not interfere with its other tenants, as the rent from other commercial tenants likely exceeds the rooftop lease revenue. The property owner will also want to ensure that it reserves rights to access the roof for regular maintenance and inspections, and that it reserves sufficient roof space to allow for maintenance and replacement of rooftop HVAC equipment, as well as flexibility to allow building tenants to install rooftop satellite dishes and telecommunications equipment.
Construction of the Solar Facility
As with any lease involving substantial construction, the property owner will want to confirm that the solar facility will conform with industry standards and safety requirements, will not invalidate its property insurance policies, and will not cause structural damage or damage the integrity of the roof or invalidate roof warranties.
Additionally, the property owner will want to ensure that there is sufficient security (for example, in the form of bonds or guarantees) to protect against mechanics’ lien claims against its property and ensure that the solar project can be completed. The solar developing tenant will want to limit the amount of capital it ties up to provide this security. This can be one of the most difficult issues in the lease negotiation, and its resolution will depend on the size of the project and the credit of the solar developing tenant. One possible solution for reducing the amount of required security (while providing the landlord with comfort) would be for the solar developer to demonstrate a certain level of investment in solar panels and equipment before project construction starts, as well as financing commitments for the balance of project costs. This way, the landlord has reasonable assurances that the developer has a financial stake in the success of the project, and an incentive and ability to pay off liens and pursue the project to completion.
Roof repairs are another thorny issue which should be discussed early in lease negotiations. Over a twenty- to thirty-year initial lease term, it is likely that at some point the roof will need to be replaced. The solar developing tenant will want to minimize downtime and disturbance from roof repairs, and will want roof repairs to be performed in the winter months, when there is less sunlight available for generating power. From the property owner’s perspective, the lease needs to ensure that repair costs will not be materially increased by meeting the solar developer’s scheduling requirements. It will also need the flexibility to do emergency repairs and to quickly repair leaks, as the lost revenue from unhappy building tenants (not to mention the damage to landlord’s building) could quickly outpace the revenues from the solar lease.
This issue is another that can be more difficult to negotiate than in a typical building lease. The solar developer’s improvements may be substantial and costly. It will want assurances that its facility will be on the roof of the building (or any replacement building) over the long term, so it can achieve a return on its investment. From the property owner’s perspective, it does not want to be obligated to rebuild the building solely to meet its obligations under the solar lease, if reconstruction does not otherwise make economic sense (for example, if a key building tenant has terminated its lease) or if the property owner’s lender refuses to allow insurance proceeds to be disbursed for reconstruction.
Last, both property owners and solar developers need to look for opportunities for developing rooftop or parking lot solar installations at scale. While solar developments on existing commercial properties face fewer permitting and environmental review hurdles than raw land developments, a solar installation on an existing building will likely be much smaller than what is possible on raw land. Accordingly, the transaction costs for entering into a solar lease arrangement can be a barrier to development.
To achieve scale, both property owners and solar developers should consider leasing arrangements which allow development across a property owner’s real estate portfolio. For example, a real estate investment trust (or REIT) may own several “big box” retail developments or warehouse properties with similar dimensions and configurations in the same geographic area. In this scenario, a property owner and solar developer could develop a template lease to be replicated across multiple sites, significantly reducing the time and costs of negotiation. The template lease would address general “boilerplate” terms that arise in any lease such as assignment and subleasing, default, leasehold mortgages, and payment of taxes, and a supplementary schedule or appendix could be prepared each time a new site is developed to identify the site and any unique characteristics or site-specific deal terms.
Such legal innovations to achieve scale will be critical to take full advantage of what is potentially a large market. A 2007 Recurrent Energy study estimated that “[i]nstitutional owners of US commercial real estate, including publicly owned real estate investment trusts (REITs), control enough rooftop real estate to generate 40,000 megawatts of solar power.” Much of this potential capacity may not be economically developed, but if even a fraction of this space is developed, the market would be significant.