REITs Take On Sustainable Energy—and the IRS

Posted on March 15, 2013

The sun is rising on sustainable energy systems—solar and wind power—and some REITS want to get into the game, while others are already playing. But the question of whether and how REITS can invest in sustainable energy projects is tricky. To retain that crucial tax status, REITs need to invest in real property. Does a solar farm constitute real property? What about a rooftop PV system?

In February, the renewable energy financing company Hannon Armstrong Sustainable Infrastructure Capital Inc. filed its SEC paperwork to convert to a REIT and it has major designs on green power, planning on a $100 million IPO. The company has already arranged more than $3.9 billion of financing in more than 450 sustainable infrastructure transactions, traditionally through the securitization market, according to its SEC-11.

Hannon has also asked the IRS to weigh in on how it can invest as a REIT in sustainables. Industry watchers say there are two ways the IRS could give Hannon a green light: One would be if the firm concludes that a building can be used as collateral on a loan used to finance the building’s sustainable project. The other way would be if the IRS rules that a rooftop PV system can be treated as a real property asset because it is part of the total energy system encompassed in the structural component of the building.

Hannon Armstrong has the IRS response in hand, but a public version has not yet been made available. The company declined NREI’s request for comment.

In theory, if the IRS rules that a rooftop PV system is real property, other REITs might decide to loan money to developers who erect buildings and install rooftop PV, says Kelly M. Kogan, a senior attorney with Chadbourne & Park and a sustainability financing expert.

Kogan stresses that one company’s private IRS ruling does not automatically apply to all taxpayers. However, she says, REITs informally rely on other companies’ rulings as long as their assets are legally and factually the same.

There was a flurry of excitement about REITS and the solar sector in recent months after San Francisco-based Renewable Energy Trust Capital Inc. asked the IRS for a ruling on whether solar farms could be classified as real property.

Renewable Energy declined to comment on the pending request. In January, the company’s CFO, Christian Fong told Bloomberg: “There’s no practical way for individuals to vote with their dollars and invest in solar power generation. … A solar REIT would, for the very first time, give them a way to do that.”

Kogan says she would welcome a blanket IRS ruling that would give solar farms a REIT blessing, but she’s doubtful that would happen. First of all, she says, the IRS has already indicated that equipment and machinery is not a good REIT property, even if it is permanent.

The agency has also issued rulings that Kogan argues specifically excludes systems that generate electricity. In one, she says the IRS ruled that an electrical transmissions system was a good REIT property, but specifically noted that the system in question does not generate electricity.

Getting REITs into the sector, she says, is going to be incremental. “I don’t think it’s going to be a dam breaking and all of a sudden REITs will be jumping into renewables,” says Kogan.

Beyond REITs, there are other ways to get capital into sustainable energy. For instance, there is a push in Congress to allow master limited partnerships (MLPs) and REITs to invest. By law, MLPs can currently only invest in energy as it pertains to oil, natural gas, coal extraction and pipeline projects. Last December, a group of 29 members of Congress asked President Obama to specifically include MLPs and REITs. “Minor changes to the federal tax code could provide the renewable energy industry access to large pools of low-cost private capital,” the letter states.

While some REITs are negotiating the size and scope of the playing field, others are already in the game. “Our approach to investing is to look at good projects that are 100 percent down the fairway in terms of qualifying as real property as we sit here right now,” says Arun Mittal, vice president for New York-based Power REIT.

In December, Power REIT closed on its acquisition of a fee‐simple interest in land beneath a 5.7MW solar farm in Salisbury, Mass. Mittal says the deal is good for the environment and it provides the REIT with a “very credit-worthy,” tenant as well as stable income that is not bound to the whims of the economy.

Mittal says REITs can play an important role in bringing in needed capital to the sector. And that need is pretty great. Bloomberg New Energy Finance predicts that in order to maintain the growth of U.S. solar power projects, the industry will need a $6.9 billion shot of capital through 2020. “We can provide a way to close the gap in the financing capital stack,” Mittal says.

Right now most renewable energy projects are financed on the base of tax incentives, like the 30 percent federal tax credit that is set to expire in 2017. That covers some needs, but it clearly now has an expiration date, and it also does not cover everything.

“There will still be the balance that is real estate, land, land improvement, grading, road construction and those types of expenses,” Mittal says. “We bring the capital that can finance those pieces very effectively, relative to the other solutions in the market.”

Jennifer V. Hughes, National Real Estate Investor.