Sunwheel Energy Partners Workers install solar panels in Richmond Village, a 202-unit complex in Los Angeles. A quarter of the solar electricity generated offsets 73 percent of the electricity used by the common areas in this California community. The remainder of the electricity savings reduces costs for tenants.

Darren Van’t Hof, Director of Renewable Energy Investments, U.S. Bank

U.S. Bank, one of the nation’s largest commercial banks, joined with developer McCormack Baron Salazar (MBS) to finance the installation of solar-energy systems on 11 existing affordable multifamily housing communities in various locations throughout California.

This transaction involved three main entities and their related affiliates:

• MBS, a for-profit affordable and market-rate housing developer with a focus on “green” architecture and sustainable design;
• Sunwheel Energy Partners, an MBS affiliate that finances, operates, and maintains photovoltaic solar systems; and
• U.S. Bank, the investor.

The financing structure used a combination of state rebates and federal tax credits under the new markets tax credit (NMTC) and investment tax credit (ITC) programs.

Solar Power-Sharing Agreements

Sunwheel installed solar panels on 11 rental housing communities in California. In separate financial transactions, MBS had previously developed several of the affordable-housing communities using low-income housing tax credits. The solar power generated by the solar panels lowers utility costs in the affordable housing community and, in some cases, the benefits are shared with the tenants, through reduced utility bills.

An affiliate of Sunwheel entered into solar agreements with the host sites by which the affiliate would operate and manage the solar installation. “Due to differences in the local utilities’ solar programs around the state, the Sunwheel affiliate needed to be flexible and had to tailor the solar agreements for the sites based on their location,” said Michael Steinbaum, Sunwheel’s Chief Operating Officer. In some areas, the host entered into a power purchase agreement. In other locations, they used a solar equipment lease. In all cases, the utilities provided a credit to the host site’s account based on the amount of power generated by the solar installation.

For the affordable housing communities in Northern and Southern California served by Pacific Gas and Electric and Southern California Edison, a power purchase agreement was used, in which the host site purchases the power generated at an agreed-upon price from the Sunwheel affiliate. Because the agreement price is set at a lower price than the host’s grid rate, the host’s electric bill is reduced by the difference. Typically, provisions in a power purchase agreement establish (1) the length of the term, (2) the starting price and an escalator rate that predetermines the price over the course of the term, (3) an option for the host to purchase the solar power system at fair market value before the end of the term as well as at the end of the term, and (4) other contractual duties, such as which party maintains insurance.

Virtual net metering is an innovative feature offered under the California Solar Initiative’s Multifamily Affordable Solar Housing (MASH) program that was used in several of the affordable communities. With virtual net metering, the host can elect to allocate some of the solar energy production to tenant units, regardless of whether the units are physically connected to the solar installation, thus, the “virtual” part of virtual net metering.

The host provides the solar energy benefit to tenants at no cost. The total amount of energy produced by the on-site solar system is measured before it is distributed to the electric utility. Then the utility adjusts the electricity bills for the individual tenants and common areas to reflect the credit for their portion of the solar energy produced, using a formula based first on the common area-tenant allocation percentage, and then for each tenant, based on the number of bedrooms in the unit.

In some cases, the hosts allocated more than 50 percent of the solar energy produced at the site to tenants. This was made possible because the MASH rebates are greater for the tenant-allocated portions of the solar installation. In this way, the program provides incentives for companies to direct the benefits derived from solar power generation more toward tenants.

The size of the solar installation and number of panels installed depended on the size and configuration of the buildings’ rooftops as well as the host’s electricity usage. At one site the rooftops were not suitable for the solar installation, so Sunwheel designed systems mounted on carports. At this desert site the carports provided the added benefit of shaded parking for the tenants.

Four of the low-income housing tax credit communities, located in Southern California in the Los Angeles Department of Water and Power service area, used solar equipment leases. In these cases, the host site leased the solar installation from the Sunwheel affiliate at a predetermined price. The sites get credit on their energy bills from the utility, and the predetermined lease rates, being less than the estimated credit, allow the sites to save on overall energy bills. Using this approach, the communities in Los Angeles have been able to cover about 90 percent of the electricity used by their common areas.

Sunwheel worked with the solar integration firm Real Goods Solar for the Bay Area installations. Residents from the affordable housing sites and local residents who had completed workforce training programs offered by Solar Richmond and San Francisco City Build were hired by Real Goods Solar for the installation. “For some residents, this was their first job and first paycheck.” Sunwheel’s Steinbaum said, “Although these jobs were temporary, several of the workers were ultimately offered additional work after the installation was complete.”

The community benefits were threefold:

• Energy costs were reduced for affordable housing operators and tenants;
• Jobs were created in low-income areas; and
• Renewable energy resources were created.

Tax Credit Financing Structure

U.S. Bank joined with MBS’s affiliated community development entity, which used a portion of its NMTC allocation, and Sunwheel and its affiliated special purposes entities, which own and manage the solar systems. U.S. Bank used a “twinned” tax credit financing structure, in which the NMTC and ITC benefits ultimately flowed to the bank.

By blending the federal tax credits and the utility rebates, the twin structure provided an acceptable rate of return and created enough net equity in the project to reduce the debt service requirement to one percent, making the solar installation financially viable.

U.S. Bank provided equity to an investment fund that, in turn, invested in the community development entity (CDE) with an NMTC allocation. Simultaneously, an entity was set up as a master tenant to receive and pass-through the Section 1603 benefits (cash in lieu of energy investment tax credits) to U.S. Bank. With this twinned structure, virtually all of the benefits from both the NMTC and ITC transactions flowed through to U.S. Bank as the top-end investor.

U.S. Bank contributed bridge financing to the investment fund in an amount equal to the anticipated MASH solar rebates from the local utilities. Sunwheel had previously applied with the local utilities and been approved for MASH rebates for each solar project. (MASH rebates are not paid out until projects are complete, and the utilities approve and commission the installations.) Once the rebates were received, the bridge financing was reimbursed.

To further magnify the tax benefits, the modified accelerated cost recovery system allows five-year, straight-line depreciation for eligible energy investments, including solar installations. The depreciation benefits and any losses are allocated through the ITC entity, with 51 percent going to the managing partner and 49 percent going to U.S. Bank. This transaction structure is shown in the following figure.

Figure 1: Structure for Sunwheel Investment Fund Transaction

Although both tax credit transactions are priced and bid as stand-alone deals, U.S. Bank analyzed the combined benefits when deciding to make this investment.

At the end of the seven-year NMTC compliance period, U.S. Bank has the put option to sell its remaining interests in the investment fund and the ITC entity to Sunwheel at a fixed price or Sunwheel can exercise a fair market value call right to purchase the solar power system. When that option is exercised the financing structure will collapse. At that point, Sunwheel will acquire all rights to the solar installation.

Due Diligence Important

When the bank is underwriting a tax credit investment, sponsor quality and strength are important. The bank conducted due diligence on both MBS and Sunwheel to evaluate their ability to finance, install, and manage solar projects. Sunwheel and its affiliate are responsible for proper installation as well as ongoing maintenance, such as cleaning and repairing the panels. There also may be manufacturer and integrator warranties to evaluate. U.S. Bank’s underwriting analysis also focused on standard elements, such as projected cash flows, construction cost estimates, engineering reports, appraisals, feasibility studies, and marketing plans.

This due diligence is particularly crucial in an NMTC transaction. For the full seven-year NMTC compliance period, if MBS loses its the Community Development Financial Institution Fund’s certification as a CDE, or if less than 85 percent of the proceeds were deployed in qualifying low-income investments, then the NMTC benefits would be fully recaptured. U.S. Bank ensures that both of these scenarios are highly unlikely by choosing strong partners that will exercise appropriate controls over project selection, development, and completion.

This investment provides a triple bottom-line benefit that offers community impact and energy sustainability, while making the solar system investment profitable for both the developer and the bank,” Steinbaum said. “The low-income housing community lowers its operating costs, while the high cost of installing energy saving equipment is offset by the combined tax credits and the utility rebates.”