The making of a solar REIT: By the numbers

Power REIT (NYSE:PW) recently announced that it had closed on a deal to buy approximately 100 acres of land leased to the owners of more than 20 MW of solar projects near Fresno, CA. This will be the company’s second solar transaction and increases the share of its revenue from solar to 21 percent. These two solar transactions put PW well on its way to becoming the nation’s first REIT to get most of its revenue from renewable energy. The balance of its revenue comes from leasing its railroad property. Whiile not renewable energy, rail is also a green asset in that transport by rail is much more fuel efficient than the alternative: trucking.

Salisbury, MA Transaction
Just last week, PW completed financing for its previous solar transaction, by closing on a $750,000 bank loan.  I thought it would be helpful to dig into the newly released numbers to understand the economics of the transactions.
Below are the details of the completed transaction for land under the True North Solar farmin Salisbury, MA. These, and the details about the Fresno transaction discussed below come from the press releases, interviews with the Chairman and CEO of Power REIT, David Lesser, and my own searches of news stories and public records.

• Land: 54 Acres. Zoned commercial, near I-95. Potential for commercial development after lease term.
• Solar Farm: 5.7 MW fixed tilt PV.
• Purchase Price: $1,037,000
• Lease: 21 years, at $80,800 with a 1 percent annual escalator.
• Financing:
  • $122,000 municipal debt, amortizing over 19 years at 5 percent.
  • $750,000, 10 year bank loan, amortizing at 5 percent on a 20 year amortization schedule.
  • $165,000 equity from cash on hand plus new issuance between $10 and $11.
• Real Estate Taxes: Approximately $9,000 in 2013.

This is nearly enough information to build a full financial model of the investment.   The remaining unknowns are:

1. How and at what rate will the remaining $508K principal of the $750K loan be refinanced in 2023?
2. How will property taxes change over the term of the lease?
3. What will be the land’s value after the end of the lease?

I ran two scenarios, one which I consider conservative (refinancing at 7 percent, 5 percent annual increase in taxes, flat land value) and one which I consider optimistic, but not wildly so (refinancing at 4 percent, 2 percent annual tax increases, 50 percent increase in the value of the land over 21 years.)  The first scenario is very conservative in that it’s very unlikely that real estate taxes would almost triple  (a 5 percent annual increase becomes a 2.8x increase in taxes over 22 years) without some increase in property value.)  Mr. Lesser considers even my “optimistic” scenario to be conservative, since he believes that he acquired the land at half its true, unencumbered value because of the owner’s need to sell quickly.  Corroborating this, a Salisbury reporter I spoke to confirmed that the previous owner needed to sell quickly to pay debt secured by the land.
In both scenarios, net income from PW’s investment starts at over $28,000 per year, or a 17 percent annual return on invested equity ($165,000 – ROE will be higher on a GAAP basis), and increases from there because the increase in rent increases revenue much more quickly than property taxes rise.   In cash flow terms, both scenarios produce mildly positive cash flow until the loan is refinanced.  The conservative scenario then shifts to mildly negative cash flow, while the optimistic scenario achieves slightly greater cash flows than before.   The cash flow internal rate of return exceeds 10 percent for the conservative scenario, and exceeds 13 percent for the optimistic scenario.  If the residual value of the land is higher, as Lesser expects, an extra $1,000,000 in terminal land value increases the IRR about 2.5 percent.
Given the small positive effect on cash flow in its early years, the investment has a slight stabilizing effect on Power REIT’s finances, while increasing earnings by approximately 1.6 cents a share, and revenue by 4.8 cents/share.
Fresno, CA Transaction
The Fresno area is currently a hotbed of PV development activity, with 17 utility scale projects having been approved by Fresno County since 2011.  The number of projects under construction makes it impossible for me to determine with certainty which ones occupy the land Power REIT just purchased.  However, we do have significant information about the projects.

1. They have Power Purchase Agreements (PPAs) with Southern California Edison(NYSE:SCE) and Pacific Gas and Electric (PCG).
2. They were originally supposed to be in service by October 2013, but it now appears that construction will not be complete until early 2014.  Note that PW is financially protected from such delays by supplemental payments from the developer which will begin in October and continue until the in-service date.
3. The developer is a major international player, and has completed over 100 MW of other projects.  It has a pipeline of other projects which may lead to future transactions for Power REIT.

While many commercial solar farms have been approved in the Fresno area, the most active international developer is multinational European renewable energy developerGestamp Solar.  Gestamp has an office in Fresno, and is developing seven solar projectsnearby, with sizes between 1.5 MW and 14 MW.   I did not find any other developer with projects of the right number and size in the Fresno area.
The financial details of the deal are:

• Land: Approximately 100 Acres, most likely previously agricultural.
• Solar Farms: Over 20 MW PV.
• Purchase Price: Approximately $1,600,000
• Lease: 25 years, at $157,500 fixed, with two options to renew at “market rate” through 2048.
• Financing: Acquisition financing has been provided by Hudson Bay Partners, an investment vehicle owned by PW’s CEO, David Lesser.  The financing consists of two tranches:
  1.  Tranche A (Senior): $1,115,000.  Interest only at a 5 percent interest rate for the first 6 months, with a step up to 8.5 percent thereafter.  Planned to be replaced by bank financing ASAP.
  2. Tranche B (Mezzanine): $445,000.  Interest only at 9.5 percent for 6 months, with a step up to 13.5 percent thereafter.  May be refinanced by issuing new equity, depending on PW’s stock price.
• No equity on closing, but see tranche B above.
• Taxes: $27,000 annually.  If taxes rise, lease payment will increase to compensate.

I ran two financial models, both assuming that the first tranche could be refinanced at 5 percent in the next six months amortizing over the 25 year term of the lease.  In the first scenario, I assumed that Power REIT chooses not to issue equity to refinance tranche B, but instead refinances it with debt in 2020 (at 11 percent) and 2024 (at 7 percent) when the increasing equity in Tranche A allows.  In this scenario, increases earnings by $7,338 thousand in 2014 (about 0.4 cents a share), and by increasing amounts in future years.  Cash flow is again marginally negative until the second refinancing of Trance B after 10 years, when it turns slightly positive.  Assuming the terminal value of the land is equal to the purchase price, this scenario yields an internal rate of return on the cash flows of 7.6 percent.

http://www.renewableenergyworld.com/rea/news/article/2013/08/the-making-of-a-solar-reit-by-the-numbers