Why The Commercial Solar Market Needs Shorter Term Loans

Industry growth

As we in the industry are well aware, business in the US solar market is booming. Growth is both strong, and accelerating. Earlier this year, we surpassed one million solar installations (27.5 GWdc), and built 1,665 MWdc in just the first three months of the year. That’s up 24% from the same time last year and the highest observed non-Q4 growth rate to-date.

But, as has also been frequently reported, most of this growth has occurred in the residential and utility-scale market segments. According to industry groups, and Wunder’s experience lending in the space, comparatively anemic solar growth in the commercial market segment is largely due to limited access to affordable capital, an issue especially true for smaller commercial projects (less that 200 kWdc in size). Much of the lending for these types of projects is done by local banks and credit unions, making traditional loans based on the business principal’s credit and general business assets. Most of this lending is both inefficient and time-consuming.

Fortunately, we’re starting to see more solar-specific financing options. For larger commercial projects, there are several solar finance organizations that can be a good fit. States have started to get on board with loan programs like Nebraska’s Dollar and Energy Savings Loan Program and Colorado’s C-PACE Program. Big banks, Wells Fargo for instance, have rolled out some limited solar-specific options like the Solar Financing Program. Smaller banks and credit unions like the Vermont State Employee Credit Union are trying their hand at local solar-specific lending. And even a few utilities offer solar financing, like PSE&G’s Solar Loan Program.

“You’ll save money from day one”

We can all agree that more financing options is a very good thing for a market segment starved of capital. However, project origination and lending in the solar industry, small commercial in particular, suffers from an over-focus on short-term costs. Wunder is currently working with EPC and developer partners in 22 states and the most common pitch to customers looking for financing is generally some version of “save money from day one.” It’s a proven sales tactic and it works.

However, focusing on monthly, quarterly, or even annual project returns can be a mis-step. Prioritizing short-term returns, borrowers can lose sight of overall ROI.

The cost of longer terms

Looking at a very simplistic loan model (fixed rate, fully amortized, term) there are three levers for adjusting payment amounts: loan amount; rates and fees; and term.

The customer only has so much wiggle room in their budget, so loan amount is typically fairly firm. Rates and fees are generally set by the market and lending policy, so there isn’t a ton of flexibility there. Plus, as some portion of the principal is paid back along with interest and fees in fully amortized loans, the only real approach is to adjust the loan term. Therefore, to get costs lower than or equal to expected savings, most finance organizations are asked to provide loans with 10+-year terms, some going out as long as 20 years.

The problem with extending the loan term is that time isn’t free. Longer terms result in the borrower paying down the principal more slowly, meaning that they will pay more in interest and fees over the course of the loan. It’s not just a cost-shift, it’s a cost increase.

For example, a $100K loan at 5.00% for 5 years will have a monthly payment of $1,887 and cost approximately $13,227 in interest. That same loan with a 20-year term will have a monthly cost of $660, but a total price tag of approximately $58,389. To achieve lower monthly costs, the borrower is giving 45% of the value of their loan to a third-party--potentially gutting their investment of any meaningful return. This is also reflected in the customer returns from third-party ownership structures.

The decision to switch to solar is, for some customers, not based on the economics. They want to reduce their carbon footprint or they believe a greener image will help stimulate sales. However, for most, it’s an investment. Utility rates have continued to increase and they are looking for a way to offset their operational costs. Therefore, it is critical to provide customers with financing solutions that allow them to maximize their solar ROI.

How significant are the costs?

While the “save money from day one” message can be helpful for engaging with customers concerned about the potential costs of installing solar, it shifts the conversation away from what the actual costs are. For most of the borrowers Wunder works with, electricity isn’t a major cost to the organization. Most are stores, restaurants, offices, and other low-energy-consuming business. Given their average useage, most need fairly small systems, with costs dwarfed by other business expenses. A shorter-term loan for their solar system might not save them money from day one, but those additional costs, say a few hundred dollars a month, are very manageable for these borrowers compared to their other operating expenses. Then, once paid off, they can enjoy the benefits of virtually free power for 20+ years.

Ownership isn’t for everyone

Many argue financing centered around system ownership is a long-tail product. Basically, that most potential customers don’t have the means, or desire, to own their own systems. Certainly, this thesis has been proven out in the residential market segment. However, given the lack of solar development in commercial (small commercial in particular), the market segment remains a green-field market. There are tens of thousands of vibrant, established, profitable small business helmed by experienced financial professionals that currently don’t have a lending solution, either because of standard loan terms or early/prepayment penalties, that enable them to maximize the benefits of going solar.

With these customers in mind, Wunder and other financing companies have developed several short- and medium-term lending products. Customers can pay their lenders back when the monetize the ITC, other benefits, or have some room in their operating budget, without any penalty. We don’t believe that short-terms or even system ownership is the best approach for all customers, but we believe solar finance as a whole can do a better job of serving the needs of those for whom it is.

This article was originally published in Solar Industry Magazine.

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