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Nine Critical Issues in Solar Rooftop Leasing
By properly navigating the risks and liabilities, building owners can create additional revenue streams while helping the environment.
The United States is undergoing a major transition to a clean, sustainable energy ecosystem that is dependent on the integration of renewable energy sources into the existing energy infrastructure. One of the most popular renewable integration strategies is installing solar photovoltaic systems on rooftops of existing commercial and industrial buildings to sell clean energy to consumers.
While this allows building owners to facilitate the generation of renewable energy — and additional income — on-site at a property, various legal, financial and operational issues must be addressed upfront to ensure the long-term viability of each rooftop solar project. This article will walk property owners through the process of solar rooftop leasing and discuss how to navigate the risks and liabilities associated with these projects. If all of these items are considered and the parties involved commit to working together, this is an excellent opportunity to create additional revenue streams, benefit the environment and maximize the usefulness of commercial property.
Ideas to Know
The general principles of commercial leasing apply to rooftop solar leases. However, solar rooftop leasing also involves additional issues property owners should consider.
- Typical Deal Terms
Generally, rooftop solar leases run from 15-25 years, sometimes with an option to extend. Rents can be fixed but more commonly are calculated based on a dollar amount per megawatt of installed capacity. If negotiated, some rents may contain an escalation year over year. Before starting construction of solar facilities, landlords may require tenants to provide either a cash credit or letter of credit.
The solar energy the facilities produce may either be sold to an offtaker (sometimes a public utility company) or put into a community solar program, or the landlord could enter into a power purchase agreement with the solar tenant and provide the building with discounted electricity to reduce energy costs for building occupants. A decommissioning assurance provision is often required to secure the tenant’s obligation to remove the solar equipment at the end of the term, either in the form of a bond, letter of credit or cash account, typically funded in the last five years of the lease term. The solar tenant will need several easements or license areas to support equipment installation, including a ground area for a transformer pad, any necessary utility easements, and a temporary construction laydown area to stage materials.
One threshold issue for landlords to consider is whether any third-party approvals are required, including “without limitation” consents needed from lenders, building tenants or joint venture partners. It is important to start this dialogue early on, including with internal stakeholders at the landlord entity who may not be as prepared to risk trying something unfamiliar with their asset management.
- Ownership and Control of the Roof
Property owners should be mindful of whether they have granted rights to the building’s rooftop to any of the tenants. In multi-tenant buildings, the landlord usually retains exclusive ownership and control of the roof, whereas in single-tenant buildings or ground leases, the roof may be under the tenant’s control, including maintenance and repair obligations. If the tenant is responsible for the roof’s maintenance under terms of the building lease, or if the tenant leases the entire property (land and building), the landlord will need to amend the building lease so that the landlord may legally lease the rooftop to the solar provider.
- Age of the Roof
Many solar tenants are looking for a site with a new roof at the inception of the solar lease because the term of the lease will likely be 15-25 years. However, landlords will want to retain the option to replace the roof during the term of the solar lease in the case of emergency and carve out opportunities to repair the roof during the solar lease if necessary.
If the roof is not new but has 10 or 15 more years of useful life, a building can still accommodate a solar facility. However, landlords will need to negotiate with solar tenants to allocate the cost-sharing of a midterm roof replacement and the mechanical and operational logistics of removing the solar panels and then reinstalling them once the new roof is completed. Alternately, some landlords may move up roof replacements that weren’t planned for a few more years to accommodate the solar facility’s installation; this is also subject to negotiation. The parties typically conduct a structural assessment of the roof during the development term of the lease, and if the assessment reveals any structural problems, the parties negotiate the right to terminate the lease. Also, landlords generally include provisions regarding preservation of the roof warranty.
- Integration With Existing and Potential Future Users of the Building
The solar tenant should accommodate any existing rooftop equipment, such as HVAC units, but landlords might want to set aside additional areas for future equipment needs before solar facility plans are set in stone. For example, landlords may envision future tenants requiring additional rooftop HVAC units during the term of the solar lease. If so, it would be prudent to designate certain solar-free “reserve areas” in advance (though sometimes this is unnecessary depending on the site specifics).
Interference is another area to consider. It is important for the rooftop solar lease to contain provisions requiring the solar tenant to remedy any interference the solar facility may cause with the operations of the building tenants; sometimes this comes in the form of parking lot disputes.
In addition, the solar lease should deal appropriately with building access. Generally, solar rooftop tenants are limited to accessing the exterior of the building only, and access to the roof is by exterior ladder. However, landlords will sometimes allow solar rooftop tenants access through the building’s interior (if available). If there is a power purchase agreement, solar rooftop tenants will also need access to the building’s electrical room to tie into the building’s electrical system.
- Insolation
Solar tenants require a certain degree of insolation assurance, which means they need to know that sufficient sunlight will reach their solar facilities for maximum energy production. It is common for solar leases to contain protective language saying that landlords will not do anything to impair the sunlight or cast shadows over the solar facilities. Landlords should work to carve out certain rights that would preserve their autonomy and flexibility to lease out their primary asset (the building), including the right to exclude existing rooftop installations and landscaping from the areas leased to the solar tenant. Landlords will also want the right to relocate and increase the size of rooftop HVAC units if a new building tenant demands greater HVAC capacity, while recognizing that they may need to compensate the solar tenant for decreased insolation.
- Casualty Implications
Generally, if a building is materially damaged and the landlord is not obliged to restore it under other binding agreements (such as a building lease), then the landlord should have the right to terminate the solar lease. In some instances, and as a compromise, language can be inserted stating that the parties will use best efforts to find an alternative location for the solar facilities. However, landlords generally cannot guarantee that a new location will be available.
Under scenarios in which the landlord is obligated to rebuild the building, the solar tenant typically receives a proportionate abatement of rent during the time the roof is unusable. It is important for landlords to know that they should not be forced to rebuild their primary asset (the building) just to satisfy the solar tenant.
- Financing-friendly Provisions
Given that solar developers are making such a large-scale, long-term investment in the solar facilities to be installed, tenants generally obtain leasehold financing from traditional lenders and equity from tax credit investors. The federal investment tax credit is currently 30% of most of the costs of the solar facility (this can increase to up to 60% if specific requirements for “adder” credits are met, such as using certain domestic equipment or constructing solar facilities in certain low-income areas or sites where fossil fuels previously dominated). This credit is taken over the first five years of the solar facility’s operation.
Solar lenders and tax equity investors require the solar lease to contain several lender-friendly provisions, including notice and cure rights, plus other terms more likely to be seen in a ground lease than a building lease, including the right to obtain a subordination, nondisturbance and attornment agreement (SNDA) from any landlord lenders. This is different from traditional commercial leases in which most tenants request, but are unsuccessful in obtaining, an SNDA from the landlord’s lender.
- Ownership of the Solar Facilities
Solar leases generally contain an extremely specific delineation of who owns what. The solar facilities, though possibly considered “fixtures” under property law, are expressly and exclusively owned by the solar tenant. In addition, solar leases specifically delineate who owns (usually the solar tenant) the various environmental attributes and incentives that are allocated to or generated by a solar facility, including carbon trading credits, renewable credits, tax credits, accelerated depreciation, etc. It is important to ascertain each party’s ownership of the various assets.
- Interruption of Electrical Output
Solar tenants typically want assurances they will be compensated for any time that the solar facilities are down due to an event caused by the landlord. The concept of “lost energy revenue” is often seen in solar rooftop leases. This represents the sum of all revenue the solar tenant would have received from the sale of energy generated from the solar facilities, the revenue it would have received from solar incentive programs or rebates or assistance programs, and tax credits it would have received (or recapture of the tax credits).
It is not uncommon for the solar tenant to provide a fixed number of days (or kilowatt hours of production) each year for the landlord to make repairs without having to pay this lost energy revenue. This is an important concept to protect the solar tenant from downtime caused by the landlord’s actions because the solar tenant has obligations to whoever is purchasing the power and to its financing parties and tax equity investors.
Approaching Solar With Confidence
The risks and rewards of solar rooftop leases are many. However, with an understanding of the market’s various intricacies and with the advice of experienced counsel, industrial property owners can undertake these transactions with confidence, all while contributing to the reduction of carbon emissions and making some additional income at their properties.
Jennifer Connelly is a partner at Sherin and Lodgen LLP.
