1 Pricing: Higher Always Better?
The decision to select the highest price should be based on more than just the dollar figure. It is essential to consider the likelihood of a project’s successful development, construction, and revenue generation. This depends on whether the developer has the requisite experience in solar project development and a strong capital partner, as substantial risk capital is needed for project development. In the solar industry, it is common for interconnection upgrade costs to exceed $1 million for smaller projects. These expenses must be paid within a relatively short timeframe, and without sufficient industry experience and capital, developers may risk losing their projects if they miss these deadlines.
For large utility-scale projects, typically managed by major developers, land prices in the Midwest have found stability in the range of $1,000 to $1,200 per acre. In contrast, smaller solar projects, particularly community solar projects, tend to attract newer and less experienced developers who offer enticing leasing rates. However, these smaller projects often consolidate over time, primarily because they are funded by the same investors eventually.
Based on our extensive project due diligence as an investment manager and technical advisor, it is evident that unreasonable pricing, whether in the form of excessively high lease prices to accommodate landowners or extremely low electricity prices to entice electricity buyers (off-takers), often accompanies other project design issues that make the project uninventable. To illustrate, during our review of 12 portfolios a while back, only two portfolios were designed and developed properly, and all the investors are willing to pay substantive premium for these two portfolios. Notably, these two portfolios were developed by large developers and investment funds. In contrast, all the other 10 portfolios, crafted by various small developers, including those with over a decade of experience and a strong track record in the markets, exhibited multiple issues that deterred investors from participating in those projects.
The community solar market is expected to mature, and pricing will eventually align with large utility-scale projects.
At LXI Capital, we are actively involved in acquisitions, both for our own portfolios and on behalf of our clients. Leases for the funded projects are typically aligned with those for large utility-scale projects, with prices expected to remain within the $1,000-$1,200 range, or slightly higher due to market demand, ensuring successful development and funding until the operational stage.
2 Escalation rate: 1.5% vs. 2% vs. 3%?
In comparison to the lease price per acre, the solar project is more sensitive to escalation, primarily due to the compounding effect over the long term, often spanning 40 years. Since most power purchase agreements (PPAs) feature a 2% annual escalation, a 3% or higher escalation rate on the land lease may have a detrimental impact on the project’s overall economics. At LXI, we will NOT pursue projects with a 3% or higher escalation in the lease agreement.
3 Structure:
The infrastructure industry typically operates on a take-it-or-leave-it business model due to the inherent rigidity of infrastructure projects. For distributed solar projects, the standard structure often includes:
- Option period: 24 months (6 ~7 years for large utility scale projects)
- Construction phase: 12 months (2 years for large utility scale projects)
- Operational period: 40 years (20 years for battery storage projects)
4 Property Tax:
Since most farmland falls under the agricultural property tax code, the development of the parcel into a solar farm project often triggers a change in zoning and tax code to an industrial classification. Farmland typically enjoys numerous tax benefits, with its assessed valuation often based on agricultural product yields in many states. However, when agricultural status is relinquished, the land may be assessed at its true market value. For instance, land that was assessed at $250 per acre under agricultural classification may be reassessed at $15,000 per acre once it is reclassified as industrial. Usually, the development company absorbs the increase in property tax. However, the landowner might receive the actual property tax bill from the county due to their ownership records. It’s crucial that the landowner passes this bill to the developer, who is responsible for the prorated portion.
5 Timing: Should I Wait for the Next Ideal Developer or Shop Around?
These are typical questions that landowners often grapple with. The solar industry is thriving in the U.S., especially in the Midwest, which is still in the early stages of growth. This can result in varying situations for landowners, with some receiving multiple offers simultaneously while others may not have heard of solar leases.
Regardless of your situation, the first step is to decide if a long-term lease, such as one spanning 43 years, is suitable for you. It’s important to note that even with a lease agreement, you can still buy or sell the land.
If you opt for a lease, it’s highly likely that leasing your land for a solar project is the best option to achieve high cash rent for most landowners in the current market. Solar cash rent typically surpasses the income from farming operations.
The next question is: which development company should you choose to work with?
It’s essential to determine whether you prefer working with a large developer or a smaller one, where you might have more negotiating power. Large developers usually have land department employees or outsourced contractors, often referred to as landmen, who handle basic land lease matters but might lack knowledge about interconnection or power markets. Once the landmen receive your interest in leasing, you’ll proceed to work with the legal departments. Please be aware that due to the high volume of land in their pipeline, developers within these large companies may not be able to focus on your parcels immediately. It’s common for a large corporate developer to manage 20 projects simultaneously, and they may have hundreds or thousands of parcels like yours in their pipeline.
Pros of working with large developers: they are usually well-funded by investment-graded entities, and their projects tend to be developed correctly, thanks to in-house capabilities and expert external teams.
Cons: they might request a 3-year option period, and the offered price might be lower. Please note it’s common for developers, both large and small, to buy and sell projects or portfolios for various reasons.
For smaller developers, it’s vital to assess their experience and capabilities.
6 Strategic Investment in Land Proximity to Substations for Solar Development Leasing
In the realm of strategic investment opportunities, the decision to purchase land close to substations for the purpose of leasing to solar developers requires careful consideration. Much like the principles of real estate, the pivotal factor at play here is “location, location, location.” However, defining what constitutes an ideal location in this context is a multifaceted blend of both art and science.
It is worth noting that many solar developers prioritize proximity to substations as a primary criterion during their initial site selection process. This preference serves as a straightforward metric to convey to real estate and land acquisition teams. Nonetheless, this approach may fall short in accounting for the available capacity at the Point of Interconnection (POI). In some cases, it can result in substantial costs associated with interconnection upgrades and eventual project abandonment.
At LXI, we establish collaborative partnerships with landowners and investors, offering valuable technical guidance for informed site selections. Together, we identify and acquire sites with a higher likelihood of successfully reaching the operational stage, ensuring that landowners can realize their lease payment expectations. Our expertise in site selection and project viability assessment ensures that investments in proximity to substations yield optimal returns and minimize associated risks.