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Posted: December 06, 2011

Rooftop solar and dirt law

Don't forget the real estate fundamentals

J. Marcus Painter

 Not much will excite a commercial real estate owner more than low cap rates, cheap financing, and the offer of something for nothing. While the first two are still elusive in this anemic economy, the abundance of federal, state and other incentives in the renewable energy sector has created the opportunity for commercial and apartment property owners to truly receive something for nothing. But only if all parties are careful.
The vast array of renewable incentives has spawned an entire industry commonly referred to as "distributed solar generation."

In general terms, distributed solar is electricity generated from photovoltaic solar panels installed on or near the building where the electricity is used. The vast flat roofs of commercial, office, industrial and apartment buildings are perfect locations for such solar installations under the predictable Colorado sun. A distributed solar system is typically owned by a solar investment company, installed on the commercial building at the solar company's cost, and through a power purchase agreement with the building owner, the solar-generated electricity is sold to the building owner for consumption on site.

The "something for nothing" component is that the building owner doesn't pay anything for the system, gets electricity cheaper than utility prices, and usually has a right to buy the system later for an affordable amount. The solar developer makes a little money on the ongoing sale of electricity, but the big investment return for the solar developer comes in stripping out the tax rebates and other incentives for the cost of the system. This incentive arrangement drives the success of many sustainable projects.

Unfortunately, all too often, owners and solar providers become enamored of the projected savings and forget about some important real estate obstacles that can turn the "something for nothing" element into major, expensive problems for all parties. For instance, virtually all commercial buildings have significant mortgages on them through standard bank financing, conduit or insurance company loans, or bond financing. And most solar developers must finance the solar equipment they install. The solar equipment loans are typically secured with a lien on the installed solar panels and racking attached to the building's roof, which begins to look a lot like a "fixture" or a part of the real estate covered by the building mortgage.

The solar developer's lender does not want a foreclosure on the building to result in a loss of the solar system, so it wants an acknowledgement that the solar equipment isn't covered by the real estate mortgage. On the flip side, the building owner's mortgage almost always has a prohibition on allowing any other liens against the property. So just allowing the solar developer to give a lien to its lender can result in a default on the building's loan, which is a bad thing for all parties.

There are solutions to this problem, but they are not always easy and they take time to work out. Many commercial real estate loans are handled by distant loan servicers who have no interest in making exceptions to their standard operating procedures. Solar may not be new, but it is new enough that many loan servicers are reluctant to "approve" the installation of a solar system that is subject to another lender's lien. Further, even if the loan servicer does consent, the language of the consent may not be enough to satisfy the solar company's lender. That's when the deal slows down and the negotiations get very delicate. Both parties want to avoid pushing their respective lender too hard.

Some loan servicers simply refuse to respond. Others will only respond when someone advances them money to cover their legal fees for even reviewing the matter. In the end, the art of the deal is having sophisticated parties and sophisticated counsel who know how to probe the lenders' areas of flexibility and match those to the other's true needs. And there is no substitute for creativity in finding ways to finesse the lenders' objections and concerns, such as using a long term license (not a real property interest) instead of an easement (a real property interest), or using a subordination and non-disturbance agreement in a new way that satisfies both parties.

Obtaining mutually acceptable consents from lenders is generally the most time consuming hurdle, but it isn't the only significant hurdle. The parties are well advised to obtain a full title search on the underlying real estate to uncover any other parties with rights to the real estate that might have a say in the installation. Also, not all distributed solar goes on the roof. Sometimes it is installed on adjoining land, and electrical connections must cross streets that are subject to utility or access easements, parking rights or other similar interests. Or a title review may reveal that the building is actually on a long term ground lease and the underlying owner must also give consent.

The development rights of adjoining owners that may result in overshadowing of the system are important considerations, as may be anchor tenants' rights to approve modifications to the appearance of the property (a big issue with many shopping centers). Glare problems for adjoining airport flight paths, height restrictions, zoning or planned unit development limitations also must be considered.

These issues are but a few of the details that need to be considered and resolved to ensure that the benefits of a solar installation are part of a true "win-win" for the parties and the sustainability of the project. With proper care and due diligence, building owners can install distributed solar without violating mortgage covenants and other property rights, and truly enjoy significant utility cost savings, a lower carbon footprint, and a more socially responsible and marketable project.
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J. Marcus Painter chairs Holland & Hart LLP’s real estate practice, where he focuses on complex real estate transactions, developments and financing, including distributed renewable energy projects. For twenty-five years, Mr. Painter's developer and lending clients have sought his creative counsel in navigating difficult transactions to profitable completion. He can be reached at 303-473-2713 or mpainter@hollandhart.com.

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