As Shakespeare Might Have Said, To Buy or Lease: That is the Question

Whether we are business leaders or homeowners, we frequently think of solar power as a way to save money on utility costs.  After all, energy from the sun is free, whereas electricity from a traditional utility involves monthly bills that we automatically assume will continue increasing steadily.  This much of the conventional wisdom is correct: It is very possible to enjoy significant, life-long savings by installing solar photovoltaic (PV) panels.

But those of us who decide to proceed with solar quickly discover that things are more complicated than they seem.  It is entirely possible to lose money rather than save it, depending on the choices we make.

There are two major approaches to “going solar.”  Own or lease.  It sounds like the choice many people face when deciding whether to buy or lease a car although in the case of solar the decision is a bit more complex.  This choice – to buy or to lease – involves differing advantages and disadvantages, and the contrast may be more complicated than it first appears.  As the old saying goes, “the devil is in the details.”

Ownership.  In the first approach, a property owner can hire an experienced solar contractor to install a system, paying for it up front either with a loan (similar to buying a house or an appliance) or with cash.  In this case, the owner of the solar system can take advantage of a federal tax credit equal to 30% of the cost of the system.  Tax credits are better than tax deductions as they can be used to offset tax liabilities dollar-for-dollar.

In other words, suppose a large big box store chooses to install PV panels that produce 500 kilowatts (kWs) of electricity per hour.  If the cost of installation were $3/watt the installation cost would be $1.5 million ($3 * 500,000 watts).   When paying taxes for the year of installation the store can reduce its tax liability by $450,000 (30% * $1.5 million).  If its tax liability were $500,000 it would pay only $50,000 that year.  The federal government would thus pay 30% of the cost of the system.

In addition to the tax credits a commercial building owner (though not a homeowner) could also depreciate the value of the solar system and reduce its adjusted net income by the amount of the depreciation allowance.  At present the depreciation allowance can be accelerated and taken over 5 years which can help a building owner recover as much as 30% more of the cost of the PV system.

Finally, in some states the owner can take advantage of other incentives as well.  For example, in Massachusetts, Connecticut and New Jersey – three high priced electricity states — the building owner can sell renewable energy credits equal to at least $150 per megawatt hour of electricity produced.  A 500 kW system might produce 600 Megawatt per year.  The owner could sell renewable energy credits each year and collect, in this case, $90,000 per year.

The cumulative value of these tax benefits and other incentives can help the building owner recover the entire cost of the PV system.  Once recovered, the system would continue to produce free electricity for years to come.

Lease.   The second major approach is to lease a solar system provided by a solar company.   A developer, bank or other financial institution pays 100% of the cost of installing the PV system.  Title and ownership of the system remain with the developer, bank or financing company which then leases the system to the solar “host” – ie, the building owner.  The host consumes the solar electricity produced by the system and pays a monthly lease fee to the owner.

A variation on the lease is called a Purchase Price Agreement (or PPA).  In a PPA, the solar host pays a fixed amount for each kilowatt hour of electricity produced by the PV system.  The PPA payment takes the place of the monthly payment due under a conventional lease.

In addition to owning the PV system, the leasing company assumes all the responsibility for maintaining the system including repairs, replacement of the inverter that converts direct current produced from sunlight into alternating current consumed by the home’s appliances, and replacement of the panels in the case of damage from, say, hailstones.

Comparing Owning vs. Leasing.  The “zero-down” nature of the leasing option makes it very attractive to end users.  Leases are also attractive because lessees of solar (or solar hosts who are party to a PPA) will have nothing to do or to worry about.  The title holder is responsible for all maintenance and repairs.

Nevertheless, there are still a number of important considerations that solar hosts should take into account.  In this section we highlight a number of these factors:

  • Ability to use tax credits. If a solar host – corporation, non-profit institution, or homeowner – has no tax liability, a lease or PPA will probably be the best option.  After all, the generous tax credits offered by the federal government cannot be used if there is no tax liability to offset.

If, on the other hand, a solar host can use the tax credits, ownership could provide better long term benefits as discussed further below.

  • Savings Projections. How much can building owners expect to save from solar PV systems?  The answer depends on the difference between (i) what the owner or lessor pays for the PV system or the electricity produced and (ii) the price of utility power.

Buyers of PV systems must be cautious about projecting future utility price increase.  Many solar contractors will project such savings yet future savings are completely speculative as nobody can project future utility prices.  Many solar contractors tell prospective customers that utility prices have been going up by 5-6% per year for decades and will continue to do so.  In fact, the past 20 years utility prices nationwide have increased less than 3% per annum and there is no certainty they will continue to increase.  In Connecticut in July 2015, for example, utility prices dropped over 30%.

The assumption about future utility price increase is critical. Most lease or PPA arrangements typically include annual rate increases of 2.9% or more.  If utility prices were to increase less than the escalator clauses in these contracts, it is possible after a few years, homeowners with leased solar systems could end up paying more for electricity than they would have if they had never switched to solar.   In July 2015 the Wall Street Journal reported that some Arizona consumers complained about just that.

A buyer of a solar PV system will look at future savings differently.  If a buyer pays for a system out of cash the relevant metric will be the owner’s alternative returns if instead of the solar system the owner invested the funds elsewhere; those returns must be compared to the avoided utility costs from the PV electricity production.   If a buyer borrows the cost of the system the amortization payments for the loan will be compared to the avoided utility costs.

In most cases the cost of buying a system (or the returns that the buyer foregoes) will be less than the avoided utility costs.

  • Penalties. The fine print and technical details in a lease agreement are critically important.  For example, if an owner sells a property within five years of taking tax credits, those credits might need to be forfeited.  If a third party paid for the system the solar host might need to pay penalties that offset amounts clawed back by the IRS from the developer, bank or financial institution that took advantage of the tax credits or depreciation allowance.
  • Value.  Another important advantage to buying solar rather than leasing concerns property values and one’s ability to sell a home or business if needed.  Buildings with their own solar systems are immediately worth considerably more than they were without the systems, and are more marketable.  The operating costs of the building are reduced by the amount of solar production.

By contrast, with leasing, the opposite may be true.  The leased solar system is not something the homeowner or building owner can sell.  The existence of an ongoing contract to buy power from the developer will complicate a sale and can make it impossible for prospective buyers to obtain loans.  The building owner’s only options might be to pay in advance for the entire remainder of the power purchase agreement or to default on it – and hope that when the solar company removes its system the roof won’t suffer any damages.

Many building owners wonder about what’s involved in maintaining a solar system once they’ve purchased it, and what to do if the system breaks or fails for some reason.  On this issue it is important to remember that unlike a car, solar systems contain no moving parts, and are entirely passive.  Service problems are extremely rare.  In addition, if a building owner works only with an experienced, qualified contractor when purchasing the system and having it installed, that same contractor will be able to assist with potential problems.

There is one kind of maintenance issue a building owner should take a careful look at when analyzing and comparing the choice between buying or leasing, and that is the prospect of natural damage to the solar system that could occur due to severe storms, such as those that shower rooftops with hail.  A lease agreement may put all the responsibility for such maintenance on the shoulders of the solar utility company, but will also have the costs of this embodied in the details of the lease agreement, so the building owner will be paying for the risk of potential maintenance costs all along.  In contrast, when buying a solar system, building owners should consult an ordinary insurance company, to find out in advance what it will cost to insure the system in the event of unusual nature-caused accidents.

The devil may be in the details, but a building owner who takes the time to study the options carefully and thoroughly can be assured of reaping significant financial rewards by using solar power.  A building’s energy costs can be reduced drastically – and permanently – and the building’s value and marketability can be increased substantially, as well, depending on the specific choices made.