Real estate investment trusts, or REITs, have become a popular way to invest in any sort of real estate development. Apartment buildings, commercial buildings, oil and gas pipelines, and even casino real estate have been formed to take advantage of the tax advantages of REITs.
So, I'm wondering when the trend hits the solar market? And if it is, who is most likely to take advantage of the REIT structure?
REITs are a corporate structure under U.S. federal income tax law. The technical definition is "any corporation, trust or association that acts as an investment agent specializing in real estate and real estate mortgages."
The advantage of REITs is that they can avoid paying corporate income taxes if they pay at least 90% of taxable income to investors. REITs can still borrow money to produce leverage, have overhead, and perform other normal business functions; but the center of their business has to be real estate.
This sounds like the perfect structure for a growing number of solar developments across the country, and I think it's a coming trend for solar.
Solar's transition from modules to projects
Over the past few years, solar companies have made a transition from being strictly module producers to being more vertically integrated down the supply chain. That means developing and maintain solar projects. First Solar has amassed 3.0 GW in backlog, and SunPower also has a large pipeline of projects. These could fuel the solar REIT of the future.
So far, these big projects have been sold to investors, partially because of the tax benefits. Berkshire Hathaway is spending between $2.0 and $2.5 billion to buy the Antelope Valley project from SunPower, and also purchased Agua Caliente and Topaz plants from First Solar. Berkshire gets a 30% tax credit on the cost of building the newer projects, something that wouldn't benefit a REIT yet.
SolarCity is another developer that could use the REIT structure. The company has residential and commercial developments across the country and, like SunPower and First Solar, has chosen to sell assets for now.
But in the near future, the solar REIT will make a lot of sense. Government subsidies are melting away, and investors will look for a way of creating a tax-advantaged system.
Suntech Power has even tried to gain a foothold in project development in the U.S. after some experience in Europe.
How it would work
We know that solar companies have the assets to develop REITs, and other companies have provided the blueprint for how to do it. Penn National Gaming just announced the formation of a REIT to own its hotel assets, while the original company will operate the casino and pay rent to the REIT.
Kinder Morgan has built a REIT that it pushes assets down to as the parent company acquires and develops them. This could be very similar to what we see from the solar industry.
Foolish bottom line
I think the solar REIT is closer than we think, and it could unlock a lot of value in solar. Companies use REITs to lower the cost of capital and free up other capital at the parent company for other activities. As investors gain more confidence in the reliability of cash flows from solar projects, this could be a huge advantage for the industry, lowering cost per watt across the board.
I think SolarCity, First Solar, and SunPower are the most likely to take advantage of this structure; but if it's successful, others will surely follow.
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The article The Next Trend in Solar -- Solar REITs? originally appeared on Fool.com.Fool contributor Travis Hoium manages an account that owns shares of Berkshire Hathaway, SunPower, and Kinder Morgan. Travis Hoium is personally long SunPower and has the following options: Long Jan 2015 $7 Calls on SunPower and Long Jan 2015 $5 Calls on SunPower. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw. The Motley Fool recommends Berkshire Hathaway and Kinder Morgan. The Motley Fool owns shares of Berkshire Hathaway and Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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