301 Moved Permanently

301 Moved Permanently


How are real estate investment trusts (REITs) putting money in renewables? That is the question a colleague and I set out to answer when we organized the “REITs and Renewables: An Emerging Combination” conference held in Washington, D.C., in early April. The conference brought together representatives of the REIT and renewable energy industries to participate in panel discussions on the involvement of REITs in the renewable energy space. The goal was to understand how this involvement is already occurring. The challenge was to find ways to expand upon that involvement.

The event did not disappoint. While the discussions revealed that REITs are not a one-stop solution to the funding needs of the renewable energy industry, they also made clear that REITs can play an important role in this area, albeit one constrained by the limitations unique to REITs. These limitations relate primarily to the requirements that the bulk of a REIT’s assets must be “real property,” that a REIT not use those assets in the active conduct of a trade or business and that a REIT distribute at least 90% of its taxable income annually to its shareholders as dividends. It turns out that REITs are finding ways to include renewable energy assets in their portfolios while successfully navigating around these limitations.


Quest for clarity

The idea for the conference arose largely in response to widespread predictions of the impending birth of the so-called “solar REIT.” Many of these predictions were fueled by the belief that the IRS was about to rule that a solar PV farm was real property under REIT rules.

We were skeptical of these claims for two reasons. First, the IRS typically considers whether property qualifies as real property on an item-by-item basis. To conclude that an entire solar farm is real property would represent a significant departure from this historical approach. Second, comments by the IRS in prior REIT rulings suggest that it believes that electric generating equipment may not qualify as real property. Since a PV system’s function is to generate electricity, concluding that it was real property would have required the IRS to reconcile its prior comments with that conclusion. We believed it was unlikely that the IRS would do that in the context of a private letter ruling to an individual taxpayer.

At the same time, it was clear to us that REITs could play an important role in the renewable energy industry within the limitations imposed on them. For example, even if certain assets, such as a solar PV panel, might not be good REIT property, other assets, such as the land on which the solar PV panel is located, could qualify as good REIT property. More traditional REIT assets, such as the space on the roof of a building, could be used to host solar rooftop systems that are owned by other persons. A solar system that is used solely to provide electricity or hot water to a building may, under certain circumstances, be so closely associated with the building that the building’s status as real property carries over to the solar system.

What we learned at the conference is a “good news, bad news” scenario. The good news is that there definitely are opportunities for REITs to invest in renewables. The bad news is that there are significant barriers preventing the type of investment that so many are hoping for.


Navigating the barriers

First, the barriers. In addition to having enough good REIT assets and generating enough good REIT income, a REIT must avoid selling anything that the IRS considers to be inventory. Otherwise, a REIT is subject to a 100% “prohibited transaction” tax on its net income from those sales. It is not clear whether the IRS considers electricity to be inventory under REIT rules.

REITs are also inefficient users of tax credits, such as the energy tax credit. Tax credits don’t pass through a REIT to its shareholders. They are also disallowed at the REIT level to the extent that a REIT distributes its taxable income. This means that because a REIT is required to distribute at least 90% of its taxable income each year to its shareholders, at least 90% of any tax credits otherwise available to a REIT will be disallowed in that year.

Finally, even if one concludes that a majority of assets of a solar project are good REIT property, other questions remain, such as whether they can also qualify for five-year depreciation, whether the treatment of those assets as inherently permanent is inconsistent with certain positions taken in tax equity structures and whether foreign investors will be able to avoid getting ensnared in a special tax regime applicable to foreign persons that own interests in U.S. real property or U.S. corporations that own U.S. real property.

These barriers mean that a REIT is not going to participate in renewable energy projects as a substitute for an investor in a tax equity partnership. The good news, however, is that some REITs are starting to find ways to work around these challenges. The panel discussions at the conference revealed four models that REITs are using to do this.

The first, and most straightforward, model involves a REIT that owns and leases property that unquestionably is real property, such as land. This REIT funds its distributions to its shareholders from the rental payments it receives from its tenant, which is usually a project company that operates a solar project on the land. Alternatively, a REIT acquires a leasehold interest in land that hosts a solar project, in which case the REIT funds distributions to its shareholders from the spread between the rent it receives from the sub-lessee and the rent it pays to the lessor.

The second model involves a more traditional REIT that uses renewable energy assets to enhance the return on its existing good REIT assets. One example involves a REIT that owns buildings with a significant amount of rooftop space - itself a good REIT asset - that it leases to an unrelated person. The other person then constructs and owns a solar system that generates electricity, heat and hot water, which it sells to the REIT, the REIT’s other tenants and/or third parties. The REIT receives rental income from the lease of its rooftop space, and the other person receives income from the sale of solar-generated utilities.

Alternatively, a REIT can own the solar system and use it to generate utilities that are consumed entirely by itself and/or its tenants. Such a system can qualify as a good REIT asset if it is incorporated both functionally and structurally in a building owned by the REIT. If this is not possible, then the REIT can include the project in its portfolio as a bad REIT asset, or it can own the project indirectly through a taxable REIT subsidiary (TRS). A TRS is a corporation that is partly or wholly owned by a REIT and, together with the REIT, has made an election to be treated as a TRS. A TRS generally can engage in any business activity, including activities that are forbidden to REITs. In return, unlike a REIT, a TRS must pay corporate income tax on its earnings.

The third model discussed at the conference was a mortgage REIT model. This is a REIT that owns loans secured by real property rather than an equity interest in the real property. These loans can be used by the real property owner either to purchase the real property or fund improvements to it.

The fourth model is not really a REIT model at all: It relies instead on the use of a Canadian income trust, which is a type of pass-through entity formed in Canada that generates high yields. The units of a Canadian income trust are traded on Canadian stock exchanges. The money raised from the sale of units in a Canadian income trust is pooled for investment. Because Canada does not impose any limits on the type of property an income trust can own other than the property not be used in carrying on a business in Canada, Canadian income trusts are a good option for owning renewable energy assets in the U.S.

Now that several months have passed since the conference, the question of whether it was a success can be considered. The answer depends on one’s perspective.

If one’s expectation was that the conference would reveal the path toward tax equity-type investments by REITs in renewable energy projects, then disappointment is the likely response. On the other hand, if one’s expectation was to shed light on a path that can be taken, then I believe the conference succeeded by illuminating the creative approaches that have already been taken to combine REITs and renewables. Let’s continue with that creativity. S


Kelly Kogan is a senior attorney in the project finance and tax practice at Chadbourne & Parke. She can be reached at (202) 974-5671 or kkogan@chadbourne.com.

Industry At Large: Project Finance

The Status Of REITs And Renewables: An Update From The Field

By Kelly Kogan

Real estate investment trusts are finding ways to include renewable energy assets in their portfolios.











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