Large real estate investors are facing a confluence of challenges relating to the amount and type of energy that they, and their occupiers, consume. Geopolitical and macroeconomic events in recent years have caused high and fluctuating energy prices in the UK, creating a lack of price certainty and energy security.
Additionally, there is increasing pressure on investors from multiple stakeholders, including their funders, investors, tenants, customers and employees, to deliver or contribute to net zero.
This creates a commercial and moral imperative to “do the right thing” on climate change and net zero. It also presents a commercial opportunity for investors to make a further return on their portfolio.
On-site generation and storage
For many years, investors have received regular approaches from renewable energy companies offering to install renewable energy generation and storage.
Early adopters of rooftop solar were able to benefit from the feed-in tariff, which provided a lucrative additional revenue stream and encouraged the rapid growth and investment of those early years.
After removal of the subsidy, on-site renewables still present a viable long-term investment opportunity for developers as equipment prices have fallen, quality has risen, and developers and funders better understand the risks and financing profile of this asset class.
In recent years, large investors have recognised that they do not need third-party finance and, in this burgeoning market, can contract directly to deliver these schemes.
The viability of on-site solutions depends on the technology or mix of technologies that can be implemented and framework solutions over multiple sites offer greatest opportunity for aggregation and variety.
Solar photovoltaics remains the most established technology, but cases differ and mixes are increasingly common, including battery storage, generation and storage of heat, and links with electric vehicle charging infrastructure.
This can provide greater opportunity for the investor and also greater benefit and attractiveness to the occupier through lower cost, greener heat and support for any EV fleet and employee use.
The PPA model
The most common model for the delivery of on-site commercial generation is through a power purchase agreement, which is known as “the PPA model”. Where this model is used by an investor, that investor (as landlord) installs the energy equipment and retains ownership of it, being responsible for its operation, maintenance and performance.
The landlord will need to finance the capital costs of procuring and installing the energy system and the ongoing operational expenditure. It therefore needs a long-term revenue stream to repay the financing and generate a suitable return on investment.
That revenue stream is generated through a long-term power purchase agreement with the occupier, typically for 10-20 years, under which the occupier agrees to purchase the power generated by the equipment.
This may be a commitment to purchase that power in priority to another licensed supplier or elsewhere up to the level of the occupier’s actual demand or to purchase a minimum guaranteed amount on a take-or-pay basis.
The contract price is commonly a fixed, indexed price (based on the consumer price index) but, depending on the appetite for risk and reward for both parties, discount to market price options with a cap and collar have also been concluded.
From an occupier’s perspective, the PPA model is popular as it allows the occupier to benefit from renewable energy without the upfront cost and risk associated with owning and operating their own system. It also provides price certainty and security of supply, which can help businesses to manage their energy costs more effectively.
To allow for the installation, operation and maintenance of the energy equipment, the investor needs to have retained or excluded the roof/structure and airspace or to have reserved necessary rights in any lease of whole, or it will need to secure a variation to that lease. In determining the scope of these rights, the investor needs to consider and cater for potential future adaptations and improvements in technology, or new technologies, and colocation of assets and leases need to be future proofed, so far as possible.
The evolution of on-site schemes
Rooftop solar PV under the PPA model continues to be very popular owing to the reasonable cost of the electricity generated, and payback periods being shorter, particularly in periods of higher market pricing for electricity.
On the downside, solar PV only provides intermittent power during daylight hours.
Battery storage can be a solution and may provide occupiers with additional efficiency and revenue benefits (particularly when paired with EV charging) but short duration storage (1-2 hours) will not address a 24-hour warehouse’s night-time energy needs.
Some energy storage options being developed and explored include alternative battery chemistry offering longer durations, but the energy efficiency and financial return on smaller scale on-site storage remains a challenge to its success.
Increasingly, developers and landowners are looking at multi-technology options that provide renewable electricity and also heating and cooling.
This can be delivered through air, ground or water-source heat pumps, or through other more complex technologies, such as geothermal – tapping into underground aquifers to draw and also store heat, with some projects also looking at accessing heat from underground mine workings.
There is also a continuing market for on-site heat and power generation through combined heat and power plant, which, while powered by gas, can provide a very efficient solution for campuses or larger occupiers, but cannot provide the outward facing benefits of powering sites with renewable energy.
Landlords and occupiers should be mindful of the changing requirements of a commercial fleet and employees’ and customers’ vehicles. We are likely to see a surge in demand for solar PV car ports over existing parking areas, allowing vehicles to charge and to make a significant contribution to the site’s overall energy needs.
Corporate power purchase agreements
Beyond on-site generation, another option available to large investor landlords wanting to buy renewable energy for their portfolio is corporate power purchase agreements. There are three main types of CPPAs – private wire, sleeved and virtual.
Private wire PPAs involve the supply and purchase of electricity from a nearby energy generation facility through a physical cable – the corporate buyer purchasing actual electrons generated from that adjacent facility. This is similar to the private wire aspect of a rooftop solar installation, but with the adjacent project owned by a third-party developer.
Sleeved and virtual CPPAs, on the other hand, involve a contractual arrangement for the purchase of an amount of electricity equivalent to that generated by the specific project, with pricing often being fixed and indexed.
These are most commonly for 10-15 years and are traditionally only appropriate for larger projects. However, there are now more opportunities for smaller corporates, with new market entrants looking to develop a more fluid and flexible market between multiple smaller generators and multiple smaller offtakers.
The CPPA options provide the same benefits to landowners (and their occupiers) in securing a long-term supply of renewable energy at a fixed price – providing price certainty and reducing exposure to volatile energy markets and reducing their carbon footprint – but at a scale that is not limited by the development viability of their property portfolio.
A large volume of power can also be supplied by an experienced third-party developer without the complications and risks associated with installing on-site generation.
CPPAs also offer businesses the opportunity to support the development of new renewable energy projects. By entering into a CPPA, businesses can provide developers with the revenue certainty they need to secure financing for new projects.
This can help to increase the amount of renewable energy available on the grid, reducing reliance on fossil fuels and supporting the transition to a low-carbon economy.
The direction of travel
On-site generation can be a valuable investment opportunity for investor landlords, and there will be an increasing imperative from regulators, occupiers and shareholders to ensure that portfolios are protected from volatile energy pricing, and can be shown to be contributing to the sustainability journey.
There are opportunities beyond solar PV, but with greater complexity comes greater risk and one size will not fit all.
However, the advent of combined projects, with battery and EV charging, presents a greater range of opportunities, and solar car-ports will, we believe, become increasingly standard across
the UK.
Considering and concluding on-site energy agreements, the appropriate property rights/interests and CPPAs are complex processes that involve multiple parties and require careful consideration of various factors – commercial, technical and legal.
Expert advice should be sought on all aspects if the corporate buyer does not have that experience in house, but the rewards are likely to make this a worthwhile investment.
James Wood-Robertson, Chris Pritchett and Liz McKillop Paley are partners at Shoosmiths LLP
Photo: Bim/iStock
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