Loan or lease?

In October, SolarCity introduced MyPower, a new solar financing product for PV systems that offers a zero-down payment option and reimbursements based on system output. While this sounds like the company’s standard power purchase agreement offering, the difference is that MyPower is a loan, and customers own the system.
This is a radical change in approach for SolarCity, the largest installer and financier of residential PV in the U.S. And it follows GTM Research’s June prediction that in 2014 the market share of residential solar power purchase agreements and leases, known collectively as third-party solar, would peak and then decline.
SolarCity is not alone. A number of other installers and third-party companies in the U.S. have announced loan products, to take advantage of this pending shift in the market.

The third-party model

In order to understand these changes, it is first important to look at what made third-party-owned solar so successful in the U.S. residential market.
Third-party solar is an American invention. And while there have been attempts to export it to other nations, it is a business model rooted in the particular characteristics of the U.S. PV market. Specifically, without the guaranteed, long-term income provided by feed-in tariffs, U.S. homeowners have fewer and more expensive financing options for the high up-front costs of installing a PV system.
The U.S. also has a culture of buying items on credit instead of saving for purchases. An essential advantage of thethird-party model is that it offers consumers a way to acquire solar with no upfront cost, similar to paying an electricity bill.
“I think you have to think about the way that people are used to paying for electricity,” explains SolarCity VP of Communications Jonathan Bass. “They pay for it by the month.” As third-party solar has grown the market for residential PV, it has also expanded the demographics of PV system adoption. Multiple studies by third-party solar provider Sunrun and PV Solar Report have found the largest third-party solar market is in medium-income postal codes, as opposed to the wealthier neighborhoods that previously dominated.
Because third-party solar companies own the solar PV systems, they also take care of maintenance and repairs, which are aspects that can be difficult and expensive for most homeowners to oversee independently. “Customers really want it to be a managed service,” says Bass. “The comparison that we make is for a utility – I get my electricity, it just works, I pay my bill every month.” These are compelling advantages, and the model has proven successful despite the higher installed cost of third-party solar and the transfer of incentives from the homeowner to the provider. By 2012, three-quarters of the residential PV installed in California was third-party, and the model soon came to dominate all the largest state markets, including Arizona, Colorado, Massachusetts and New Jersey.
By 2013, third-party solar represented 66% of the total U.S. residential market, up from 42% two years previously, and only five years after SolarCity and Sunrun first made this option available in California.

The rise of loans

SolarCity says that third-party solar has also thrived because homeowners have found it difficult to navigate the loan process, and because financial institutions were often not offering products or a solar PV system that was desirable to potential customers.
This includes navigating credit requirements, loans that required higher monthly payments and shorter terms than customers wanted, and generally what SolarCity describes as a “clunky experience”.
However, during the past few years new lenders have begun offering loan products for PV systems. This includes financial institutions like Admirals Bank and PV module makers such as SunPower, ReneSola and Canadian Solar.
More importantly, lenders have begun offering a wider range of products, including 20- to 30-year loans with rates in the 5 to 10% range. This means lower monthly payments for customers who might not be willing or able to afford higher payments under shorter-term loans.
“Customers want the benefits of both third-party and direct ownership, where you are saving money from day one,” says GTM Research Solar Analyst Nicole Litvak. “So with a longer loan you can get pretty much the same thing.” And finally, the falling cost of installed solar is tilting the market towards direct ownership. Litvak says that costs have come down enough that a significantly larger amount of people can own a system or take out a loan.
The result is that in the largest state markets including Colorado, Arizona and Massachusetts, the portion of third-party owned residential solar declined in 2013, although it has remained steady at around 70% in California and rose during this period in New Jersey.

Third-party solar meets leases

Following the publication of GTM Research’s report predicting “peak lease” in 2014, SolarCity and other third-party solar companies began releasing highly sophisticated loan products, which in many cases include some of the benefits of third-party solar, such as zero-down options.
SolarCity is offering loans with interest as low as 4.5% annually and 30-year terms, which the company notes that it was not able to offer five years ago. And unlike PV module makers, SolarCity is providing financing in-house through a subsidiary.
“It is all about keeping costs low and providing the best experience for consumers,” says SolarCity Structured Finance Manager Leland Price. “By bringing it in house, we can control the customer experience.
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“It’s the same reason that Ford Motor Credit exists. They can offer a better deal to customers than a bank or other financial institution can.” SolarCity is offering its standard service package bundled with the MyPower loan, using its 52 operations centers across 15 states. Mosaic also offers a service package with its solar loan, and GTM Research predicts that other loan offerings will follow suit, further tilting the market in favor of loans.

Enter PACE

Another factor in California is the resurgence of Property Assessed Clean Energy (PACE) programs. PACE was pioneered in Berkeley, California, and gives homeowners an easy, low-interest way to finance PV and energy efficiency improvements, through loans based on liens against the property, sidestepping the personal credit of the owner.
PACE has been stalled on the national level for years after semi-public federal mortgage lenders took issue with the program. However, California moved ahead with its own HERO program, which GTM expects will provide loans for roughly 33 MW of PV systems in 2014, or 5% of the state’s entire residential PV market.
GTM’s Litvak notes that installers are using PACE in combination with third-party solar options, and describes the way the program is being used as “in-between a loan and a lease.” “What installers are using PACE for is to target a wider range of customers, particularly customers with lower credit scores who might not be accepted for other loans,” explains Litvak.

The future of loans versus leases

The pending conclusion of the 30% solar investment tax credit (ITC) is expected to have repercussions throughout the U.S. solar market, including the residential sector. Under current law, at the end of 2016 the ITC will not go away entirely, but rather become a 10% credit that only businesses can apply for.
This includes third-party solar companies, and as a result of this economic edge GTM expects the market share of third-party solar to rise temporarily in 2017. However this is not expected to fundamentally alter the overall trend of more loans and fewer leases.
Ultimately, the shift to more loans and less third-party solar is not driven by any external change, but as part of the evolution of the solar industry and the ongoing reduction in PV costs, including financing.
While SolarCity maintains that third-party ownership will continue to hold substantial market share, it has also been frank about the future growth potential of loans, predicting that MyPower will be as much as 50% of its sales by the end of 2015.
Fundamental to actualizing the potential of loans will be meeting customer needs. “The major barrier that third-party ownership addresses is the up-front cost of solar,” explains SolarCity VP Bass. “To the extent that loans can also do that, they will be popular.” Litvak and others expect not only growth, but ongoing evolution in this space. “We aren’t seeing what customers want; we are seeing what has been offered to them,” notes Litvak. “And that is dictating what financing options are more popular now. In a few years, it’s really going to depend on what customers want.”