The non-residential solar sector may be the only segment to experience annual growth within the U.S. industry in 2017. That’s a unique position for a sector that’s lagged noticeably behind for years.
As utility-scale and residential solar markets benefited from dropping equipment prices and favorable policies, commercial solar has struggled to get off the ground -- stunting development for an estimated 20 percent of the potential solar market.
“Compared to residential and utility, commercial is a little behind,” said Michelle Davis, senior solar analyst at GTM Research. “A lot of the problems that typically plague the commercial market have been solved, to a certain extent, in the residential and utility markets. And that’s mostly because of the commercial market being so diverse and localized.”
Compared to residential and utility-scale projects, commercial development can range widely in size and complexity -- and depend heavily on state policies.
“That has left this industry with a dearth of folks that are focused on it,” said Jesse Grossman, CEO and co-founder at solar independent power provider Soltage.
Although the C&I market will likely see 9 percent average growth through 2022, significant hurdles remain. According to GTM Research, unique challenges in customer acquisition, development and investment continue to plague the C&I space, even as a growing roster of startups and developers tries to untangle its complexities.
The long development pipeline
Commercial projects can change hands several times throughout development.
While one local company might acquire a customer and an installation site through referrals or outreach, another may tackle contracting and other late-stage development steps. And another still -- such as an insurance company or YieldCo -- could buy the project in the end, handling long-term ownership and asset management.
That leads to a development process more complex than a simple transaction between installer and a homeowner or utility. According to Davis, the outcome of all that ownership-swapping is simple: “It takes longer to do deals.”
In a November GTM Research report on commercial asset ownership, Davis noted that a growing number of owners are investigating early-stage development risk and management of projects from start to finish. That allows owners more control in streamlining the process, but requires regional knowledge and increased costs for staff.
Soltage self-develops and acquires projects at different stages of development. Grossman said this allows the company to control the development trajectory of some projects from start to finish in states where it has expertise, but also to work with projects where the early-stage development has already been taken off the table by an initial developer.
These two models "really complement each other,” said Grossman.
GTM Research found that the company experienced the sector's largest relative market-share increase last year.
Like the Soltage example suggests, those self-developing owners may grow market share faster than companies acquiring projects later in the development cycle. Companies such as NRG, Soltage, Greenskies and NextEra all self-develop projects. Davis expects that group of firms to have collectively tripled their 2015 portfolios by the end of 2017.
Though there seems to be some concrete payoff, it’s unclear how advantageous early-stage involvement is in the long run. “Since owners that self-develop are also experiencing growth from community solar, it remains unproven whether this strategy actually addresses the major challenges in the commercial solar market,” wrote Davis.
According to Grossman, it's likely that project-swapping will continue to be common among developers working in the commercial space and trying to keep transaction costs low for small projects. "There’s no doubt that this industry is consolidating and there are getting to be more streamlined entities," he said. "That said, it is a fairly common business model now for entities to just do development and transfer those assets over to a buyer."
SEIA has undertaken the formidable issue of the project pipeline as well, drafting standardized power-purchase agreements and contracts to speed along development.
"The one that got away"
According to several startups in the space, one barrier to commercial projects trumps all other development hurdles: money.
“Every C&I developer has a story about the one that got away,” said Jeff McAulay, co-founder at Energetic Insurance. “A project that should have been really good, [but] they couldn’t get the deal because financing fell apart.”
The traditional financing mechanisms that work for utility-scale projects (e.g., power-purchase agreements) and for residential customers (e.g., loans and third-party leases) haven’t been entirely standardized to work for a diverse pool of commercial offtakers and developers.
In part, that's because risk-averse financial institutions want power offtakers to have a credit score that easily allows the bank to quantify risk. Aside from governments and the Fortune 500, few business entities do, or they’re below investment grade.
“The beauty of residential is, if you have a FICO score as a residential customer, there is no additional underwriting expense for the bank,” said Ilyas Frenkel, director of growth at Wunder Capital. “Since businesses have a lot of income streams, there hasn’t been a great way for banks to assess risk. They’re basically left in the dark when it comes to solar financing.”
Davis said the easiest way to avoid the challenges of customer acquisition and financing is to target "the safest pipeline" of investment-grade customers. But “owners and developers report that the supply of this pipeline is dwindling.” If commercial developers don’t come up with a fix fast, the market may not reach its potential.
There are several possible workarounds, however. Soltage's Grossman said he still sees large financial firms “hewing to their traditional investment guidelines,” but small, regional banks that have watched the space develop on a more local level can provide funding streams for focused developers that build relationships.
Another well-known example is property-assessed clean energy (PACE), which enables project financing through property taxes. According to the Department of Energy, in early 2017, 30 states plus Washington, D.C. had commercial PACE legislation and had financed $400 million in projects.
For a market potentially worth billions, $400 million is only a start. Wunder Capital alone had about $600 million in financing requests in 2017. Frenkel estimates the company could see up to $1.5 billion in projects this year. But that's a fraction of what startups building new financial models for C&I development are hoping for.
Frenkel calls Wunder Capital the “white-label financing arm” for small and medium-sized projects. Through a roster of partners, the company builds a balance sheet to present to the customer at the point of sale, instead of developers finding loans themselves.
The money comes from accredited investors that pay a minimum of $1,000, some private equity investors that offer $1 million to 5 million, and larger institutional partners such as multinational banks with more to invest. While banks can take three to six months to fund a project, Wunder-backed projects close on average in 61 days.
Frenkel said the model has proven effective for community projects, traditional commercial projects, and those in the “MUSH Market,” that is, municipalities, universities, schools and hospitals.
Energetic Insurance, a SunShot-funded startup founded in 2017, comes at the investment problem from a different angle. This year the firm plans to launch its first product: a credit wrap insurance policy called EneRate that allows unrated offtakers to transfer credit risk to the insurer.
“Ultimately, we think this is a mispricing of risk -- that the market isn’t really moving just because it’s a young market, not because it’s a bad risk,” said McAulay. So far the company is actively working on underwriting deals, but has yet to announce one.
These innovations represent promise. But if the potential pipeline of low-risk projects runs out before asset owners can get a handle on expanding the market, it could put the industry in a bind.
“There’s movement in the solar industry and the banking industry; people are getting more comfortable developing and investing in solar for the small commercial sector. But it’s complicated,” said Mike Mendelsohn, senior director of project finance and capital markets at SEIA. “It’s like you take two steps forward and move one step back.”
A community effort
If anything has been a step forward for C&I, it’s community solar. That space has become the fastest-growing area in commercial solar.
“A lot of developers and owners I speak with say if they are not in the community solar arena, they would like to be,” said Davis. “It helps avoid many of the hurdles” present in other C&I markets.
Community solar projects can be located offsite and feature numerous customers. That makes the deal look less risky.
So far, though, only a few states have gained traction on community solar. It remains concentrated in specific states because of incentive programs and rebates, according to Davis. A large driver of the spike in projects in 2016 and 2017 resulted from demand related to expiring or changing state incentive programs.
California dominates 63 percent of the commercial market in small projects under 500 kilowatts, and 51 percent of projects between 500 and 1,000 kilowatts. Above 1,000 kilowatts, Massachusetts accounts for 41 percent of projects and California for 26 percent of projects. Arizona, New Jersey and New York also account for notable portions of the segment. Though Minnesota recently emerged as a leader in community solar installations above 1,000 kilowatts, over 90 percent of all commercial projects are still in the five market-leading states.
Interest in the sector is strengthening. “We’re seeing more and more states getting into the game,” said Frenkel, adding that an increasing number of local and regional residential installers are eyeing untapped opportunities in the space.
Both Frenkel and Mendelsohn said they expect a “long tail” to follow the early projects and the developers working on them.
In the meantime, Davis projects a slight drop in projects in 2018. The short-term slump mirrors a slowdown in the rest of the solar industry, according to GTM Research's base-case scenario.
A growing crop of projects, driven by falling prices, and more community solar and solar-plus-storage projects, will bring incremental growth after 2019.
Though Mendelsohn said there's no "silver bullet" for commercial sector woes, watchers remain hopeful that barriers will get broken down.
“It doesn’t feel right that this large of a market should be left out of the solar boom,” said McAulay. “I’m a big optimist. I know there are some headwinds, but long term, there is so much value here.”
Join us for the 11th annual Solar Summit 2018 in San Diego, May 1-2. Powered by the unique blend of research and economic analysis from the GTM Research team, this year's agenda will feature themes from beyond traditional project finance to innovations in solar and the transformation of electricity.