In the US the investment need for renewables assets is expected to be over $150bn by 2025

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Sep 3, 2019

According to Atrato - a boutique consulting firm that provides highly individualized research and advisory solutions to the alternative investment allocator community - an uptick in conversations this quarter as an element of broader investor interest in ESG themes over the past year. In the US alone, the investment need for renewables assets is expected to be over $150 billion by 2025. The solar and wind spaces, particularly projects that are in excess of $50 million in size, are dominated by institutional buyers and forward-looking returns are modest as a result (mid-single digits). We have focused our research time on managers partnering with developers or purchasing projects in the $5-25 million range, where yields are a couple of hundred basis points wider (in the low double digits) than traditional projects. While these projects tend to come with 6-18 months of construction risk, they are generally backed by long-term (15-20+ years) Power Purchase Agreements (PPAs) which ensure long streams of stable cash flows for the usable life of the assets upon completion. The usable life of most renewable assets is about 30 years, with major maintenance milestones at 15 years. The assets can be leveraged because of the typical length of PPAs (15-20+ years) and overwhelming exposure to investment grade off-takers (unrated municipalities are often off-takers as well). Debt on these structures is typically floating rate, but managers often swap into fixed rates in order to eliminate interest rate risk from their portfolios. There are multiple exit options for these portfolios once they are aggregated to scale ($500+ million): securitization, public listing as a REIT, sale to a large infrastructure/renewable sponsor, or sale to European institutional buyer (lowest cost of capital in the space). The ideal exit will realize several hundred basis points of cap rate compression to generate capital appreciation on top of the yield profile of the assets, though a positive return profile does not rely on meaningful compression. One deal-specific opportunity identified over the quarter came from a manager whose specialty has historically been in traditional energy (i.e. E&Ps). This manager first deployed capital to the renewable space following the boom/bust period that was fueled by subsidies and venture capital. Since that washout, investors have focused on unsubsidized wind and solar that is competitive with or even cheaper than traditional fossil fuels (as discussed above and in the graph to the right). This manager is in the process of partnering with a leading developer and setting up a direct investment (in a fund structure) into residential solar installation. Investors get the benefit of depreciation on the assets, pass-through tax credit exposure, and the ability to leverage the tax credit to enhance returns.