The transaction flowchart
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Traditionally, rooftop solar projects have demanded substantial capital, making them exclusive to large investors. However, the landscape has changed, with various solar investment models that have lowered investment thresholds. One such model currently offered by some platforms works on the concept of fractional ownership, just like real estate investment trusts (Reits), and the entry ticket for investors is as low as ₹500.
Here is how the scheme works under this model. An entity, say a Residents Welfare Association (RWA), seeks access to cost-effective solar power but is wary of the significant upfront investment necessary for purchasing solar panels. To cater to this need, a specialized solar asset leasing platform steps in, not only installing but also taking charge of maintaining the solar panels. The RWA agrees to pay for the power it uses from these panels over the contract’s duration (at rates lower than what it pays the electricity distribution company).
The leasing platform then invites investors to contribute funds. After the requisite investment capital is gathered from interested investors, a Limited Liability Partnership (LLP) is formed. Each investor then becomes a partner in this LLP, collectively holding a stake in the solar project.
Once the solar project is operational, the platform acts as the project manager and supervises its functioning. It receives revenue from the RWA for the power consumed and disburses the returns or payments on a monthly basis to the investors, now LLP partners.
When the contract ends, the solar panels employed in the project are usually transferred to RWA at a token price, often set at ₹1, enabling the entity to assume ownership of the panels used.
Throughout the duration of the contract, the RWA has the option to buy out the solar project at varying stages and values. This potential buyout takes into account factors like the panels’ annual degradation rate (typically 1%) and provisions for third-party maintenance.
Existing market structures
The LLP model offers pre-tax internal rate of return (IRR) ranging from 9-11%. Investors directly engage by becoming partners in the LLP, which owns and leases the solar assets. Platforms like Pyse, SustVest, and Incept.Green facilitate these investments. However, LLPs come with drawbacks, such as substantial compliance burdens and complexities in managing numerous LLPs. Some platforms in the past have received warning notices from the Ministry of Corporate Affairs due to the sheer number of LLPs they were operating. Taxation occurs at the LLP level, subject to a 31.2% tax rate, providing an illiquid and unlisted investment without premature withdrawals that are not assigned any credit ratings.
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Another model of investment is direct leasing, which entails investors owning entire solar assets directly, yielding pre-tax IRRs of 10-13%. Platforms like Vested have announced plans to operate within this structure, but direct leasing incurs goods and service tax (GST) of 12% on solar panels without input tax credit. The investments remain illiquid and unlisted, with taxation based on the investor’s marginal tax rate.
“At Vested, we chose to adopt a model in which we allow investors to purchase panels and lease it back to us to install and maintain them as part of a rooftop project. We believe that this model is scalable and can help rapidly deploy solar panels across multiple projects. Our project sizes tend to be 100kW to 200kW costing between ₹60 lakh and ₹1.2 crore. To spin up individual LLCs for each of these projects can become operationally challenging at scale. The downside of having to directly purchase panels is that individuals will need to pay GST. But even with the GST cost, the IRR can still be 10-13% or even more, providing a good steady income diversification option to individuals,” said Viram Shah, CEO, Vested.
Yet another option used elsewhere in the alternative investment space is securitized debt instruments (SDIs). This would involve the asset’s originator issuing SDIs to investors through a trustee registered with market regulator Sebi. Although Incept. Green plans to introduce SDIs, current projects face challenges due to their long-term nature (15-25 years). SDIs offer liquidity as they are rated by credit rating agencies and can be traded in the secondary market, while taxation is based on the investor’s marginal tax rate. However, tax deducted at source remains high at 25% of the interest component.
Lastly, electricity bill credits offered by platforms like SundayGrids provide discounts in electricity bills without the LLP or SDI structures. This investment avenue doesn’t generate tangible returns, faces no taxation, and is also illiquid and unlisted, but allows a mechanism to facilitate premature withdrawals.
“The mismatch between nature of available investment instruments and the long-term nature of solar power purchase agreement (PPA) contracts is one of the biggest challenges for us. We eagerly await Sebi’s introduction of small and medium InvITs, similar to Reits, which could make decentralized rooftop projects more viable by lowering the minimum listing to ₹40-50 crore”, said Kaustubh Padakannaya, co-founder, Pyse.
Risks still exist
While platforms constitute a small fraction of larger corporations’ power needs, interruptions or reductions in production don’t typically affect the payments made for PPAs. However, this isn’t the case with residential projects, where changes in RWA elections or corporate shifts can prompt negotiations for revised unit rates, posing collection risks. Unfortunately, platforms have limited recourse in such situations.
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“Investing in solar projects does not make sense for a retail investor. With IRRs less than 10% and risks pertaining to maintenance of the panel over a period of 20 years; a retail investor is better off investing in a AA rated corporate bond offering better returns”, said Anshul Gupta, co-founder and chief investment officer, Wint Wealth.
Moreover, there’s a looming risk of default or credit issues. If the lessee defaults, substantial principal investments are at stake. Although platforms suggest the possibility of selling or relocating panels, the costs involved in removal, transport, and potential damages drastically reduce the recovery amount.
Reinvestment risk also exists. While the IRR takes into account cash flows reinvested at the same rate, the reality is that not every monthly cash flow can be reinvested at such high rates for the entire 15-year tenure.
Another concern is the status of investors on asset leasing platforms as operational creditors. In the unfortunate event of bankruptcy, they’re positioned last in line for repayment.
These risks vary across projects. Larger corporations’ production fluctuations don’t impact PPA payments significantly, but residential and small corporate projects face challenges due to governance changes and potential renegotiations. “Of all the available solar investing options, we believe that investing in an LLP, where the larger commercial solar plant is owned by the LLP itself, offers the best risk-adjusted returns to investors. However, investors need to be aware that this might be treated as an unregulated Collective Investment Scheme (CIS) by Sebi,” said Yash Roongta, co-founder of The ALT Investor.