Anatomy of a solar lease

One of the biggest disadvantages of solar power is the steep price tag that stands between homeowners and their shiny new solar panels. Although the installed price of solar PV systems has decreased by 50% in the last five years, the cost of residential solar panels is still significant for most homeowners.

One way to make solar energy more accessible is to decrease the upfront expenses for the consumer. As we discussed in an earlier post, there are three different paths to putting solar panels on your roof. You can lease them, you can purchase them outright, or you can choose to be a solar utility customer (also known as a power purchasing agreement, or PPA). Each of these three paths has its own advantages and disadvantages. In today's article, we'll focus on the first option: the solar lease.

Understanding your lease option

Most of us are quite familiar with the concept of a lease. An automobile lease is the prime example: instead of an all-cash purchase, we can start driving a brand new car as soon as we start making monthly lease payments. The catch, of course, is the ownership. The car doesn't belong to us; it's still the property of the leasing company, and we just have the privilege of using it. At the end of the lease term, the lease has to be renewed or the car has to be returned to the owner.

The case of a solar lease is very similar. A leasing company will pay for the installation of solar panels on your roof, and even take the responsibility for maintaining and servicing them as needed. Naturally, the ownership of the solar panels and all the other necessary equipment stays with the leasing company. Your obligation as the homeowner is to make your monthly lease payments and occasionally give access to your roof for maintenance work. In most cases, there are no upfront payments for the lease, and you just start with the first regular monthly payment. This "$0 down" or "free installation" feature of the lease makes it very attractive for many homeowners, but as we'll discuss later, it may not always be the most sensible financing option when it comes to solar power for your home.

We often refer to residential solar power systems as an investment. If you own the system, it adds significant value to your home. If you are leasing, however, you are paying for the right to use somebody else's assets, not your own. Thus, the lease is not an investment on its own. However, if it frees up some cash so that you can find a better investment alternative to increase your net wealth, then the lease option can still be very useful.

What is the big deal about ownership?

Pride comes with ownership, but so do a lot of responsibilities. The solar lease gets you off the hook from many of the potential headaches, such as paying for system maintenance, dealing with roof repairs and dealing with insurance. But remember that this is still your home: you'll still need to coordinate some of the repair and maintenance work to provide access to the leasing company.

However, pride of ownership is not the only reason to consider an outright purchase. There are a wide range of tax credits, rebates and financial incentives available for solar power. Some of them are at the state (or province) level, some of them are at the federal level and some of them are limited to your local utility. However, they have one thing in common: these financial benefits are almost always given to the owner of the system, regardless of where they are installed. So, in the case of a solar lease, you can only benefit indirectly from these incentives, if the leasing company decides to share the bounty and make an attractive lease offer to you.

Why does it seem cheaper to lease than to own?

When a solar installer presents you with various plans and installation options, most homeowners are surprised to see that the solar lease is generally the cheapest option with the lowest monthly payments. There are two main reasons for this: one, your monthly payments only cover the lease term (which can be shorter than the actual lifetime of the panels) and secondly, there are distinct tax advantages that the leasing company enjoys and passes on to the homeowner to sweeten the deal. If you were to purchase the system outright (with or without a bank loan), you would need to finance the entire value of the solar panels, not just the value attributed to the lease term. Consequently, the financing need is higher, as well as the monthly payments. Of course, the lower monthly lease payments do not entitle you to keep the panels after the lease term. It really pays off to think of the whole exercise as a long term investment and not just as a way to free up some cash flow in the short term.

Running the numbers: Let's take a look at an example

A 5 kW system installed in the beautiful city of San Francisco will generate about 8000 kWh of electricity during the year, or about 666 kWh per month, on average. In 2014, the average cost of of installing solar panels was around $3.75 per watt. Thus, your system would cost 5,000 watts * $3.75 = $18,750. A 30% federal tax credit for solar would then reduce your net out of pocket expense to $13,125. There could be other incentives in your area, so you should take a look at WhatNextNow Solar Discover (Incentives tab) to make sure that you are not missing out on any other tax credits and incentive programs. Most of us don't have this amount stashed under the mattress, so we need a financing solution.

Let's assume that instead of purchasing the system, you decided to go with the lease option. Here is how the leasing option would look like. You would pay a fixed monthly fee and use your solar electricity for your own needs. If you have excess production, you can pump it back to the grid. Assuming that there is net metering in your area, your monthly electricity consumption will then be offset by your solar electricity generation. That is: if you generate more electricity than you consume, your utility will give you a credit. If you consume more than you generate, you pay your utility the difference (so your total electricity cost for that month would be your lease payment plus the utility bill).

It is a very rare occurrence that your solar electricity generation will match your actual consumption. Both generation and consumption patterns change throughout the year. So what is more relevant is what happens at the end of the year. If your solar panels have been sized properly to match your annual consumption, your lease payments should cover almost all of your consumption (assuming that you aren't supercharging your home with new power-hungry appliances).

Back to our San Francisco case study: as we discussed above, a 5kW solar panel system will generate about 666 kWh per month. Using the Buy vs Lease calculator of WhatNextNow Solar Discover (Finance tab), we can compare this level of solar electricity generation with our consumption and see if a lease makes sense. For example, we can see that the lease option, with a monthly payment of $50, has a Net Present Value of $8,600. This amount reflects your total savings of switching from your utility to a solar lease. There are many variables that affect the results, such as your average electricity consumption. You can easily change these variables using WhatNextNow Solar Discover and see the impact on your solar strategy. For example, if your monthly solar lease payments are more than the $80-82 range, then a solar lease may not make financial sense.

Power production guarantee: a nice feature of your solar lease

What if your solar panels consistently generate less power than the amount promised by the leasing company? Rest assured, there is a mechanism that can compensate you in this case: the power production guarantee. Essentially, as part of the leasing agreement, the leasing company will reimburse you in the case where your system produces less electricity over the course of the whole year. They will actually send you a check to cover the difference between the annual kWh amount indicated on your lease agreement and the actual amount produced by your panels. How do they afford all this, you may wonder. It's the law of large numbers: they pool this "production risk" across thousands of consumers and they also base the calculations on annual variations. So over the course of multiple years, averaged over thousands of systems, the leasing company hopes to come ahead in the game and make a profit.

Fixed payments: watch out for the escalation rate

We mentioned that the monthly lease payments are fixed. Unfortunately, this generally means fixed for a 12-month period. Most solar lease agreements include an annual escalation rate (about 3%) that increases the monthly payments from one year to the next. While this will not make a big impact in the first few years of the lease period, since the increase is compounded, it will start adding up in the long term. Towards the end of a 20-year lease, your monthly payments will almost double if they are increasing 3-4% every year.

What is the difference between a solar PPA vs. a solar lease?

The solar power purchasing agreement (PPA) and the solar lease are close cousins. The biggest difference is how the monthly expenses are calculated. With a solar lease, your monthly lease payments are fixed, with a solar PPA, your payments depend on how much power you consumed that month. The kWh rate is fixed for the year, but the actual monthly payments of your PPA will fluctuate depending on how much electricity you use. Just like the solar lease option, you still need to keep your customer account with your traditional utility to offset low solar electricity months and to get credit when you have excess production.

In addition, certain solar PPA agreements give you the option to purchase the system after a predetermined time period, whereas solar lease agreements may not allow you to buy out the leasing company.

What is the typical length of a lease term?

Although a typical auto lease is between two to four years, a solar lease is generally much longer: around 15 to 20 years, still shorter than the average lifetime of the panels. After all, the amount of work that's involved in installing the panels is substantial, and removing them from a roof is not always easy. Naturally, some homeowners may move during the solar lease period. Therefore, it is critical that you understand what your options are if you want to sell your home.

What happens at the end of the lease term?

It is very important to understand what happens at the end of the lease term. Many leasing companies will give you three main options: upgrade the existing solar power system using the next generation products; keep the installed panels and extend the lease agreement; or have the panels removed from your roof (this is generally done for free). These options seem to cover a wide range of scenarios if you are still living in your current home, but what if you decide to move? The lease contract should clearly indicate whether or not you can transfer the lease agreement to the new owners of your home. Alternatively, you may have the option to buy out the solar panels from the leasing company, end the lease agreement, and include the cost of solar panels in your asking price for your home.

If you really feel attached to your panels, however, many solar lease companies will even allow you to take your solar panels with you when you move and have them re-installed on your new home (on your own dime). This option may not make too much sense if you are moving from one end of the country to the other, but if your new home is still in the same area it may be worth the trouble.

The taxman, the leasing company, and you

Due to the current state of the taxation law in the U.S., leasing companies have an edge over the average consumer: they can reduce their tax liability by depreciating their solar assets (that sit on top of your roof, but don't belong to you). Unfortunately, homeowners who purchase the solar panels outright are not allowed to depreciate the panels to reduce their personal taxes. Also, bear in mind that your monthly solar lease payments are not tax deductible. They are just like your cell phone bills: paid with precious after-tax dollars.

Advantages of a solar lease

- Little to no upfront investment required.

- Lower monthly cost of electricity compared to your current utility bill.

- Predictable energy pricing thanks to fixed lease payments with a pre-determined rate of increase (compared to an unpredictable and generally steeper rate of increase in your utility bill).

Increased affordability for homeowners.

Disadvantages

No eligibility for the federal tax credit

Having to deal with two separate electricity bills (one for your lease, the other for your utility)

Limited ability to make changes to property that has an impact on the PV system performance (e.g., pruning trees)

Potentially higher total cost compared to a bank loan for outright purchase

Our verdict

For many homeowners, a solar lease offers an interesting opportunity to go solar. It frees up your savings for other potential investments, it transfers quite a bit of the risks to a third party and it gives you a certain degree of cost certainty when it comes to your electricity bills. However, it may not be the best option for you. Your current utility rate and your electricity consumption levels are a big part of this decision. Furthermore, purchasing the system outright may make more financial sense depending on the tax credits, rebates and incentives in your area. If you would like an independent assessment of your case, just go to WhatNextNow Solar Discover, and with a few clicks you can see for yourself if a solar lease makes financial sense for your home.