Prepaid lease vs. cash purchase considerations

[Ian S]

If I were a betting man, and often I am, there could be a very lucrative business of buying out off lease panels for solar farm or other us such as non profit third world country energy needs. In 20yrs I'd expect a decent FMV value on the panels. As others have noted, a panel producing at least 80% of the rated output is going to be worth something to someone. Their language in the lease gives them an out. They're covering their bases and so should you. Don't take their word that you will get these panels at the end of lease for no cost. I'm expecting this to never happen.

Put on your business hat and you'll have more clarity. By pricing leases slightly lower than purchase cost for the 20yr term, you can bet they'll try to milk as much out of these as possible.

Just my opinion but I've done my analysis from a leasor‘s perspective and it didn't make sense to me.

First off, the reason the lessor can price a prepaid lease lower than the purchase after incentives is because the lessor, in addition to the incentives, takes advantage of accelerated depreciation of the full amount of the system cost, something that the individual owner cannot do. They are not relying on some end of lease recoup of value. Also realize that long before the end of the lease, the solar system will have been depreciated to zero so anything that the lessor receives from the sale of the system will be taxed as recaptured depreciation.

Now let me put on my business hat for a moment. I don't think we know what costs will be in 20 years but let's assume, reasonably I think, that we can pretty much price things in today's dollars. Today, you can buy 250 watt solar panels for about a buck a watt. Based on a warranty of 25 years, our 20 y.o. panel has about 20% of its warranted life left so you might assume that it would be worth about 20% of the price of a new panel. But of course, the panel is still outputting most of its original power so 20% seems too low a value. So, let's double it to 40%: which translates into a "value" of maybe $0.40/watt. So let's say I can sell 20 y.o. used panels at $0.40/watt in competition with brand new warranted super high efficiency ones with the latest technology costing $1.00/watt. To make it easy, let's assume we're dealing with 250 watt panels but obviously, we're going to have a wide variety of sizes and manufacturers. So I assume I can sell each panels for $100. My source of used panels is all those systems coming off leases from 20 years prior. These are owned by a variety of lessors and that's from whom I will be buying them.

I want this to be a profitable enterprise so let's back out of the retail value of the panel - $100 - what it is I can pay the lessor for them and still turn a profit. Let's take profit out first: I don't think $10 is unreasonable. Now those panels are on roofs so I'm going to have to get them off the roof and do it without damaging the roof. A typical installation might be 20 panels. To have a rental truck and a couple of guys going to a site, removing the panels and loading them into the truck in some manner and returning them to our warehouse and unloading them is liable to cost a couple of hundred $$ let's say $200 to keep it simple. That's $10/panel. At the warehouse, the panels have to be cleaned, sorted, inspected, and tested. There will likely be some damaged/rejects. I think this might all cost another $25/panel. The panels will then have to be packaged for protection which I assume would cost probably a minimum of $5/panel. The cost of the warehouse, office, insurance, contractor's license, computer, telephone, utilities, misc. overhead etc. is probably going to cost at least another $20/panel. What's left is probably the most you can afford to pay the lessor for the panel:

So: $100-10-10-25-5-20 = $30/panel

That actually represents fair market value. For a five kW installation, that's about $600 worth of panels. If I were the homeowner, I'd say to the lessor: I'll give you $700 just to avoid the hassle of having to deal with people running around on my roof. What do you think the lessor is going to do? And how long is the used panel business owner going to be around in that event?

[Volusiano]

First off, the reason the lessor can price a prepaid lease lower than the purchase after incentives is because the lessor, in addition to the incentives, takes advantage of accelerated depreciation of the full amount of the system cost, something that the individual owner cannot do. They are not relying on some end of lease recoup of value. Also realize that long before the end of the lease, the solar system will have been depreciated to zero so anything that the lessor receives from the sale of the system will be taxed as recaptured depreciation.

I've been wondering myself what's in it for the lessor to sell prepaid leases -> how do they make money if they don't keep the product in the end? So can you elaborate more on what you said in the bold part above (take advantage of accelerated depreciation of the full amount of the system cost)? Or maybe walk us through an example of how they make the money on a prepaid lease, and maybe even compare it against an example of an equivalent purchase scenario? Thanks.

[Ian S]

I've been wondering myself what's in it for the lessor to sell prepaid leases -> how do they make money if they don't keep the product in the end? So can you elaborate more on what you said in the bold part above (take advantage of accelerated depreciation of the full amount of the system cost)? Or maybe walk us through an example of how they make the money on a prepaid lease, and maybe even compare it against an example of an equivalent purchase scenario? Thanks.

I am not an expert on leasing but in the case of solar as I understand it, the leasing entity gets all of the benefits that an individual homeowner would get including tax credits and rebates. To make it simple, let's assume the system cost is $30,000 so the federal tax credit would be $9,000. So the net cost to a homeowner or the leasing entity would be $21,000. But the leasing entity gets an additional benefit: they get to depreciate the asset over a period of time. Depreciation is essentially a tax deduction that in total amounts to the entire cost of the system. Normally you would expect that depreciation to take gradually place over the life of the item but for a variety of reasons, the Feds make certain equipment eligible for something they call accelerated depreciation where the equipment is depreciated in a much shorter period of time than its actual life. So that $30,000 solar system might be depreciated over a short time say 5 years. So the leasing entity gets an additional tax deduction of maybe $6,000 per year for each of first five years the system is in operation. For many leasing entities, the value of that tax deduction can be significant: if they are in the 35% tax bracket, the total value of that depreciation would be $10,500 over five years. So after five years, the system cost to the leasing entity is only $10,500. Thus with a prepaid lease, they can beat the homeowner's after-incentive outright purchase price by $4000 and still profit by $6500. It will be a bit more complex than this especially if maintenance is included but you get the gist. And none of this assumes any value to the equipment at the end of the lease.

In the early Sunpower prepaid leases like mine, you can get an idea of how quickly they make their money: they offer me a one-time buyout opportunity in the 7th year of the lease of $844. And this is for a 6.9 kW system!

[Volusiano]

I am not an expert on leasing but in the case of solar as I understand it, the leasing entity gets all of the benefits that an individual homeowner would get including tax credits and rebates. To make it simple, let's assume the system cost is $30,000 so the federal tax credit would be $9,000. So the net cost to a homeowner or the leasing entity would be $21,000. But the leasing entity gets an additional benefit: they get to depreciate the asset over a period of time. Depreciation is essentially a tax deduction that in total amounts to the entire cost of the system. Normally you would expect that depreciation to take gradually place over the life of the item but for a variety of reasons, the Feds make certain equipment eligible for something they call accelerated depreciation where the equipment is depreciated in a much shorter period of time than its actual life. So that $30,000 solar system might be depreciated over a short time say 5 years. So the leasing entity gets an additional tax deduction of maybe $6,000 per year for each of first five years the system is in operation. For many leasing entities, the value of that tax deduction can be significant: if they are in the 35% tax bracket, the total value of that depreciation would be $10,500 over five years. So after five years, the system cost to the leasing entity is only $10,500. Thus with a prepaid lease, they can beat the homeowner's after-incentive outright purchase price by $4000 and still profit by $6500. It will be a bit more complex than this especially if maintenance is included but you get the gist. And none of this assumes any value to the equipment at the end of the lease.

In the early Sunpower prepaid leases like mine, you can get an idea of how quickly they make their money: they offer me a one-time buyout opportunity in the 7th year of the lease of $844. And this is for a 6.9 kW system!

Thanks for the informative example. But I lost you in the bold part above. How does the total value of that depreciation get calculated to be $10,500 over 5 years if they're in the 35% tax bracket? And what does it mean "total value of the depreciation"?

So the lessor starts out with a system costing $21K after the tax credit (let's ignore state and local incentives for simplicity), at after 5 years, they gain/recover $10.5K from the value of their deduction (which is the part I asked above how it's calculated), so the $ they still have tied in the system is $21k minus $10.5K = $10.5K ? So if they price the system $4K less for you, then you prepaid $21K-$4K=$17K for the lease. So at the end of 5 years, they got a total of $17K from you up front, $10.5K from the value of their deduction, so their cost is $21K - $17K from you - $10.5K from deduction value = -$6.5K in profit minus the interest $ of the $4K discount they give you minus maintenance and etc. Did I work out the detailed math correctly, except for the $10.5K in depreciation value that I didn't know how it was calculated?

So what they get out of it is:
1. The extra $6.5K profit after 5 years on top of whatever profit they make up front in pricing out the system originally (which we haven't even considered above to begin with). This is assuming that the leasing entity is the installer as well, which may not be the case. Even if they're separate, the installer get their profit and the leasing entity get their profit anyway.
2. They can squeeze even more profit from you by offering a 1 time buyout any time after 5 years.
3. If you don't chose to do the buyout, they can either give it to you at the end of 20 years or sell it for cheap to a third party or sell it for cheap to you if you offer them more than the third party.

So if this is so much more lucrative for both the buyer and the leasing entity (a win-win situation, but maybe the gov't loses), why don't they just put in the lease terms that they will give you the system outright after 20 years to make it a no-brainer for everyone to do a prepaid lease instead of purchase? What's the catch? Or there's no catch at all? Why wouldn't they want to try very hard to explain and convince the buyer to do a prepaid lease with them instead of buy?

I assume that the leasing entity must be a big enough company with high enough tax liability to broker many of such leases to be able to benefit from such depreciation at a large scale.

And if this is really this easy to have a win for the lessor, a win for the buyer, and a lose for the gov't, why wouldn't the Fed see through this and close the loop hole on the accelerated depreciation for solar?

[silversaver]

In the early Sunpower prepaid leases like mine, you can get an idea of how quickly they make their money: they offer me a one-time buyout opportunity in the 7th year of the lease of $844. And this is for a 6.9 kW system!

If you pre-paid lease your solar, it make no sense to buy out the system in 7th year. You are not buying at $844 for 6.9kw system. You lost all your benefits on so call worry free for 20 years. I'm sure the sales is doing his job giving you all your options but it doesn't make any sense if you choose pre-paid lease route still mention to other you have buy out option. How much money will you save? with $600, you get your inverter cover for 20 years. People are worry about which manufacture will last long enough to cover the warranty of the panels, the good news is you got another additional concern now.

[Ian S]

Thanks for the informative example. But I lost you in the bold part above. How does the total value of that depreciation get calculated to be $10,500 over 5 years if they're in the 35% tax bracket? And what does it mean "total value of the depreciation"?

So the lessor starts out with a system costing $21K after the tax credit (let's ignore state and local incentives for simplicity), at after 5 years, they gain/recover $10.5K from the value of their deduction (which is the part I asked above how it's calculated), so the $ they still have tied in the system is $21k minus $10.5K = $10.5K ? So if they price the system $4K less for you, then you prepaid $21K-$4K=$17K for the lease. So at the end of 5 years, they got a total of $17K from you up front, $10.5K from the value of their deduction, so their cost is $21K - $17K from you - $10.5K from deduction value = -$6.5K in profit minus the interest $ of the $4K discount they give you minus maintenance and etc. Did I work out the detailed math correctly, except for the $10.5K in depreciation value that I didn't know how it was calculated?

So what they get out of it is:
1. The extra $6.5K profit after 5 years on top of whatever profit they make up front in pricing out the system originally (which we haven't even considered above to begin with). This is assuming that the leasing entity is the installer as well, which may not be the case. Even if they're separate, the installer get their profit and the leasing entity get their profit anyway.
2. They can squeeze even more profit from you by offering a 1 time buyout any time after 5 years.
3. If you don't chose to do the buyout, they can either give it to you at the end of 20 years or sell it for cheap to a third party or sell it for cheap to you if you offer them more than the third party.

So if this is so much more lucrative for both the buyer and the leasing entity (a win-win situation, but maybe the gov't loses), why don't they just put in the lease terms that they will give you the system outright after 20 years to make it a no-brainer for everyone to do a prepaid lease instead of purchase? What's the catch? Or there's no catch at all? Why wouldn't they want to try very hard to explain and convince the buyer to do a prepaid lease with them instead of buy?

I assume that the leasing entity must be a big enough company with high enough tax liability to broker many of such leases to be able to benefit from such depreciation at a large scale.

And if this is really this easy to have a win for the lessor, a win for the buyer, and a lose for the gov't, why wouldn't the Fed see through this and close the loop hole on the accelerated depreciation for solar?

If you have a tax deduction of $30,000 and are in the 35% tax bracket, the total value of that deduction is $30,000 X 35% = $10,500. Of course you don't take it all at once, it gets divided up over the period of time specified for the accelerated depreciation, in our example five years. There actually were some early prepaid lease contracts that essentially valued the end of lease buyout at $0 (actual purchase buyout of $1.00.) However, my understanding is that a specified $0 amount may run afoul of IRS rules regarding such leases and that the IRS wants a fair market value to be determined presumably so they have a chance to claw back taxes on recaptured depreciation. Meaning, if you got to depreciate the full amount of the system and then sell it for some non-zero amount, they want to tax that. The specified buyout in my lease in the 7th year may also violate IRS policy because now most if not all leases have a fair market value qualifier inserted for buyout options.

As for accelerated depreciation, this is a very common corporate tax break and obviously popular for industrial equipment leasing. There are big financial interests in industrial leasing and they likely have good lobbyists.

[Ian S]

If you pre-paid lease your solar, it make no sense to buy out the system in 7th year. You are not buying at $844 for 6.9kw system. You lost all your benefits on so call worry free for 20 years. I'm sure the sales is doing his job giving you all your options but it doesn't make any sense if you choose pre-paid lease route still mention to other you have buy out option. How much money will you save? with $600, you get your inverter cover for 20 years. People are worry about which manufacture will last long enough to cover the warranty of the panels, the good news is you got another additional concern now.

Considering that my upfront prepaid lease cost was $6729, the total with payment of the additional $844, makes my cost per watt just under $1 which was far less than an outright purchase would have been at the time. I'm still not sure whether or not I will avail myself of the buyout simply due to the additional coverage the lease provides. But the nice thing is I have that option.

[Naptown]

The leasing company is permitted to depreciate 85% of the system cost.
So it cost say $100
They get the 30%
The basis value for depreciation is $85

[Ian S]

The leasing company is permitted to depreciate 85% of the system cost.
So it cost say $100
They get the 30%
The basis value for depreciation is $85

I stand corrected.

[russ]

I stand corrected.

Good analysis of the concept Ian - thanks!

[silversaver]

Considering that my upfront prepaid lease cost was $6729, the total with payment of the additional $844, makes my cost per watt just under $1 which was far less than an outright purchase would have been at the time. I'm still not sure whether or not I will avail myself of the buyout simply due to the additional coverage the lease provides. But the nice thing is I have that option.

Since you are in different state, what would be your purchase for the solar system net?

[Ian S]

Since you are in different state, what would be your purchase for the solar system net?

Keep in mind I signed the lease two years ago this month. At that time, the purchase price of the 6.9 kW Sunpower system was just shy of $30K. APS had a $1/watt rebate, there's the 30% tax credit and the state (AZ) offered a $1500 tax credit. The net figure depends on how the rebate is handled for tax purposes but for me would have been around $14.5K.

[silversaver]

Keep in mind I signed the lease two years ago this month. At that time, the purchase price of the 6.9 kW Sunpower system was just shy of $30K. APS had a $1/watt rebate, there's the 30% tax credit and the state (AZ) offered a $1500 tax credit. The net figure depends on how the rebate is handled for tax purposes but for me would have been around $14.5K.

Thank you for your answer. There is "big" different between cash purchase and pre-paid lease. You are talking about $14.5k vs. $7k of course it make sense that you choosing the pre-paid lease route.

Today, people do not getting that kind of difference between a pre-paid lease and cash purchase. I am sure you have seen many post regarding to the pricing between a pre-paid lease and cash purchase. If the price is within $2k difference, would you still pick pre-paid lease?

If I was looking for getting a solar system today, I like to know the "update" info today vs info of pricing from 2 years ago. The solar system I signed in Sept 2013 is almost half the price my buddy getting in Sept 2012. Of course we are comparing with a 5kW SunPower vs 6.6kW Bosch.

[Ian S]

If the price is within $2k difference, would you still pick pre-paid lease?

At that price point, I could go either way. I really don't know what was going on two years ago. It was one of those things that sounded too good to be true. It does make some sense when depreciation is considered but it's like they gave the full benefit of that to me! Since Sunpower was newly into leasing maybe they were trying to make a splash. Maybe they were trying to get rid of older panels (mine are 230 watt ones.) Maybe they just screwed up on the prepaid pricing. I'd love to know the story because it was an awesome deal.

[silversaver]

At that price point, I could go either way. I really don't know what was going on two years ago. It was one of those things that sounded too good to be true. It does make some sense when depreciation is considered but it's like they gave the full benefit of that to me! Since Sunpower was newly into leasing maybe they were trying to make a splash. Maybe they were trying to get rid of older panels (mine are 230 watt ones.) Maybe they just screwed up on the prepaid pricing. I'd love to know the story because it was an awesome deal.

Same thing happen to me back in August 2013 when I signed for 6.63kW Bosch for $18,799. My net after incentives will be around $12,400. I don't wanna spread that pricing around because I know the deal isn't happen again on discontinued panels, most likely not... It is a great price for SoCal area, but hey it happens and I don't mind they were discontinued panels. I will only suggest people keep shopping, and I'm sure they will find the ultimate price meet their targets.