Rooftop Solar Takes Off in Ontario
Does this sound like a bad business? A business that hasn’t had a significant new revenue stream since the 1980s? Well, that would be the commercial real estate business.
Here is how it breaks down:
1. In the ‘olden days’, Commercial Landlords received rent, a gross rent.
2. From that they paid—their mortgage, property taxes, operating costs, insurance, utilities, repairs, maintenance and administration staff. And whatever was left, was profit.
3. Then inflation happened (in the 1970s and 1980s).
4. Interest rates went to 21%.
5. Landlords went out of business in a hurry as cities raised taxes, utilities raised rates, staff wanted more dough, …
6. The industry reacted—they went to net, net, net rents (triple net rents). That means that tenants paid their basic rent (or minimum rent) which went to the Landlord (from which they paid their mortgage). Everything else was paid by the Tenant in the form of additional rent so if costs went up, their additional rent went up.
7. Some Landlords ‘retailed’ their utility bills to their Tenants on the basis of what the Tenant would have paid for their consumption if they had been in a standalone relationship with the utility company and not buying wholesale as many Landlords were doing.
8. Landlord’s also grossed up their Tenant’s space so that the Tenants were also paying for common areas and even for vacant space.
9. Landlords would also charge a fee for their administration and management as well as recovering their insurance costs and maintenance and repair costs sometimes even collecting for structural and other major repairs.
10. So the minimum rent was truly ‘net’ to the Landlord.
Over the years, Landlords tried lots of other things to add to their bottom line. They tried charging for parking, introducing cable and telecommunications services that they controlled and charging for signage. For most locations, this did not amount to much and, in some cases, the results were negative—it turned out that running a cable system or telecom system was too complex for them and they were losers both financially and operationally.
Then along came the Internet—every developer was going to have a server farm in each of their buildings. That didn’t last long either.
Now in Ontario, here comes rooftop solar. Heavily subsidized by the Province of Ontario, solar looks like it might add 40 to 50 cents per square foot per year to the bottom line of commercial landlords with suitable roofs. These revenues are triple net and derived from (mostly) ballasted systems installed by third parties. The rooftop ‘gold rush’ might lead to the development of micro utilities with scale; some will control dozens or hundreds of rooftop installations in the Province.
Or the Landlords can install the systems themselves and make more money (cap rates are probably in the order of 10 to 11% p.a.). Of course, they will then be on the hook for the capital costs and operating costs of these systems. Big Landlords can borrow money a lot cheaper than most entrepreneurs so a cap rate of 11% looks mighty tasty to them when their borrowing costs could be less than 4%.
Risk averse or capital short Landlords may prefer the triple net, money for nothing approach. 40 to 50 cents may not sound like much but, at least for industrial buildings which yield around $8 per square foot per annum, triple net in places like Ottawa, that’s a raise of 5% to 6.25%. And don’t forget, the IRR on that marginal revenue is infinite since they are paying 0 dollars for the installations.
Prof Bruce
Postscript: there is another new revenue source on the horizon for commercial landlords, at least the ones with superior locations and lots of drive-by or pedestrian traffic. But that is a story for another day.
Postscript 2: the commercial real estate biz is today mostly reserved for large scale enterprises. Regional malls and mega office towers are almost exclusively the preserve of Banks, pen finds, insurance companies and publicly traded REITs with very low COF (Cost of Funds). Entrepreneurs have to find a different playground where returns are higher and elephants stay out. Industrial condos, self storage, land development, apartment hotels and resorts are some of the areas where entrepreneurs can hope to find a piece of the action.