Infrastructure Project Equity Financing

Running Head: Infrastructure Project Equity Financing

Presidio
Graduate
School

Capital
Markets
SUS6175_S12_SP11

May
12 ,
2011

Infrastructure Project Equity Financing

Table
of
Contents

1.
Executive
Summary ................................................................................................................. 3

2.
History .................................................................................................................................... 3

2.1
Challenges
around
raising
funding/bond
issues ........................................................................................................ 5

3.
Capital
Markets
and
Sustainability .......................................................................................... 5

4.
Analysis................................................................................................................................... 7

4.1
Alternatives: ............................................................................................................................................................................... 7

4.1.1
REIT ............................................................................................................................................................................................. 7

4.1.2
S-Corp
and
C-Corp................................................................................................................................................................. 9

4.1.3
Master
Limited
Partnership
(MLP) ............................................................................................................................... 9

4.2
Comparison
of
Corporate
Structures............................................................................................................................... 9

5.
Recommendation .................................................................................................................. 11

5.1
Assessment
of
MLPs
and
S
&
C
corporations .............................................................................................................11

5.2
Next
Generation
REITs
Show
Great
Promise .............................................................................................................12

5.3
IRS
recognition
&
Congressional
Approval
of
Next
Generation
REITs ...........................................................12

5.4
Next
Steps
for
Local
Governments..................................................................................................................................13

6.
References ............................................................................................................................ 14

2


1.
Executive
Summary

The demand for and cost of electricity is growing and is expected to do so for the foreseeable future.
There is general interest in building renewable energy infrastructure projects to help meet that
demand. Climate Action Projects depend on increased use of renewable energy to lower
environmental impact and also include provisions for infrastructure to support electric vehicles.
Municipalities are experiencing severe financial hardship and in many cases, are overwhelmed by
debt while under pressure to execute their climate action goals. These fiscal challenges are
preventing municipalities from using new bond issuances to financing infrastructure projects.

An alternative method to support the development of new infrastructure projects is proposed and
relies on public private partnerships financed with equity rather than debt. Such alternatives can
allow projects to move forward in the current economic situation.

Several recommendations are offered; the most preferred involving an adaptation of the existing
Real Estate Investment Trust (REIT) vehicle to allow it to better meet renewable energy
infrastructure project requirements. Other options, which do not require such adaptation, are
recommended as alternatives.

2.
History

Traditionally, funding for municipal infrastructure projects has been raised through municipal
bonds, also called “munis.” These bonds are divided into two primary categories, general
obligation bonds which are repaid out of the municipality’s budget and revenue bonds, which are
repaid based on revenues earned by the infrastructure project, such as bridge tolls and fees for use
of mass transit. Muni bonds have historically been attractive due to perceived low risk coupled with
tax benefits that exempt their interest payments from federal taxes.

Recently, there has been a reversal in the popularity of munis with many cities defaulting on
repayment as they file for bankruptcy. As a consequence of the increasing perceived risk, muni
bond debt has become expensive for a city to repay. Currently, a 10-year muni bond from a AA
rated municipality would pay interest of up to 5.64%. In contrast, a similarly rated corporate bond
would pay just 4.9%, but would not offer the same tax incentives, thus resulting in an even lower
effective rate of return. A few currently trading muni bonds have yields as high as 8%. Investors
have flocked to safer investments such as U.S. Treasury Bonds and Bank CDs even though their

3


returns are lower with ten-year treasuries
yielding just 3.46% and two-year notes
yielding a fraction of one percent.

Launching infrastructure projects has
become increasingly challenging as state
funding has declined and basic
infrastructure, such as roads, have remained
under funded causing infrastructure to
crumble and decay. San Francisco, for
example, is estimated to have a backlog of
$440 million dollars of street maintenance
projects alone. Similar problems exist Figure 1 - U.S. Total Electricity Consumption
throughout California and across the United
States.

As these problems persist, others brew in the
background. Demand for electricity is growing
(see Figure 1) and that growth is expected to
continue for the foreseeable future. At the same
time, the cost of purchasing energy is increasing
(see Figure 2). Climate action plans have begun
to put pressure on cleaning up the generation of
energy. Municipalities don’t have the luxury of
putting these projects on hold until existing
infrastructure projects are addressed.
Figure 2 - PG&E Average Commercial Rate
Power Purchase Agreements can be part of the
solution. These projects can produce immediate
returns by guaranteeing a price for energy that is
lower than the municipality currently pays (see
Figure 3). The benefit will increase over time as
the cost of energy rises. Additional revenue
opportunities exist for projects that include
electric vehicle charging infrastructure, which can
charge a premium rate for convenient access to
charging, while still saving consumers compared
to the price of fossil fuels. This however, doesn’t
address the problem of how to raise needed
monies. Figure 3 –Cost Benefit of Using a Solar Power Purchase Agreement

4


2.1
Challenges
around
raising
funding/bond
issues

Federal stimulus money is being used to meet immediate needs such as filling potholes and helping
to rebuild crumbling infrastructure. Cities are mired in debt. Oakland, CA for example, a city that
struggles with one of the highest crime rates in the U.S., laid-off police officers last year to balance
its budget. This year it has threatened to lay off over 500 teachers. Raising funds for renewable
energy or electric vehicle projects would normally be completed through revenue bonds, which, due
to current fiscal challenges, are not an option. (Personal Communication, Garrett Fitzgerald,
Sustainability Director, City of Oakland).

While interest rates remain low, banks are hesitant to lend, especially to municipalities with
downgraded credit ratings. The state and federal government continue to struggle with their own
budget challenges and are in no position to assist. Municipalities need an alternative means to raise
needed funds, preferably without creating new debt.

3.
Capital
Markets
and
Sustainability

In capital markets today, investors can choose from a number of different vehicles (e.g. mortgage
backed securities, bonds) that offer a steady stream of payments over a fixed period of time.
However, investors who want to invest directly in public sector infrastructure development have a
limited number of options. They could purchase shares of the companies involved with
implementing and/or managing of such a project. This investment, though, would be indirect: any
potential appreciation in share price would be subject to market sentiment and conditions as much
as the overall profitability of the company (let alone the project itself). Alternatively, investors
could purchase general obligation or revenue bonds, assuming they were issues specifically for the
project. In the case of revenue bonds, the investor would be entitled to a portion of the revenue
stream generated by the project. In general, this option is best suited to secure investors in
infrastructure projects, however bond issuances are still not easily approved given current economic
and budgetary conditions. That being said, infrastructure installations that promise to generate
profits (and eventually returns for its investors) would likely generate interest amongst individuals
looking to share in those returns.

Given the general need for liquidity, and the varying investment horizons of the market, investors
would require both: a convenient method of buying in (e.g. shares) and a market that would allow
trading of shares (or equivalent investment vehicle). Project sponsors could accomplish the first
objective by creating a legally compliant business entity (e.g. REIT or C-Corp) that was funded, at

5


least in part with equity shares. Equity ownership structure would make it easier for investors to
compare the opportunity to other currently traded alternatives. Project sponsors would also need to
ensure that individuals could freely buy and sell these shares, ideally in a public marketplace. If the
shares could be listed on an existing exchange (see Figure 4), it would significantly increase the
visibility of the shares and likelihood of finding interested individuals. Being exchange-listed
would help assure interested parties that shares would be subject to the same oversight and legal
enforcement (e.g. SEC regulations) as are their existing investments. Listing shares on a publicly
traded exchange would provide access to the largest pool of potential investment dollars.

Figure 4 – Listing Shares of an Equity Financed Project on Major Exchange

This approach to funding could be used to spur the development of any revenue generating
infrastructure project. It could be used to further the development of the United States’ renewable
energy infrastructure. However, as discussed earlier, most infrastructure development efforts are
subject to municipal or state budgetary constraints. Alternative means of funding projects could
therefore break the logjam amidst cost cutting efforts by legislators. Additionally, twenty-nine
states have already set renewable electricity standards (RES) that require a minimum percentage of
electric utilities’ generated energy to come from renewable sources within the next 10-20 years
(Slabaugh, 2011). In order for the public and private sectors to meet these numbers, they will need
to fund both large and small initiatives. Funding big projects will likely require outside help, e.g.

6


the Energy Department’s $3.7B in loan guarantees (Hull, 2011) made in April of this year for solar
thermal projects in CA. Smaller initiatives, though, could be made possible with budget
negotiations & appropriations or even more creative funding approaches.

Using an equity model could also help promote local ownership & involvement within the
community. At face value, the idea of infrastructure that generates renewable energy for the
community while turning a profit for its investors would seem like an easy sell. The local
government could benefit even more by positioning the project as an opportunity for citizens to
invest in the community’s long term well being. Assuming regulations and/or incentives were
utilized to encourage residential ownership, more people could be directly connected with the
global sustainability efforts underway.

4.
Analysis

4.1
Alternatives:

Efforts have been made to develop alternative solutions to raising capital for infrastructure projects.
We researched a number of different solutions including Real Estate Investment Trusts (REITs), S-
Corporations and traditional corporations (C-Corps), as well as Master Limited Partnerships
(MLPS). Each of these offer interesting advantages along with their own challenges. All but the C-
Corp are good contenders for the initial formation of an entity and are discussed in more detail
below:

4.1.1
REIT

A number of these alternatives have revolved around modifications to an existing investment
vehicle: the Real Estate Investment Trust. REITs were created to allow individual investors the
ability to invest in real estate. They generally trade as publically as stocks and thus have greater
liquidity then direct real estate investments. REIT’s are a type of corporation and have many of the
benefits of a C-Corp, without the burden of double taxation. REITs can also be held in retirement
accounts that offer tax deferral.

REITs must conform to a number of guidelines:

● 90% of taxable income needs to be distributed to the shareholders
● No more than 50% of the shares can be held by five or fewer individuals during the last half
of each taxable year (5/50 rule)
● Excise taxes are levied on annual profits that are not distributed

7


● Cash can be invested in government securities or other REITs, or can invest in property

Renewable energy infrastructure projects have a difficult time conforming to all of these
stipulations, yet the REIT is attractive due to significant tax and liquidity advantages. The IRS has
recently extended REITs to allow for investment in gas and electric distribution systems (Deloitte
2010), taking it closer to being a fit for renewable energy infrastructure projects. Additionally,
several efforts to offer alternatives types of REITS are underway. These alternatives include the S-
REIT and the Infrastructure REIT.

4.1.1.1
S-‐REIT
(Solar
REIT)

Joshua Sturtevant of the George Washington University Solar Institute has proposed an amendment
to current tax codes to treat revenue generated by power purchase agreements as rent. Such an
amendment would allow the benefit of REITs to be extended to solar power generation projects and
would offer a number of benefits including: increased liquidity, increased opportunity for
participation by individual investors, and the avoidance of the double taxation inherent with C-
Corps.

4.1.1.2
Infrastructure
REIT

The Infrastructure REIT is an alternative that has been proposed by several backers including
Deloitte. Under this proposal, REIT benefits would be extended to public private partnerships (P3s)
by counting all revenues as qualifying income, regardless of whether the revenue is generated by
real estate.

It may be possible to use a REIT in its current form, but doing so will pose significant challenges.
Failing to succeed in approval for any of the aforementioned alternatives with leave a number of
other less ideal alternatives, including S-Corps and possibly MLPs.

8


4.1.2
S-‐Corp
and
C-‐Corp

S-Corporations are treated similarly to partnerships and like REITS, avoid the cost of double
taxation. The S-Corp could be offered through a Direct Public Offering (DPO) on a limited scale,
but in order for a true public offering to occur, it would first need to be converted to a C-
Corporation.

C-Corporations are traditional corporations. They have the advantage of being able to offer stock on
a scale limited only by the corporation itself. They have the undesirable characteristic of double-
taxation, causing the corporation to be taxed and the owners to be taxed as well.

4.1.3
Master
Limited
Partnership
(MLP)

Master Limited Partnerships (MLPs) offer the tax benefits of a limited partnership along with the
ability to trade on a public exchange. MLPs are generally limited to very specific businesses, such
as those related to oil, natural gas, or coal. There are also MLPs for the finance sector, other natural
resources and real estate. There are groups that are advocating for IRS changes that would allow
MLPs to be used for renewable energy (Zweibel, 2010). It does not seem like it would be a big step
to add that allowance.

MLPs have some key differences from REITs, even though their benefits are quite similar at a first
glance. REITs are better understood by investors as they have been available for a greater period of
time. Taxable obligations are reported on a 1099 form, something most investors are already
familiar with. They offer the advantage of passing through earnings and losses, a significant benefit
in periods where there are losses, for example, in the early years of a newly launched business.
Tax-wise, the IRS treats dividends from an MLP more favorably as they reduce the cost basis of
investment. Taxes on dividends are not paid until the holding is sold. Another difference is that an
MLP is not a corporation and thus is not a separate legal entity as is a REIT. Partners who own the
MLP are personally liable and could be called on to repay any capital they receive. Likewise,
partners are personally liable for any loans received by the partnership.

4.2
Comparison
of
Corporate
Structures

MLP REIT S-Corp C-Corp
Corporate Structure A Master Limited May be Treated as Exist as an entity
Partnership is a structured as a c- partnerships for separate from their
partnership that is corporation, tax purposes owners and pay taxes
able to trade assets, trust, or while having as such an entity.
similar to stocks, association some of the Managed by majority
on stock exchanges advantages of a owner.
C-Corp in terms

9


of liability.
Managed by
majority owner.
Ability to trade stock MLPs are able to Trade on May have only May have multiple
trade “units” which exchanges in a one class of stock, classes of stock, no
perform similarly manner May not have limit in the number of
to stock equivalent to more than 100 stockholders,
stocks shareholders. shareholders may be
Shareholders must U.S. or foreign
be U.S. Citizens, citizens
or entities
Ownership Owners are Must be jointly May not have Owned by
partners in the firm owned by 100 or more than 100 shareholders, with
more individuals shareholders. largest powers of
ownership going to
the majority owner.
There is no maximum
number of owners.
Liability Partners are Shareholders do Offers Limited Shareholders do not
personally liable to not have Liability have personal liability
creditors. This personal liability Protection from
liability can extend creditors
to shareholders
Taxation Treated as Treated as Treated as Double taxation: Net
partnership partnership partnership income is taxed at the
corporate level before
it’s distributed to
shareholders, who
must also pay tax on
income.
Dividends Payouts are called Pay dividends of S corporation is Dividends are taxed
distributions rather at least 90% of not eligible for a at the preferential
than dividends and the REIT's dividends 15% rate. Is eligible
they reduce the taxable income received for a dividends
equity owned Not taxed at the deduction. received deduction.
causing a tax preferred 15%
advantage. but instead are
taxed at 35%
Losses Passed through to Not passed Passed through to Not passed through to
shareholders through to shareholders shareholders
shareholders
Income Limitations N/A Must earn 75% Unlike a C Subject to the 10
of more of its corporation, an S percent of taxable
gross income corporation is not income limitation
from rents or subject to the 10 applicable to
mortgage interest percent of taxable charitable
income limitation contribution
applicable to deductions.

10


charitable
contribution
deductions.
Other Disadvantages No more than
20% of its assets
may consist of
stocks in taxable
REIT
subsidiaries.
At most 50% of
the shares can be
held by five or
less individuals
during the last
half of each
taxable year
(5/50 rule)
Management Partners Board of Partners Board of Directors
Directors

5.
Recommendation

5.1
Assessment
of
MLPs
and
S
&
C
corporations

C and S corporations are well defined and understood company structures that can be used for
equity financed infrastructure initiatives. Whereas S-Corps receive more favorable tax treatment
than C type entities, their capped number of total shareholders and additional liability exposure limit
the scope of projects that they can be used for. S corporations would be best utilized for small, local
initiatives with relatively low risk of default and a small number of potential investors. C
corporations, on the other hand, do address the two limitations of S type entities described above.
However, they are subject to a 39% national corporate tax rate (Hodge, 2008) and double taxation
rules that significantly impact the returns to investors. C corporations are therefore not ideal for
such projects unless they expect to grow significantly over time (justifying the associated overhead)
and offer robust returns to compensate for tax expenses.

MLPs are liquid and receive favorable tax treatment and pass through abilities; attributes which
make them attractive for infrastructure project sponsors to consider. However, the risk exposed to
partners may limit investor participation. A means to reduce risk and relaxation of rules by IRS to
allow their use in renewable energy infrastructure projects would both be needed to make them a
viable option.

11


5.2
Next
Generation
REITs
Show
Great
Promise

Project sponsors utilizing a REIT structure would reap benefits similar to those offered by MLPs
and S-Corps. Given a REIT’s composition and revenue distribution requirements, though, the
majority of renewable energy infrastructure projects do not fit within current guidelines. Disparate
efforts have been proposed to redefine REITs to make them more suitable for such projects.
Sponsors would be best served by the creation of a next generation REIT designed specifically for
this purpose: a Renewable Energy Infrastructure Trust (hereafter called REIT-2G).

Fundamentally, a REIT-2G would differ from a traditional REIT with respect to the source of
income requirements. The REIT-2G model would require a project to certify that the overwhelming
majority (if not all) of the energy they generate comes from renewable sources.
(This would essentially be a further extension of the IRS’ decision to allow gas and electric
distribution projects to qualify for REIT status.) Similar to the modifications proposed with S-
REITs and Infrastructure REITs, the definition of approved income sources should be broadened to
encompass the different types of projects being considered today. If a project were able to meet
these qualifications, it would then enjoy the tax and liability benefits of a traditional REIT.

Making the REIT-2G a reality can only occur if either (a) the current interpretation of REIT tax
code was broadened via an IRS private letter ruling or (b) changes were made to the U.S. tax code
to allow for a new such entity. Given the information and feedback collected thus far, a private
letter ruling seems unlikely. As such, this initiative would need to be sponsored by individuals who
have the authority to change the tax code – the United States Congress.

5.3
IRS
recognition
&
Congressional
Approval
of
Next

Generation
REITs

Getting the REIT-2G added to the federal tax code would require lobbying Congress with several
groups of interested parties. Ideally, representatives from PPA organizations (e.g. Tioga Energy,
Solar City) should be brought in to testify how much more successful their renewable energy
infrastructure ventures would be (or could have been) with the proposed legislation changes. In
addition, key NGOs with financial resources and lobbying power (e.g. EDF, NRDC, Sierra Club)
should be brought on board ask key sponsors of the initiative. Their support (and that of the groups’
members) could go a long way in lending legitimacy to the effort. Lastly, city and state legislators
should collaborate to inform their federal counterparts about the benefits that the tax code changes
would bring to the state.

Within Congress itself, REIT-2G should be ideally championed by legislators either pushing for
renewable energy infrastructure projects and/or changes to the tax code that promote job growth and

12


energy independence. Getting their buy-in and commitment would require a fair amount of effort
on the part of the aforementioned groups, but ultimately would offer the best chance for success.

5.4
Next
Steps
for
Local
Governments

While awaiting legislative changes to occur the federal level, municipalities can (and should)
explore alternative project funding approaches. (For example, the city of Berkeley, CA could lease
roof space on buildings to a company for the purpose of operating and maintaining a renewable
energy installation.) For such initiatives, the city would be best served by collaborating with private
sector technology/business partner(s) to conduct a feasibility and impact assessment of the proposed
project. These joint discussions should drive the completion of a joint RFP which included
preferences for equity based ownership structures. The city could then, through an RFP process,
green light the project once a profitable business model and technology partner were identified.
Assuming the newly formed entity chose to issue equity shares of the project (perhaps through a
Direct Public Offering), the city could work with them to promote the initiative within the
region/state and beyond.

13


6.
References

Hodge, Scott A. (2008, March 18). U.S. States Lead the World in High Corporate Taxes.
Retrieved from: http://www.taxfoundation.org/publications/show/22917.html.

Hull, Dana. (2011, April 18). Energy Department announces $2.1 billion loan guarantee for
Mojave Desert solar project. San Jose Mercury News. Retrieved from:
http://www.mercurynews.com/bay-area-news/ci_17875239

Slabaugh, Seth. (2011, April 10). Wind industry feeling a little more welcome. The Star Press.
Retrieved from:
http://www.thestarpress.com/article/20110411/NEWS01/104110315/0/ENTERTAINMENT03
/Wind-industry-feeling-little-more-welcome

“1st energy infrastructure REIT being created - Pensions & Investments,”
http://www.pionline.com/article/20101130/DAILYREG/101139999.

“BlawgConomics: The Solar REIT: A Vision for the Future of German Solar Development,”
http://blawgconomics.blogspot.com/2010/11/solar-reit-vision-for-future-of-german.html.

“Country’s First Green Energy REIT Launches in New York City | Green Real Estate Law Journal,”
http://www.greenrealestatelaw.com/2011/03/countrys-first-green-energy-reit-launches-in-
new-york-city/.

Deloitte, 2010, REITs and infrastructure projects The next investment frontier? Retrieved from:
http://www.deloitte.com/assets/Dcom-
UnitedStates/Local%20Assets/Documents/MA/us_ma_Infrastructure%20REITS_040210.pdf

“EIA - Short-Term Energy Outlook,” http://www.eia.doe.gov/steo/#Electricity_Markets.

“Ellensburg Community Solar Project — Community Renewable Energy,”
http://nwcommunityenergy.org/solar/solar-case-studies/chelan-pud.

“Envision, ACE unveil new Solar Tree carports and leasing option  : Solar Energy - Clean Energy
Authority,” http://www.cleanenergyauthority.com/solar-energy-news/solar-carport-leasing-
and-electric-car-charging-022211/.

“Federal Energy Management Program: Energy Savings Performance Contracts,”
http://www1.eere.energy.gov/femp/financing/espcs.html.

“FT.com / Capital Markets - Debate rages over muni bond defaults,”
http://www.ft.com/cms/s/0/96cefa8a-1dac-11e0-aa88-00144feab49a.html#axzz1Hr4aQpyo.

14


“FT.com / Capital Markets - Moody’s forecasts ‘distress’ for US muni markets,”
http://www.ft.com/cms/s/0/01c136f6-3d2d-11e0-bbff-00144feabdc0.html#axzz1Hr4aQpyo.

“FT.com / Capital Markets - Muni woes could sour appetite for bonds,”
http://www.ft.com/cms/s/0/8d596ba2-f732-11df-9b06-00144feab49a.html#axzz1Hr4aQpyo.

“FT.com / Capital Markets - Record amounts withdrawn from US muni funds,”
http://www.ft.com/cms/s/0/0aae4f6a-24ff-11e0-895d-00144feab49a.html#axzz1Hr4aQpyo.

“FT.com / Capital Markets - Sell-off in US local debt rattles investors,”
http://www.ft.com/cms/s/0/81b169e4-f27d-11df-a2f3-00144feab49a.html#axzz1Hr4aQpyo.

“FT.com / Reports - Municipal bonds: Spotlight falls on US cities’ fundraising,”
http://www.ft.com/cms/s/0/9b92bb96-273f-11e0-80d7-
00144feab49a,s01=1.html#axzz1G0HReYFi.

“Guidelines for Financing Municipal Energy Efficiency Projects.”

“Innovative $2.1B Energy Infrastructure REIT Launched -- DALLAS, Nov. 29, 2010
/PRNewswire/ --,” http://www.prnewswire.com/news-releases/innovative-21b-energy-
infrastructure-reit-launched-110977879.html.

“Law Firm Of Pepper Hamilton LLP | REITs: Looking to the Rooftops,”
http://www.pepperlaw.com/publications_update.aspx?ArticleKey=1345.

“Power Purchase Agreements,” http://syndicatedsolar.com/Financial-Resources/Power-Purchase-
Agreement.php.

“Public-Private Partnerships -- The Silver Lining for Solar | Renewable Energy News Article,”
http://www.renewableenergyworld.com/rea/news/article/2009/07/public-private-partnerships-
the-silver-lining-for-solar.

“REITS are Poised to Finance an Independent and Modern Grid - POWERGRID
International/Electric Light & Power,” http://www.elp.com/index/display/article-
display/302307/articles/electric-light-power/volume-85/issue-4/columns/taking-it-into-
account/reits-are-poised-to-finance-an-independent-and-modern-grid.html.

“Solar Power Purchase Agreements | Green Power Partnership | US EPA,”
http://www.epa.gov/greenpower/buygp/solarpower.htm.

“SOLAR TODAY: Exclusive: Financing Large-Scale Solar Projects,”
http://www.ases.org/index.php?option=com_content&view=article&id=1034&Itemid=23.
Zweibel, Ken, (2010, May, 15), “Solar for ‘Everyman’” The Solar Review, Retrieved from:
http://thesolarreview.org/2010/05/15/solar-for-everyman/.

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