What Is An Operating Lease?

The Skinny

An Operating Lease is a third-party-owned financing mechanism that allows a business to use a solar energy system without purchasing it.

The financing company (the Lessor) owns the solar installation, while the business using the equipment (the Lessee, or Off-Taker) makes regular lease payments over an agreed term.

Unlike a loan or Capital Lease, the Off-Taker does not acquire ownership simply by completing the payments. The Lessor generally retains the tax benefits associated with ownership, including depreciation and applicable federal tax credits, and can use their value to improve the economics of the lease.

On CleanFi, operating leases for commercial solar installations can be quoted instantly (at the writing of this email – note that financial products and conditions change frequently on CleanFi). We quote it just like any other credit-based structured product, alongside our other financing mechanisms. No need to submit the project for competitive bidding through our BidDesk.

The Details

How does an Operating Lease compare to other financing mechanisms?

Operating Lease vs. Capital Lease

A Capital Lease is essentially a financed purchase, generally allowing the customer to claim the solar tax benefits and acquire the equipment at the end of the term, often for $1.

An Operating Lease keeps ownership and generally the associated tax benefits with the Lessor. This can be advantageous for businesses that cannot use those benefits themselves, allowing their value to be reflected in the lease pricing.

Operating Lease vs. Straight Loan

With a conventional loan, the business purchases the solar system, assumes responsibility for repaying principal and interest, and generally retains the available tax benefits.

An Operating Lease avoids the equipment purchase and may conserve conventional borrowing capacity. However, it still requires credit underwriting and creates a contractual payment obligation.

Operating Lease vs. Power Purchase Agreement (PPA)

Both are third-party-owned structures. But a PPA sells electricity, generally priced per kilowatt-hour, while an Operating Lease rents the solar equipment for an agreed payment.

Unlike a PPA, where the investor generally manages system performance and maintenance, an Operating Lease may leave those responsibilities with the Off-Taker.

The lease can offer a more straightforward financial arrangement, without the production-based pricing and potentially lengthy investor bidding process associated with PPAs.

Operating Lease vs. C-PACE

C-PACE finances the acquisition of improvements through a special assessment secured against the real estate. The property owner generally owns the installed solar system and receives the associated tax benefits.

An Operating Lease does not ordinarily require the property owner to pledge real-estate equity or accept a C-PACE assessment. That makes it attractive where property equity is limited, a mortgage lender will not consent to C-PACE, or the Off-Taker does not own the building.

Instead, the Lessor relies on its ownership rights in the solar equipment, the payment obligations of the Lessee, and the creditworthiness of the business.

What sort of lien is typical in an operating lease?

Different financing mechanisms protect their capital through different forms of collateral.

A conventional equipment lender or Capital Lease provider generally files a UCC-1 financing statement covering the solar equipment.

A C-PACE funder secures its investment through a special assessment against the real estate itself.

An Operating Lease investor, much like a PPA investor, retains ownership of the solar installation and will generally file a UCC-1 to establish public notice of its interest in the equipment. Depending on the structure, this may be a precautionary filing rather than a conventional loan lien.

The distinction: The Operating Lease generally does not create a new mortgage or property-tax assessment against the building. However, roof-access rights, fixture filings, and existing mortgage agreements may require additional documentation or consent.

For more detail, see How Different Financing Mechanisms Secure Their Risk: All About Liens.

Who is the ideal Operating Lease customer?

Consider a business with strong revenues, predictable cash flow, and a good credit history, but relatively little federal income tax liability.

The business could borrow to purchase the solar system, but might be unable to use the available Investment Tax Credit or depreciation deductions efficiently.

It may also prefer to preserve its existing credit lines for working capital and business expansion.

This is a particularly good Operating Lease candidate.

The Lessor can potentially use the tax benefits that the Off-Taker cannot, while the business obtains the electricity generated by the solar system in exchange for predictable lease payments.

But remember that limited tax appetite is not the same thing as poor credit.

Operating Leases are credit-based transactions. A company with persistent operating losses, weak cash flow, or excessive existing debt may still fail underwriting, regardless of the attractiveness of the solar project.

Read our articles on Debt Service Coverage Ratio (DSCR) and Pre-Qualifying a Commercial Prospect for Financing for more on evaluating potential applicants.

The Good 👍🏼

👍🏼 Instant preliminary quotes on CleanFi, with no BidDesk submission required.

👍🏼 No large upfront equipment purchase.

👍🏼 The Lessor can monetize eligible tax benefits that the customer may be unable to use.

👍🏼 Fixed, predictable lease payments, depending on contract terms.

👍🏼 No C-PACE property-tax assessment or conventional real-estate mortgage required under the standard structure.

👍🏼 Potentially conserves existing bank borrowing capacity.

👍🏼 Lease payments may be deductible as operating expenses, subject to tax classification.

Not So Good? 👎🏼

👎🏼 Requires satisfactory business credit and cash flow.

👎🏼 Tax credits and depreciation generally belong to the Lessor, not the Off-Taker.

👎🏼 The Off-Taker may be responsible for system maintenance, insurance, and repairs.

👎🏼 Ownership does not automatically transfer at the end of the term.

👎🏼 Early termination and equipment buyouts can be expensive.

👎🏼 Unlike older accounting rules, most Operating Leases must now be recognized on the Lessee’s balance sheet under ASC 842.

Note that an Operating Lease is not a loan. The rate equivalent we present is a calculation tool, not a contractual borrowing rate or APR. Residual equipment value, tax benefits, and other differences must be considered when comparing total financing costs.

The result is a convenient way for contractors and property owners to compare Operating Leases with the other mechanisms available on CleanFi, at the earliest stage of project development.

All preliminary proposals remain subject to final underwriting and contract terms.

Finding the Right Financing Mechanism

The objective of CleanFi is not to steer every project into one particular financing product.

We believe that the best financing mechanism depends on the project, the property, the financial condition of the business, the tax situation of the owner, and the intended long-term use of the improvement.

An Operating Lease can be an excellent solution for one project and an unnecessarily expensive solution for another.

That’s why CleanFi carries multiple financing mechanisms, including loans, Capital Leases, Operating Leases, C-PACE, and third-party-owned energy and capacity purchase agreements.

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