When you hear the term real estate investment trust (REIT), what stands out is that it's an investment tied to real estate. The kind of real estate can vary from company to company, but the common thread for all REITs is that they own, develop, and operate a portfolio of real estate assets.
One company you may come across when searching for real estate investments is Hannon Armstrong Sustainable Infrastructure (NYSE: HASI). It certainly has a great elevator pitch: It invests in renewable energy assets across the U.S. and has a large portfolio of development projects in the wings.
If you look further, though, you'll find that Hannon Armstrong as an investment isn't as simple as renewable energy + real estate = profit. Let's take a look at what makes investing in this segment seem so compelling and what investors need to know about Hannon Armstrong before buying.
An unconventional way to invest in renewable energy
Based on the numerous stories about the growth of renewable energy, the idea of investing in this red hot sector would seem to be a slam dunk. According to the Bloomberg New Energy Finance report, about $13 trillion will be invested between now and 2050 on new power generation, and 77% of that is slated to go to wind and solar.
Despite the monumental growth in the industry, there have not been that many investment success stories thus far. One of the biggest headwinds for investors is that it has been a wildly cyclical industry, and companies are constantly needing to reinvent themselves with better technology.
The one element that has been relatively stable in this industry, though, is owning and operating renewable energy assets. Those in the real estate industry will find the reason to invest in renewable power facilities very familiar: They tend to generate stable revenue under long-term contracts, they come with generous tax breaks and incentives, and the cost for maintenance is relatively low.
That kind of business seems incredibly well suited to be a real estate investment trust.
Not your parents' real estate investment trust
Real estate investment trusts tend to come in two flavors: equity REITs and mortgage REITs. Equity REITs are the ones that own and lease physical real estate to tenants, whereas mortgage REITs buy, own, and manage a portfolio of real-estate-backed mortgages. A mortgage REIT generates profits by buying mortgages with higher interest rates than the debt it issues to buy them.
Hannon Armstrong is a bit of a hybrid of these two things. It owns physical real estate, but that is only about 15% of its total portfolio. Those physical property investments are for land upon which developers build utility-scale solar power facilities. It then collects rent from the company that owns the power-generating assets.
Other parts of its portfolio are more similar to mortgage REITs. For example, a significant portion of its assets are residential, commercial, and industrial solar leases. A solar lease is a contract payment that an owner of a building pays to a solar developer for a rooftop solar system. They can either be a conventional loan payment or a power purchase agreement where they pay for the amount of electricity that the solar system produces. Hannon Armstrong helps developers finance the upfront costs to build those solar systems and gets an ownership stake in each contract. According to management, about 37% of its portfolio consists of these kinds of solar leases.
The difference between a solar lease and a conventional mortgage, though, is that solar systems aren't an appreciating asset. Solar systems degrade over time and typically need to be replaced every 10 to 20 years. More comparable to a solar lease is an automotive loan. It may be backed by a physical asset, but that asset's value depreciates over time.
This is only one example of the different kinds of investments that Hannon Armstrong makes in this sector. Overall, the company issues loans to water remediation projects and other climate change related projects and manages small-scale utilities, such as university power plants.
Many of the company's investment opportunities are intriguing, but the collection of all of these types of assets under a single portfolio makes it more difficult to understand what the company owns and how to follow its financials.
Also, because the company is in the business of project and development finance, it carries much higher debt levels than a conventional equity REIT. Hannon Armstrong's debt to capital ratio currently stands at 58%. That's a tad high for an equity REIT, but more in line with what you would expect from mortgage REITs.
The bottom line
The idea of getting the growth potential of renewable energy with the stability of real estate makes for a compelling elevator pitch to investors. Being able to invest in an entity with a mission to abate climate change is certainly going to turn a lot of heads for investors looking for companies with high environmental, social, and governance (ESG) scores.
When you look under the hood at Hannon Armstrong, though, you see that it isn't a real estate investment in the conventional sense. Absent a portfolio of property, Hannon Armstrong's fortunes will be determined by its ability to secure financing at low interest rates, then lend it at higher interest rates to renewable power and other sustainable infrastructure projects. Being able to identify high-return projects with low probabilities of defaults means your investment is wholly reliant on management's underwriting acumen. For those looking for a simple investment backed by physical assets like real estate, Hannon Armstrong isn't it.