According to a new report by GTM Research and the Solar Energy Industries Association, the third quarter of 2016 was a record quarter for the U.S. solar industry. 4.14 GW of solar was installed, nearly as much as all of the solar installed in 2013 (4.76 GW). For all of 2016, the researchers predict 14.1 GW of solar will be installed, enough to power 2.3 million homes. 

This is an interesting finding considering the challenges solar stocks have faced this year. First Solar (NASDAQ:FSLR), SunPower (NASDAQ:SPWR), Tesla (NASDAQ:TSLA), and Vivint Solar (NYSE:VSLR) have all seen their stocks plunge for a variety of reasons. And it's those details within the report that are worth examining. 

Image source: Getty Images.

The biggest solar segment by a long shot

77% of all solar installed in the U.S. last quarter was utility scale, which has helped First Solar and SunPower as two of the country's largest installers. But we knew late 2016 was going to be good as developers completed projects contracted to go online by the end of the year. 

Image source: GTM Research and Solar Energy Industries Association Q4 2016 Solar Market Insight.

An interesting takeaway from the report is that 2017 is shaping up to be a little better than expected. Corporate customers are buying energy from solar projects, and a policy known as PURPA that allows clean energy projects to be built if they're lower cost than the avoided cost of fossil fuels is driving adoption. 

The low cost of utility solar is starting to take hold, and over the next few years it's the cost advantage that will drive greater adoption. For now, it's good news that 2016's record year may not be followed by a completely terrible 2017. 

Commercial solar is becoming a strength

One major bright spot was commercial solar, which was up 15% sequentially and 37% from a year ago. This report includes community solar in the commercial, or non-residential, segment, so that helped the growth figures. 

What's worth pointing out is that commercial customers are finding solar attractive to purchase and developers are figuring out ways to finance projects. That's a new trend in 2016, and as costs come down and financing becomes available we could see a boom in commercial projects in the same way we saw in residential solar from 2010 to 2015. 

Residential solar is having a tough time

Speaking of residential solar, it's becoming harder and harder to sell incremental rooftop solar systems, a challenge that led to a shrinking market in the third quarter. Installations were down 10% sequentially and 2% from a year ago. 

There were strengths in new markets like Utah, Texas, and South Carolina, but big markets like California are actually in decline. National installers like SolarCity and Vivint Solar are also dealing with a "quicker than expected" customer shift from leases and power purchase agreements to loans. 

Despite the decline in residential solar last quarter, this remains a segment with a lot of potential long-term. A relatively small number of states -- including California, Massachusetts, and Arizona -- have long accounted for most rooftop solar demand, and as more states open up the segment will grow. But it could be a choppy transition, particularly for companies without flexible business models to adapt to customer preference. 

What we learned in Q3 2016

Overall, the solar industry is hitting record levels primarily because of its cost competitiveness in a growing number of states. And investors should take some comfort in the fact that demand for utility projects in 2017 is growing and commercial demand is picking up steam. 

With that said, the next year or two will be challenging for residential solar as well as utility demand in some states. Investors will want to look at the industry cautiously, because record high demand doesn't mean everyone in the solar industry is seeing a bright future. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.