cost versus rewards

[lovelyone2]

I am trying to figure out if the cost of a solar panel system is worth the repayment time. For a 4.41 KW system in New Jersey, the offset from the utility company and the SREC accumulation will take many years to recoup the price paid. How will the system be worth buying with such a slow return rate?

Thank you for you reply

[Naptown]

When figuring this take the cost of the system. Subtract the federal and any state incentives. This will give you a net cost after incentives.
Then add the KWH the system will produce annually plus SREC value over those years.
Divide your net cost by annual savings + SREC income to come up with a simple payback time in years.

[pleppik]

How will the system be worth buying with such a slow return rate?

Well, you didn't say just how long it will take for the system to pay for itself.

One way of looking at it is to look at a PV system as a pure financial investment, like buying a savings bond. With a savings bond you pay a certain amount of money up front and earn a guaranteed interest rate until the bond matures.

With a PV system you pay a certain amount of money up front and earn the savings on your utility bill until the system needs to be replaced in 20-30 years. There's a little bit more risk than with a savings bond (for example, the system may need repairs unexpectedly, or the rules for net metering might change in a way which is unfavorable to the PV owner). On the other hand, the effective interest rate earned with a PV system will be higher than on a savings bond in most places, plus your earnings go up if the utility rates go up and you get some protection against inflation.

Calculating the effective interest rate you earn on your PV investment is complicated (to do it right you need to calculate something called the "internal rate of return"), but as a very approximate rule of thumb if your PV system breaks even after 10 years you're doing a lot better than you would with a savings bond; if it breaks even after 15 years it's kind of a wash; and if it takes 20 years or longer then the PV system earns a lower return than a bond. This is assuming the PV system is expected to last 25+ years.

Some people also look at non-financial considerations. For example, a desire to avoid the pollution caused by generating power with fossil fuels, a desire to stick it to the power company, or a desire to be the first person on your block with solar panels.

Those are all legitimate reasons to want to install PV, but only you can decide how much they are worth to you.

For me personally, my wife and I decided that if a PV system is likely to break even within its lifetime, then it would be worth installing for the benefit of avoiding a significant amount of CO2 pollution. What we found is that without any incentives, the system would pay for itself in 15 years or so (making it a reasonable long-term financial investment in our eyes, when compared to the low interest rates offered on savings bonds). When you include the generous state and federal incentives available to us right now, the system pays for itself in about 8 years and provides an extremely attractive financial return.

[J.P.M.]

Well, you didn't say just how long it will take for the system to pay for itself.

One way of looking at it is to look at a PV system as a pure financial investment, like buying a savings bond. With a savings bond you pay a certain amount of money up front and earn a guaranteed interest rate until the bond matures.

With a PV system you pay a certain amount of money up front and earn the savings on your utility bill until the system needs to be replaced in 20-30 years. There's a little bit more risk than with a savings bond (for example, the system may need repairs unexpectedly, or the rules for net metering might change in a way which is unfavorable to the PV owner). On the other hand, the effective interest rate earned with a PV system will be higher than on a savings bond in most places, plus your earnings go up if the utility rates go up and you get some protection against inflation.

Calculating the effective interest rate you earn on your PV investment is complicated (to do it right you need to calculate something called the "internal rate of return"), but as a very approximate rule of thumb if your PV system breaks even after 10 years you're doing a lot better than you would with a savings bond; if it breaks even after 15 years it's kind of a wash; and if it takes 20 years or longer then the PV system earns a lower return than a bond. This is assuming the PV system is expected to last 25+ years.

Some people also look at non-financial considerations. For example, a desire to avoid the pollution caused by generating power with fossil fuels, a desire to stick it to the power company, or a desire to be the first person on your block with solar panels.

Those are all legitimate reasons to want to install PV, but only you can decide how much they are worth to you.

For me personally, my wife and I decided that if a PV system is likely to break even within its lifetime, then it would be worth installing for the benefit of avoiding a significant amount of CO2 pollution. What we found is that without any incentives, the system would pay for itself in 15 years or so (making it a reasonable long-term financial investment in our eyes, when compared to the low interest rates offered on savings bonds). When you include the generous state and federal incentives available to us right now, the system pays for itself in about 8 years and provides an extremely attractive financial return.

Re: PV vs. the savings bond: A big difference is when the bond stops paying interest you get your original principal back. With a 20yr. old PV you get a 20yr. old system that may still be producing power at some rate, perhaps for some time to come.

[Ian S]

For someone wanting to calculate IRR, there's a great little financial calculator for both Android and iphone from Bishinews. My prepaid lease IRR works out to over 21%!

[pleppik]

Re: PV vs. the savings bond: A big difference is when the bond stops paying interest you get your original principal back. With a 20yr. old PV you get a 20yr. old system that may still be producing power at some rate, perhaps for some time to come.

That's an important point, and why the "right" calculation is IRR.

A PV system which (for example) saves you 10% of its cost each year is not equivalent to a savings bond paying 10% interest. The return on the PV system is less than 10% because you don't get the cost of the PV system back when its lifetime ends.

[J.P.M.]

That's an important point, and why the "right" calculation is IRR.

A PV system which (for example) saves you 10% of its cost each year is not equivalent to a savings bond paying 10% interest. The return on the PV system is less than 10% because you don't get the cost of the PV system back when its lifetime ends.

I'd mostly agree that IRR is a way to compare alternative investments. However, some folks prefer Net Present Value (NPV) method as being more appropriate for a lot of reasons too long for this forum. See literature on financial analysis for more. All methods have goods/bads.

In the case of solar stuff, and with any method, the outcome is dependent on the input(s). A small example, Using a 30 yr. time frame will produce a different IRR or NPV than will a 10 year time frame. Either time frame, or any other time frame may be appropriate, depending on particulars of the situation.

With solar, longer time frames usually lead to rosier outcomes and so, that's what those with solar to sell often use, appropriate or not.

Most folks are clueless about such things and therefore often get duped. Such long time frames may or may not be appropriate or realistic. Because solar panels may last 30 yrs. doesn't make that an automatically appropriate time frame to use for a particular situation. Sometimes reality gets in the way. An example or 2 of perhaps inappropriately long time frames: Selling to someone who's 90 yrs. old. Or selling to someone who owns property in a run down neighborhood who intends to move in 5 yrs. An appropriately long time frame might be for someone who's 30 yrs. old and builds their own home, intending to stay for the duration. Pick your own scenario. Some are more appropriate than others, depending.

One other comment: Although it can be used for any number of purposes, IRR is often used to compare the desirability of an option compared to the cost of funds. That may not be the best way to compare alternatives. Usually as a minimum for further consideration a project must have an IRR that exceeds the cost of capital. That's the first cut, and, BTW, sort of implies that the decision has not yet been made.

After that, when considering opportunities that make that cut comes the question: What's the best choice among those making the cut where I get the most bang for my buck for chosen time frame, e.g., solar panels, put the money in a bank, lend it out,, stock market etc. This is where NPV often comes in. For all alternatives of the same duration that made the IRR cut, the one with the greatest net present value is the one chosen when considering most economic benefit alone. After that, let other, probably more important considerations take over, make a decision, pay your money and take your choice, but do so with perhaps a better handle on the financial consequences of the decision.

[Mb190e]

Another way that I tried looking at it other than the payback by not having a utility bill, it is one of the few home improvements that actually has return. New granite countertops $7000 increases the value of your house some but it's not paying you back anything. New trex deck $12,000 once again increases the value of your house some, nice to sit out on but it doesn't really pay you anything. With the solar array I see real savings every month. I believe it increases the value of the house. If my house is put up for sale and the house down the street is up for sale and the cost of utilities on mine is 80% cheaper. That has to be worth something. No different than looking at a house with a deck versus one without a deck.

[J.P.M.]

Another way that I tried looking at it other than the payback by not having a utility bill, it is one of the few home improvements that actually has return. New granite countertops $7000 increases the value of your house some but it's not paying you back anything. New trex deck $12,000 once again increases the value of your house some, nice to sit out on but it doesn't really pay you anything. With the solar array I see real savings every month. I believe it increases the value of the house. If my house is put up for sale and the house down the street is up for sale and the cost of utilities on mine is 80% cheaper. That has to be worth something. No different than looking at a house with a deck versus one without a deck.

How much the value of a piece of property changes by adding solar as you describe it can be treated in any number of ways. One is to consider the change in value, positive or negative as "salvage value" at the end of the analysis. The rest of the financial analysis stays pretty much the same.

[Sunking]

How much the value of a piece of property changes by adding solar as you describe it can be treated in any number of ways. One is to consider the change in value, positive or negative as "salvage value" at the end of the analysis. The rest of the financial analysis stays pretty much the same.

In states that export electricity and self sufficient adding solar is a Net Negative Equity.

[pleppik]

With the solar array I see real savings every month. I believe it increases the value of the house. If my house is put up for sale and the house down the street is up for sale and the cost of utilities on mine is 80% cheaper. That has to be worth something. No different than looking at a house with a deck versus one without a deck.

That's assuming the real estate market is rational, which it often isn't.

While you can calculate the theoretical amount the utility savings would add to the price of the house, in the real world that doesn't seem to always happen. But that may change as PV becomes more common and buyers become more aware of it and the financial benefits.

[russ]

One needs to keep in mind that maybe 1 or 2% of the population really has any idea about solar.

[J.P.M.]

In states that export electricity and self sufficient adding solar is a Net Negative Equity.

You may very possibly be dead nuts right. Perhaps not quite that much. I've found that a property is only worth what someone is willing to pay, somewhat (not much, but somewhat) independent of the real world.

That a state may be a net exporter of electricity may well influence the viability of most or all residential solar in that state, independent of a buyer's awareness of the situation. However, I'd suggest (guess/wild-ass opinion) it will only influence a buyer's decision to the degree they are aware of it, and only then to the degree they think it influences them in a personal way, good/bad.

I'll agree a bit here w/ Pleppik on one point: real estate markets are like some other things in life: irrational to some degree. Perhaps not unlike a lot of folks who buy non cost effective solar systems and think they got a deal.

Since the salvage value of property in a financial analysis is based on assumptions about the future like a lot of the rest of most any financial analysis, I've always tried to remember that the salvage value is a guess/prediction/hope, not a way to influence a future outcome. I've also found in the few cases I bothered to follow up, that the salvage value is influenced by additional stuff the rest of the variables are not affected by. Thus, I've always treated any savage value #'s accuracy with a somewhat more jaundiced eye than the other variables and not put a lot of time into it. Some, just not a lot.

[J.P.M.]

That's assuming the real estate market is rational, which it often isn't.

While you can calculate the theoretical amount the utility savings would add to the price of the house, in the real world that doesn't seem to always happen. But that may change as PV becomes more common and buyers become more aware of it and the financial benefits.

I want to infer from the above that you're implying any financial benefits from solar are a foregone conclusion. Am I correct in my inference?

If so, and if you're writing about financial considerations, I'd respectfully suggest you might consider adding something like "and drawbacks" to the end of the last sentence if you'd like to add a touch of reality to it. It ain't all sweetness & light.

Residential solar as it's currently marketed and sold, in the U.S. anyway, is not usually the most cost effective choice of ways to reduce a residential electric bill, pretty much independent and regardless of people's ignorance of the subject.

[billvon]

How much the value of a piece of property changes by adding solar as you describe it can be treated in any number of ways. One is to consider the change in value, positive or negative as "salvage value" at the end of the analysis. The rest of the financial analysis stays pretty much the same.

From a recent Forbes article discussing home prices in our area (San Diego) -
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For the average installation, the authors found that solar panels added a $20,194 premium to the sales price of the house based on repeat sales data (houses were in the mid-$500,000 range). Solar is really expensive to install—the average total system cost is $35,967, but the effective price to homeowners with subsidies including the federal tax credit is $20,892. Thus, homeowners appear to recover approximately 97% of their investment costs – in addition to the savings associated with reduced energy bills.

By contrast, a luxury kitchen remodel brings a 60% payback, according to Hanley Wood’s 2010-2011 Cost v. Value report. A new steel front door brings a 102% payback. For the Hanley Wood report, click here. Of course it depends on your personality as to whether you get more enjoyment out of ushering guests through a steel door, showing off new granite countertops, or leading a tour of the mechanical guts of a photovoltaic system.
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