By now virtually everyone knows about the existence of solar power. In the middle of Africa where power grids don’t exist, night time lighting is had via solar power.
In many countries there are incentives to help cover the cost of acquiring solar power. In the US, you will receive a 30% tax credit on the entire purchase price including any tree removal or other costs directly associated with installing solar power. This basically means that anyone who pays taxes can purchase a solar power system for 70% of the retail price.
Businesses can take an additional ~20% off that price using tax deductions for the accelerated (5 year) depreciation of the solar power system asset. For a solar power company this short term makes good sense. There is no guarantee that unexpected circumstances won’t vaporize the solar company’s asset on the home owners house.
For any other company that just wants solar power for themselves, the life of the system is more than 25 years. So this accelerated depreciation works out as an additional discount off of the purchase price. The business that purchases a solar power system lands a whopping 50% discount off of retail.
Then they reap a zero dollar power bill every year thereafter. This amounts to a competitive advantage, especially if they are in manufacturing of products that use a lot of electricity. Gas stations have low margins and high lighting electricity bills. Solar helps them increase their profit margins.
OK, so what? It still takes 3 to 7 to 11 years for various people to recover their investment, right? And if you need to risk your cash for that long a period of time, then all of the incentives make sense because it seems extremely risky to make the investment in the first place, right?
If you, like the majority of people in the US, believe those statements, then you have missed the greatest value solar power systems yield their owners. The energy solar power systems produce is normally their second greatest Return on Investment.
I assume you read my earlier post and are planning to purchase your system and will not be tricked into signing a Power Purchase Agreement (PPA). But do you also know that a solar power system will yield it’s purchaser the greatest percentage rate Return on Investment in the first year after purchase?
Few people do. The typical solar power system (I can’t bring myself to say, “solar system” as that’s the thing the earth zips around within) sales pitch goes something like this: “Hey, Ms Homeowner, if you purchase this $30,000 solar power system, the Fed will give you $9,000 off and the money you save on electricity will have paid for your system in about 10 years.”
In contrast, I am explaining to you here, that you profit the first day your power system is turned on. Here’s why.
Suppose you had a 2,000 square foot home, and then you added a 1,000 square foot addition, would you expect to sell your home for the same price it would command when it was only 2,000 square feet in size? The home is now a 3,000 square foot home. There is no way anyone would offer a 3,000 square foot home for the same price they would have asked if it was only 2,000 square feet. If the original home was $200,000, the new asking price would be around $300,000.
The same goes for the addition of a solar power system, only more so. When you add a solar power system, your property value goes up. And it typically goes up by more than the cost of the power system itself. Home buyers preferentially purchase, and pay a premium for, solar homes.
Today the PG&E territory is just now reaching 5% of its capacity in solar installations. If people really understood the value, this figure would be more like 50% today. Let’s use some common figures to understand what’s going on and why it’s being missed.
Let’s assume a common solar power system cost of $30,000 (7.5kW). The 30% tax credit reduces this cost to $21,000. The solar power it produces would amount to around $2,100 per year in California (PG&E territory).
You can calculate the value of the energy a solar power system will produce over it’s lifetime at a website called PV Value.
What this site does is to calculate the future value of energy your system is going to produce. Then, it discounts that future energy value using historic inflation values. In the end, it gives you a Present Value for Future Energy Production.
In other words, if I hand you $1,000 today, it is worth $1,000. If I promise to hand you $1,000 ten years from now, it is worth around $500 to $740 today. Future money is worth (today) less.
To determine this figure, you need to make guesses as about inflation. I simply assumed a 3% inflation rate to get that value. And you need to assign a risk that you won’t receive the payment.
The point is, income years from today is worth less in today’s dollars, than is income earned today. The study of how this all works is the essence of business finance.
The PV Value web site does all this for you. That said, there are values you can enter that alter the prediction so understanding how this all works will improve your estimate of your solar power system’s Discounted Present Value of Future Energy Generation.
For the $30,000 solar power system above, we can calculate the energy it will produce and what the value is likely to be. This includes things like the percentage rate the utility rates increase each year. Using numbers I consider as accurate as possible, the 7.5kW power system will produce energy with a Net Present Value of around $55,000 in the PG&E / California market space.
So one way to think about acquiring solar power is that you are going to spend a net of $21,000 today and you are going to benefit by $55,000 (in today’s dollar equivalent) over a 25 year period in the form of future energy savings.
This is great if I’m going to stay in the home for 25 years. But few people fit that category. Most homes are sold within about 10 years and many people have a 2 to 5 year time horizon. Over 5 years, I won’t break even, therefore, solar doesn’t make sense for me………is the thought many people have.
This is how most people think about the value proposition, but this is the smaller half of the benefit. This value estimate entirely ignores the increase in property value. Virtually every solar sales person will let you know how many years it will take you to recover your investment. They are communicating to you, the above value analysis.
If you hear a solar sales person tell you how many years it will take for you to recover your investment, you know that you are listening to someone who doesn’t really understand what’s going on.
The property value typically increases by more than the cost of the system. And I find that it typically increases by less than the PV Value estimate. For the example above, My first guess would be that the property value would increase on day 1, by around $42,000. This is 140% of the Retail cost and around 75% of the value of future energy production, and about 200% of the net cost for solar a home owner pays, and roughly 300% of the net cost a business owner would pay.
I then check the value of the property. Typically, the increase in property value will be less than 15% of the property value prior to adding solar.
Let’s pretend we are dealing with a $200,000 property.
For this system, the property value should increase by between $30,000 (solar purchase price) and $55,000 (energy value estimate). In other words, if I assume $42,000 is the property value increase realized, then the owner doubled their equity on day 1.
I feel one should also verify that the solar power system isn’t too large for the property. I personally use 15% as my upper limit for property value increase based on experience. In this case, the original $200,000 property value * 15% = $30,000. So I would also consider $30,000 as a different maximum value for a different reason.
Typically I use double the net system cost as the property value increase. This would be the $42,000 figure. Then I also check whether 15% of the property value is lower or higher. In this case it is lower, so, I would reduce the expected property value increase to be $30,000. If the home value was $500,000, then 15% would be $75,000 and I would leave the $42,000 figure alone.
Basically, the higher value the property, the higher the solar power system value can be.
For the lower priced home, people typically aren’t going to spend a huge amount on electricity, and so they typically aren’t going to value a huge solar power system to the full extent it would be worth on a higher dollar home.
Keep in mind appraisers and real estate agents do not understand this, so you need to provide these figures when you sell.
If you use a loan instrument such as PACE (Property Assessed Clean Energy), then you are actually zero dollars (cash flow) out of pocket, and your equity will have increased by the same $21,000 as someone who paid cash for their system. The difference is that for the PACE property, the value went up by $42,000 minus the net loan amount of $21,000 (I assume you pay down on the note using the Tax Credit when it arrives). When paying cash, you increased in value the same $42,000, and you reduced your liquid cash equity for a net gain of $21,000.
Except for the loan origination fee and interest costs each year, loans can be a great tool to get into solar without disrupting your cash savings.
Whether you take out a loan or pay cash, you profit by $21,000 on day 1. If you take out a loan, you of course pay interest on that loan. But typically, the loan payments are below the payments you were already making to pay for electricity.
A good way to think about this is that you are paying rent on electricity if you don’t have a solar power system to generate your own electricity. If you own your system, then you are making mortgage payments on your solar equity asset.
Notice something very interesting here. Your payments are going to pay off on an asset that increased your home value. They are no longer going to pay for electricity. From the first day your system went operational, you get electricity for free, period. But you do still need to pay for the home improvement that increased your property value and resulted in, free electricity.
If you signed up for a Power Purchase Agreement and didn’t read my previous post, then you are paying your solar company rent for the electricity they produce.
Do you rent a car to drive to town every day? Probably not. We rent things we need to use once in a while. We purchase things we need to use every day because owning is typically the lower cost path in the long run.
Why then would you rent electricity? While it is true that the vast majority of people still rent electricity, this is just herd mentality and the value of solar hasn’t quite sunk in just yet.
In defense of people who don’t own solar yet, the value got better in an unusually short period of time, and most people are just now realizing that maybe they ought to look into it. What’s more, there are so many companies out there, how do you know what to ask for? Every solar sales person tells you a different thing.
Well, read my articles before you purchase is all I can say. Otherwise, have fun swimming with the sharks.
Let’s get back to our example.
Beyond the immediate profit from increased property value, you also win every year by having electricity you no longer pay for. Even if you have a loan to pay down, you are paying for the equity asset, not the electricity.
The electricity is free as a byproduct of improving your home so that it produces it’s own electrical power. The $2,100 per year the above system will generate is additional profit and not the slow pay back most sales people and most property owners think it is.
The profit happened on the first day of operation when the property value increased by about double the net cost of the solar power system.
You now understand well enough for me to introduce a far better way of thinking about solar. Acquiring a solar power system is like purchasing a Bond.
The maturity date of the bond is the date you sell your property (home or business). The cost of the bond is today, 70% of the retail cost of the solar power system. In two years, the cost of the bond will be 100% of the purchase price. The interest earned each year during the life of the bond is about 10% annually. …..we invested above, $21,000 into the system and it saved us about $2,100 per year in power costs.
Finally, the value of the bond at maturity is $42,000. It doesn’t matter if you sell this year, next year, or 25 years from now, the value of the solar power system will (paradoxically perhaps) $42,000 in today’s dollars. This is because the power system will never die. One module here, an inverter there, and so on will need replacing decades down the road. But the entire system will never die, ever.
No one (ok, there will be some strange reason someone will do this) will ever go back to paying the utility for electricity once they have free electricity. Replacement parts will always cost less than utility power.
I’ve watched a number of the shows where people flip homes. What I haven’t seen are any of those people adding solar onto the homes they flip to bump them into a completely different category. Soon they will be doing this and about the time it becomes well known that this profit potential exists, the 30% Federal Tax credit will disappear because it is already, no longer needed.
Contrary to what the vast majority of people think, the greatest profit is had by those who install solar and sell their homes within a year or two. The lion’s share of the profit is in equity, not energy savings. This turns the incorrect idea that it takes ten years to recover the investment upside down.
Try this. Go to a real estate web site that allows you to perform searches on homes for sale in your area. Then, adjust the area until you see about 100 homes for sale. Then, keeping the area of the search fixed, add the search term “solar” as a specifier to reduce the number of homes listed. Typically in California, this reduced search will have around 5 to 7 homes in it or around 5% to 7% of the original number.
Now, if someone is searching for homes in an area, and they happen to wonder about solar homes, they will perform this search. And your home will not have very many others that are both like yours, and, have solar. Thus, they will visit / consider the 5 or 7 solar homes before they wade through the hundred other homes in the listings.
This is in part, why solar homes sell faster than homes without solar, and it is why solar homes demand a premium price and sell faster.
The incentives are going to run out very soon because the economics already favor going solar without them. So, get your solar power system as fast as you can.
In PG&E territory, the limit for solar connections before the end of Net Energy Metering terms 1.0 is going to take place around November 15th of this year, 2016. It’s probably already too late to order a solar power system and get in before the change, but you might just make it if you do so this coming week.
We are rushing to build out a couple final power systems before the change takes place.
If you want to sell your home, the best way to increase your profit is to install solar first, then sell the home second. And to realize this profit, it is important to set on the counter, a description of why the solar makes your home worth more.
I recommend including a pdf print out from the PV Value web site. Copies of your utility bills showing your bills are essentially zero. By just telling people your power bills are zero, your home perceived value increases. If your home shines over the other solar homes, then I would also include a print out of nearby solar homes. But if there’s tough competition, maybe not.
Hope this helped. And the next time you write that check to the utility, remember, every penny is being flushed down the drain and could instead be deposited into your home’s equity. If you use your utility payments to pay for a solar power system, you would own it within about 5 years time, though this depends on a lot of parameters, so, 3 to 11 years is a typical range. The larger the power system the faster the pay off.
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