A financial model for residential solar power

After years of thinking about it, I’ve decided to have solar panels installed on my house.

I’m talking to three local solar power companies. In a future post, I’ll share the winning bid’s numbers. For now, I’ll share why I think installing residential photovoltaics is a financial win.

This carries a bucketload of Caveat Emptors!

• I live in Seattle. Photovoltaic economics are specific to location, orientation to the sun’s path in the sky, roof geometries, and shading.
• While the Pacific Northwest typically doesn’t have stunning solar economics, so “location” isn’t great, my house is A+ in the other three attributes.
• I’m not an electrician, electrical engineer, solar product professional, or financial analyst.
• I consider utility bill increases and solar panel degradation over time. I don’t consider the time value of money.
• I know my strengths so I’m considering only professionally-installed systems. The economics will be better if you do it yourself and know what you’re doing.
• This is an, “evaluate the economics from different perspectives,” model. It’s not a, “plug numbers into these equations and read the result,” model.

BTW, /r/solar is a great source of information about residential solar.

My simple model

This uses actual numbers from one of the bids I’ve received.

The red line is the purchase price of the photovoltaic system, net of the 26% Federal tax credit. It assumes I’ll use all of the tax credit. (I definitely will.) It assumes the system is purchased this year. (The tax credit starts decreasing in 2023.) It assumes I spend money on repairs starting in year 15. (Companies provide 10- to 25- year warranties on parts and/or labor, and one firm provides a minimum kWh guarantee.)

NB. You could instead model this as a $35,770 expense with an extra $9,300 cash income in the first year. Financial types break into fisticuffs over this. I chose to represent the purchase price as net of the Federal tax rebate.

The green solid line is the cumulative money saved on our electric bill. A bunch of values go into this.

• We spent $2,070 on electricity in the past year. (This is a real number.)
• We used 16,259 kWh of electricity in the past year. (Real number.)
• In its first year, the photovoltaic system will generate 12.15kW instantaneously and 10,209 kWh/year. (Estimates from the bid.)
• This covers 63% of our annual energy use, saving us $1,300 in the first year. (Estimate.)
• The cost of electricity increases by 4.5% per year. (Estimate based on the past 10 years.)
• The solar panels degrade a bit each year. (I don’t remember the numbers. Panel manufacturers publish degradation curves for their panels.)

Cash in and cash out

You can evaluate the red and solid green lines in a couple of ways.

Simple break-even

The simplest is, When do you recoup all of the money spent on the system? Anything after that is pure profit.

For this system, the break-even is projected at 15.2 years.

The homeowner’s guideline: If a home improvement returns all of your costs in 10 years, do it. If it won’t return all of your costs in 20 years, don’t do it. (Don’t do it for financial reasons, but you might justify it on aesthetic, personal enjoyment, safety, etc. grounds.) I don’t recall when I first heard this but it’s the law. 🙂

A 15-year break-even is in the gray zone. It’s not financially great nor financially stupid.

But there’s more to break-even than meets the eye.

Say you’re considering two photovoltaic systems, systems A and B. They use different panels that produce roughly the same energy when initially installed, but system A costs less because its panels are less expensive.

System A breaks even at 14 years while system B breaks even at 15 years. System A is the better choice, right?

Maybe, maybe not. Solar panels degrade over time. Maybe system A’s panels have a steeper degradation curve than system B’s panels. At 18 years, system A’s panels will produce 88% of their initial output while system B’s panels will produce 96%.

The system with the lower break-even may cumulatively cost more because it produces less energy over a longer time horizon.

Return on Investment (ROI)

Another way is to calculate ROI. If you put $26.5K into a solar power system and it pays you $1,300 annually, that’s a 5% interest rate. Right?

Yes and no. An investment’s principal is returned to you at some point. There are indications (see the next section) that photovoltaics increase a home’s value but the jury is still out on the magnitude of the increase. Regardless, it’s not guaranteed.

If solar power increases your home’s value when you sell by at least as much as you spent on it, then you can treat solar power like an investment with an ROI.

And note: it’s tax-free ROI. It’s a very safe, guaranteed, tax-free return.

There’s a wrinkle…

Solar power is an illiquid investment. It’s so illiquid that we can be cheeky and call it a solid investment. You can’t sell it to someone else!

There’s another wrinkle…

The green line curves upwards because the savings accelerates annually. Why? Although the solar panels’ output degrades over time, they degrade less quickly than the cost per kWh is projected to increase. The panels generate fewer kWh over the years but those kWh are worth more.

So, this starts at a 5% annual return and grows to a 10% annual return in year 25.

If you recoup all of the money spent on solar when you sell your house, residential solar is akin to a conservative leg of an investment portfolio. The return is guaranteed and is very low-risk. You will save energy and therefore money each year.

Resale value

Now let’s talk about the investment “principal.” Will you recoup your investment when you sell your house?

Studies say solar power increases resale value by at least as much as the cost of the solar installation. But they vary in quality and conclusions.

Here are four.

Resale increases by $20 for every $1 saved

A 1983 study concluded that home value increases about $20 for every dollar saved on annual energy costs. This is the green dotted line.

This sounds great, but a 2002 paper, “Housing Market Capitalization of Energy Efficiency Revisited”, concluded pretty clearly that it (and other papers) didn’t have sufficient data.

[…] The empirical studies reviewed in this paper suggest that energy efficiency improvements in housing are capitalized to some degree. However, the weaknesses and limitations of the studies reviewed make it impossible to draw reliable conclusions about the magnitude of that capitalization in typical market environments. 

Housing Market Capitalization of Energy Efficiency Revisited

A study of energy efficiency improvements

“Evidence of rational market valuations for home energy efficiency,” published in 1998, did statistical analyses of home energy improvements on tens of thousands of homes. This was a large sample set but it included many kinds of improvements and not only solar panels. While solar panels are obviously an efficiency improvement, it’s possible their effect on resale value is different than, say, attic insulation.

The net increase seen was 4% to 10%, or $10 to $25 for every $1 reduction in annual fuel bills. Wow!

A more recent study says 3% to 4% increase

A 2011 study by the National Bureau of Economic Research estimated that solar power increased a home’s value by 3% to 4%.

It’s easy to poke holes in this study.

• They looked only at homes in the San Diego area.
• It’s not a longitudinal study.
• It doesn’t account for solar capacity. You’d expect a large system to increase a house’s value more than a small system.

So, flawed but encouraging.

A study across eight states and 15 years

This is the best one I’m aware of. In 2015, a study by the Lawrence Berkeley National Laboratory concluded that a residential solar system increased a home’s value by $4 per Watt. This is the green dashed line.

This study is based on 15 years of data across eight states. And it relates the home value increase to the solar systems’ output, so system power capacity and panel degradation are factored in.

This study says that my $26K (net of Federal tax credit) solar power system increases my house’s resale value on day one by $49K. Twenty-five years from now (after I’m long gone ) the resale value will be increased by $38K.

Conclusion

There’ll always be more and better data on this question. I’m sufficiently encouraged by the trend of studies’ conclusions that the numbers are good enough for me. Because I can justify the expense based on break-even or ROI or resale value.

Solar power passes my threshold today but these studies are years old. What took me so long? It was…

• the studies, and
• the presence of local high-quality installers, and
• my personal cash flow, and
• a critical mass of online community and available information, and
• moving into a house with a solar-friendly roof and orientation, and
• improvements in the aesthetics of residential solar power, and
• getting other pursuits out of the way so this rose to the top of my stack.