One of the most common questions I get asked by real estate investors is how do you actually measure the value of going green? Energy-efficiency is nice in theory but if you can’t get an increase in your property’s value then why spend the money? In addition, most appraisers have little clue how to measure the value of energy-efficiency upgrades. There aren’t any national standards to go follow and very little data to reference.
Luckily for all of us there are a few formulas, originally presented by Energy Star that you can use to compute the value of energy-efficient upgrades. In this post we’ll take a look at a few of the formulas and I’ll present a checklist for you to use to make the case to boost your properties value with an appraiser, buyer, investor, whoever.
Green Formulas:
For purposes of example let’s assume the following:
The cost to make 123 Happy Street [Trivia question: What movie?] a high-performance green home = $5,000
Annual savings in energy costs = $1,200
Capitalization rate = 7%
1. Return on Investment (ROI):
The return is the annual savings in energy costs.
The investment is the cost of the project.
In our example, the equation would be:
$1,200 / $5,000 = .24 = 24% = ROI
2. Estimated Asset Value Increase:
ESTIMATED increase in asset value can be computed as follows:
Annual savings in energy costs / Capitalization rate
In our example, the equation would be:
$1,200 / .07 = $17,143 = Estimated increase in asset value
Currently this is the best formula to use with an appraiser. Most appraisers I’ve worked with use this formula to quantify the value of the energy efficiency measures my clients have made. It has definitely helped me (and I would recommend) walking your appraiser through the formula to make sure they understand it.
3. Payback is calculated by:
The payback period is the amount of time it takes to recover the amount invested and is computed as follows:
Project cost / Annual savings in energy cost
In our example, the equation would be: $5000 / $1,200 = 4 years, 2 months = Payback period
If the answer included decimals, you would have to convert the decimals (which are on a base of 10) to months (which are on a base of 12). For our example, the equation becomes:
$5000 / $1,200 = 4.166. This would be 4 years and 1.6/10 of a year. Then .166 x 12 months = 1.992, which is approx. 2 months. Therefore, the payback period is 4 years, 2 months. Not bad for a guy who got a C in Algebra in 9th grade.
Once you have these formulas down it’s time to make the case with the appraiser as to the increased value you’ve created. Unlike the old days, appraisers are now largely assigned by the buyers bank. Since you probably won’t know the appraiser it’s critical that you give them ALL of the info below:
- Energy Audit report (if completed).
- List of all energy-efficient measures completed (wall insulation added, HVAC system optimized, etc.).
- List of energy-efficient materials/equipment installed (low-flow shower-heads, CFL lighting, weatherstripping, etc.).
- Projected annual utility expense savings based on historical data (homes past 12 months utility bills or comparable home utility bills).
- Projected asset value increase amount according to the formula above.
In my experience, appraisers are very open to giving you an increased value on your property as long as you give them the information listed above. They know that ‘green’ adds value, they just don’t know how much. Potential investors and buyers also tend to believe ‘green’ adds value but like appraisers, they just don’t know how to quantify it. By using these formulas and checklist you should be in a better position to talk about the value of your property.
INTERESTING GREEN FACT:
LED lights save energy not only because they use 90% less than regular light-bulbs but because they run cooler. Incandescent lights run hotter and make your AC work harder to cool the room they’re in. LED run cool so your AC doesn’t need to work as hard.
Article Author: Jim SimcoeJim has written 23 articles for us.
Visit Jim's Website: http://www.jimsimcoe.com
I help real estate investors increase profits and property values through a variety of green strategies. I help clients find hidden rebates, tax incentives and credits to maximize returns on any property. www.JimSimcoe.com
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Jim, very useful post. I was not aware that this is the formula most knowledgeable appraisers use in determining the ‘green’ (no pun intended). It’d definitely be a good practice to walk/talk with appraisers to make sure they have a better understanding of how to compute that accurately.
Hi Alex,
Thanks for the comment. Most appraisers don’t know how to quantify ‘green’ so walking with them is definitely a good idea. it’s good to use these formulas with potential buyers as well.
Thanks..Jim
.-= Jim Simcoe´s last blog ..Conscious Capitalism speech =-.
Jim – I’ve debated this at length with appraiser members of the ICAAF and elsewhere. I don’t believe you haven’t factored in the initial cash flow in your cash flow. The return of $1,200/year on a $5,000 investment is 24% annually, but to calculate NPV the initial capital outlay of $5,expense (cash flow period “0″) must be included. Think a series of cash flows inputted into a HP12c. The 1st cash flow is Each successive cash flow is Now, those cash flows won’t continue in perpetuity. PV cells lose efficacy over their life span; maintenance, cleaning, upkeep expenses should be considered as well. Will a subsequent buyer pay a premium for the house with 10 year-old PV cells versus brand new? Likely not.
For example, assume 10 annual cash flows at $1,200 per period with a $5,000 initial capital outlaw, 2% “safe rate” (alternative investment rate of return), minimal reversion due to life expectancy: NPV = $5,779. Assuming 20 annual cash flows: NPV = $14,621.
The 2nd sentence should read “I don’t believe you’ve factored in the initial cash flow of in the overall series of cash flows. (thank you)
Thanks for comments Charles. As a general rule I almost never recommend PV on residential investments as rarely pencil out. happy to discuss more with you offline, email me if you want as I am not sure I understand your logic in the 1st comment. Thanks..
.-= Jim Simcoe´s last blog ..Conscious Capitalism speech =-.
Jim – thanks. Somehow my post got butchered up a bit. Will proof things before posting next time
Basically, take 10 years of cash flows at $1,200 per year. Cash flow “zero” (before the 1st payment of $1,200) is
So, your cash flow schedule would appear as follows:
CF0 =
CF1 = $1,200
CF2 = $1,200
.
.
.
CF10 = $1,200
Reversion = 0 (for this argument)
Assuming 0% interest (discount rate), the NPV of the series of cash flows is $7,000. NPV at 2% = $5,779. NPV at 4% = $4,733.
I think the ideal way to go about this would be to estimate the life expectancy of the PV cells and use that number as the total number of cash flows. It’s safe to assume the reversion (instrinsic value) at the end of their physical life woud likely be close to zero. So a 20-year life expectancy would give you one cash flow of and 19 cash flows at $1,200. Choose a reasonable rate and you can calculate the NPV of the investment.