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.
How to Analyze a Real Estate Deal
Deal analysis is one of the best ways to learn real estate investing and it comes down to fundamental comfort in estimating expenses, rents, and cash flow. This guide will give you the knowledge you need to begin analyzing properties with confidence.
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.