There seems to be a lot of misunderstanding about solar and how to evaluate if it is economical for you. In this article, I seek to clarify how to make this decision.
It Really Does Vary
It is cliche on finance blogs to say that everyone’s situation is different. In this case, it really is. The main variables that vary from person to person are:
- Location and roof orientation – Does your roof have an unobstructed view of the sun at a good angle? How is the weather in your area?
- Local promotions – Are you eligible for any tax benefits or utility company promotions?
- Net metering – Is net metering available in your area? At favorable rates?
- Miscellaneous expenses – Will you need to upgrade your electrical panel, remove or trim a shade tree, etc.?
The good news is that any competent solar installer in your area will know about all of this. All of these considerations should be clearly noted in bids you get for an install. The simple act of getting multiple bids should flesh all of this out. Of course, you can also do your own research to verify the facts.
How to Properly Measure ROI
People get confused and ask questions like “What are your electric bills?” While a low or negative electric bill is novel, this is not really the appropriate way to evaluate solar ROI.
The proper way to evaluate ROI of solar is to take the estimated production of electricity per year, multiply that by a benchmark cost of electricity in your area and divide that value by your out of pocket cost. These values should be clearly given to you on bids from solar installers.
Simple and real world example: A $10,000 out of pocket system may produce an average of 10,256 kWh of electricity per year. If the benchmark cost of electricity in your market is $0.117 per kWh, this comes to $1,200 of electricity per year (10,256 x 0.117 = $1200) or $100 per month.
At $1,200 per year for a $10,000 investment, that comes to a 12% return (1,200 / 10,000). This should also be considered a low-risk return. Generally speaking, solar panels and associated equipment are attached to your house and are covered under homeowner’s insurance at no additional cost. This is like having an air conditioning unit. If they get damaged, a normal insurance claim will cover the repair. Likewise, a 25-year warranty is typical in the solar industry, and in general, solar panels are stronger than roofs. If your panels are damaged, you likely have to replace your entire roof anyway.
On this basis alone, a low risk 12% return makes solar a no-brainer: You can’t get that in the stock market or bond market. This is how the numbers worked out for us (our real world results are more like 14% two years in a row now). It should be noted this 12% return is tax-free: Your roof is not going to send you a 1099-INT at tax time!
It should be noted this 12% return is not a compounding return. Over the course of 25 years, the output of solar is typically expected to drop by about 20% linearly. So if you want to make it more complicated, you can factor that in. In today’s dollars, that $1,200 would drop to $960 in 25 years assuming the cost of electricity is constant. So the return would drop from 12% initially to 9.6% in year 25 – long after the system has paid for itself. Still amazing.
Get bids from multiple installers. Figure out what size system you want and have them all rebid based on the same size and similar equipment so you get comparable estimates. Calculate your expected return by dividing the value of the output by your out of pocket cost of the system. If it comes to over 7%, it’s probably a good buy. If it comes to over 10%, that’s what I would call a no-brainer.
But Wait, There’s More
Not only do you get the cash flow benefit in the form of lower bills, you are increasing the value of your house. Imagine someone is going to buy your house. If the utility bills are $100 per month less, they can get a mortgage that costs $100 per month more to break even. In the real world, valuation doesn’t work so precisely, but utility expenses are very relevant and solar does increase the value of your house. In this regard, the solar may almost seem free or significantly discounted, further increasing your ROI.
You aren’t spending $10,000 only to have it vanish. You are adding a $10,000 asset to your house. A buyer may value that at $5,000 or $15,000 (like a kitchen remodel) compared to an identical house without solar, but they probably won’t think your house is worth less due to the solar (unless they don’t understand solar – maybe include a flyer about it in your open house). If you spend $10,000 to install solar, and it increases the value of your home by $5,000, your ROI is now more like $1,200 / $5,000 = 24%, because when you sell your house you will get $5,000 more for it.
But what if you finance it? Doesn’t that reduce the ROI?
If you are paying interest on a loan to finance your solar installation, it does reduce your return based on the terms of the loan. But this is another area people get tripped up.
Let’s say your loan is going to be $0 down and $100 per month at 3% interest for 115 months (9.58 years – trying to force this payment to be $100/month for simplicity).
Now you might think “Oh no! That’s the same cash flow, so there is no ROI?”. Not quite.
Go plug the loan terms into your favorite amortization calculator and look at the principal payments. Keeping with our same example, you would pay $287 of interest in the first year and pay down the loan by $914 of principal. This changes the ROI to $914 / $10,000 = 9.14%. Still pretty good.
When you pay $100 to the electric company, that money is gone – similar to rent. When you pay $100 to your solar loan payment, over $75 of that is paying off the loan and less than $25 of that is gone forever as interest paid to the bank. Given that the solar on your roof is an asset that increases the value of your home, your $100 per month is now increasing your net worth instead of vanishing into the utility company’s coffers.
We personally went for a $0 down loan at 2.99% so we could pull the trigger immediately on the solar install. We produced $20-50 worth of electricity more per month than the loan payment. We chose to pay it off a year later as we went on a debt purge binge.
There are many ways to finance solar. But, like buying a car, you do have to watch out. During our bid process, we narrowed in on two contractors. One contractor with the best price had poor financing options. It was something in the neighborhood of 5% but there was also a big “financing charge” to create the loan at some random bank. The next best bid contractor was partnered with www.svcfin.com (not a sponsor) and GE finance (not a sponsor). We did a 0% interest no payment loan for 12 months through GE finance in the amount of our expected tax credit (you get a 30% tax credit for solar installs) and a 2.99% 12-year loan for the balance. When we got our tax refund, we paid off the 0% 12-month loan. We got the contractor with the best financing to price match the lower bid and pulled the trigger.
As with any loan #s, interest rates change, your credit score is a factor, etc. Ask your installers about financing options. You could also use a HELOC,
which would make your interest tax deductible (update: no longer true) and spare you the trouble of applying for another loan.
Don’t lease solar.
Batteries vs. Net Metering
If net metering is available in your area at a good rate, batteries do not make sense economically or environmentally. If you get a full credit for net metering there is absolutely no financial reason to have a battery. If you care about the environment and net metering is available, there is no reason to have a battery.
When you net meter, your surplus electricity throughout the day immediately powers your neighbors without the loss associated with cycling through a battery. This puts your surplus electricity to the best possible use. To the power companies, it appears that your neighborhood is drawing less electricity, so they produce less (to some extent) to offset that reduced demand.
The only reason to use batteries is if net metering is not available in your area or if you need to go off grid or need backup power and don’t want to use a generator. This adds significant cost to your installation and will reduce ROI compared to net metering and probably end up costing more power kWh than just buying from the grid.