By Andy Black
How long will it take for a new solar or wind electric system to pay for itself? That depends on your local climate, utility rates and incentives. In sunny or windy states with expensive electricity, the payback is faster than in calm or cloudy states or where power is relatively cheap.
The most important factors for making solar an attractive investment include high electric rates, financial incentives, net-metering policies and good sunlight (almost all of the continental United States is within plus-or-minus 20 percent of Miami’s sunlight level).
Where net-metering laws exist (43 states plus the District of Columbia and Puerto Rico), solar energy offsets the retail cost of the electricity generated.
In some regions, solar systems are allowed to operate on a time-of-use rate schedule, enabling users to sell back electricity to the utility at peak rates, which can be even more valuable. Time-of-use rates vary in price by time of day (see charts below), with higher rates during times of power shortage (for instance, when air-conditioning loads are high). That’s when the utility must pay more to purchase electricity from generators. These higher electric rate periods often occur in the heat of the day, when solar systems are most productive.
Direct incentives can include tax benefits such as credits or depreciation. The most celebrated recent incentive is the federal tax credit for solar systems that was expanded on Jan. 1, 2009. The credit is for 30 percent of the system cost and can be coupled with state, local and utility incentives. The Database for State Incentives for Renewable Energy lists state and federal incentives around the country for all types of renewable energy and energy efficiency.
Some states have rebates of up to $2.75 per watt (up to 50 percent of system cost), cutting the up-front expense. Others have performance-based incentives (PBI) that pay 5 to 30 cents per kilowatt-hour (kWh) for power produced over three to 10 years. Some also use solar renewable energy credits (SRECs, also called green tags), which are similar to PBIs in that they produce value based on system performance.
SRECs represent the bundle of legal rights to the green part of each kilowatt-hour produced by a solar system. SRECs are valuable to utilities in certain states like New Jersey, Maryland, Pennsylvania and 18 others because those utilities must comply with renewable portfolio standards (RPS), requiring that a certain percentage of electricity sold must be derived from solar sources. New Jersey SRECs have recently been the most valuable, trading in their auction market for as high as 61 cents per kilowatt-hour, thus earning five times the price of the electricity savings they are also producing. SREC values will probably be much more modest going forward.
Feed-in tariffs (FIT) are yet another type of performance-related incentive, but one that foregoes the net-metering benefit. The customer continues to pay the regular electric bill, but gets paid for all electricity fed back to the grid. Gainesville, Fla., has a FIT of 32 cents per kilowatt-hour for 20 years, but it is so popular that the program is currently sold out. Ontario, Canada, also has a FIT program, with payments between 44 and 80 cents (Canadian) per kilowatt-hour for 20 years, depending on system size and mounting type. Georgia, Hawaii, California and Ver-mont also have feed-in tariffs.
Another factor in the economics is escalation in electric rates. Solar and wind are escalation-protected investments because they offset electricity costs at the current prevailing rate. As rates rise, the owner saves even more (see figure below).
Several useful ways to measure the economic value of a generating system are: compound annual rate of return, increase in property resale value, and cash flow if the purchase is financed. In strong economic cases, the annual returns are over 10 percent, the cash flow positive and the increase in resale value greater than system cost.
Compound annual rate of return, or CARR, is another term for interest-rate yield — a metric for comparing one investment to another. For example, a savings account might pay 1 percent interest and the long-term stock market has paid about 8 percent (including dividend reinvestment). In several states, the results for solar can be substantially better than the long-term stock market.
A theoretical increase in property resale value occurs in homes with generating systems because of the reduced utility operating costs. According to a 1998 Appraisal Journal article by Rick Nevin and Gregory Watson, a home’s value should increase $20,000 for every $1,000 reduction in annual operating costs from energy efficiency. The rationale is that the money from the reduction in utility bills can be spent on a larger mortgage with no net change in the monthly cost of ownership. Nevin and Watson calculate that historic mortgage costs have an average after-tax effective rate of about 5 percent. If $1,000 of reduced operating costs is put toward debt service at 5 percent, it can support an additional $20,000 of debt. The borrower (homeowner) pays the bank the amount they saved on the utility bill, so the total monthly cost of home ownership including utility costs is identical.
This increase in resale value was recently demonstrated (April 2011) in an extensive study by Hoen et al. (PDF 838 KB), of almost 2,000 California homes with solar electric systems that have sold over the last 10 years. The study showed that homes garnered $3.90 to $6.40 per watt in increased resale value, which is comparable to new system net cost of installation (after incentives) and also approximately equivalent to between 14 and 22 times the estimated annual bill savings. Due to the high cost of electricity in California, these results can only be used to estimate other California home values; however, it does show that 1,894 real homebuyers did pay substantially more for a home with photovoltaics on it.
Financing the system is important to many buyers. For many homeowners who finance their solar systems using home equity loans, the cash flow will be positive, either immediately or within a few years. The cash-flow calculation compares the estimated savings on the electric bill to the cost of the loan. Monthly loan cost is the principal plus interest payment required to pay off the loan, less any tax savings.
Home equity loans are often excellent sources of funds because the payment terms can be long, the interest rates on real estate-secured loans are relatively low and the interest is usually tax-deductible, so the net monthly payments are often quite low. As stated, in many cases, the net loan payment will be less than the savings the solar system will generate. Click here to see a chart of example cases from around the United States and their returns, cash flows and projected resale values (PDF 35 KB).
Over time, electric rates usually rise, so the savings increase, but the loan cost generally stays relatively constant, so the situation gets better and better for the system owner, even as the savings from the system are paying off the loan. Once the loan is paid off, all the savings go to the owner.
Those who don’t have equity available can explore other options. Two rapidly growing options for homeowners are commercial financial products applied to residential situations. These are solar power purchase agreements (PPA) and solar leases. In both cases, a “third party” (someone other than the consumer or the installer) owns the system placed on a consumer’s roof. The system and its benefits are provided at little or no up-front cost to the homeowner, reducing the homeowner’s investment, risk and need to find financing or cash.
Solar PPAs are agreements where the system owner sells power to the consumer at agreed-upon terms. The sale is for kilowatt-hours (kWh) of energy only, but not the sale of the system. Solar leases are rentals, where the consumer leases a solar system from the owner. In both cases, the parties owning the systems are underwritten by investors who can use the tax benefits and pass along some of those savings in the form of reduced per kilowatt-hour charges or reduced rental charges.
The third-party owners are taking the system ownership and performance risk and the consumer credit risk. They want to be paid for these risks and the use of their money, so typically, the homeowner will end up paying more over the long term with a PPA or solar lease than they would have if they paid cash or took a loan. With third-party ownership, the homeowner does not end up owning the system, but usually has the opportunity (but not the obligation) to purchase it at fair market value (FMV) at the end of the term of the agreement. FMV will be somewhere between what a new system would cost and scrap value. By IRS rules, FMV must be decided at the end of the term and can’t be stated up-front.
Over the long haul, the cheapest way to get a solar system is to pay cash, but that requires cash. The next cheapest way is to take a home equity loan, but that depends on the ability to borrow. The next cheapest after that are the solar leases and PPAs, which eliminate the cash or loan requirements and make solar affordable to anyone with decent credit. The most expensive way to get solar is to do nothing now and wait, because utility rates and bills will rise and incentives will go away.
Consumers should pay careful attention in PPA, lease, loan or cash sales presentations to the expectations of future electric rates or rate of increase in rates. Nationwide, rates have increased about 2 percent annually over 20 years since 1990. There’s good reason to believe rates will rise faster in the future (utilities switching away from cheap coal, carbon emissions costs, replacement of nuclear generation, etc.), but there are also things that may keep rate increases low (shale bed methane may keep gas prices low, which could keep electricity prices down, and eventually wind and solar will become cheaper than other sources, potentially curbing long-term rates). Be cautious of high PPA or lease “escalator” rates (anything over 3 percent). Over time, rapid increases in your obligation to the PPA or lease company could cause your future monthly payment to become larger than the future savings.
It is important to compare the solar investment to other investments on an even basis. For a fair assessment, critical analysis should look at compound annual rate of return, cash flow and resale value. For much more detail on the variables that affect the results, the methods of financial analysis and example results for many states, please see the article here (PDF 2.14 MB).
Solar makes economic sense for many, but only a hard look at the numbers will tell if it makes sense for your property. The reader is encouraged to check it out. Run the numbers, get evaluations and proposals from at least three solar providers, and take them to a CPA. That way the smile on your wallet can be as big as the smile on your face!