To all the posters sitting on the sideline and reading this thread, if any are struggling with the concept of "income" vs. "savings", here is a basic economic principle which I think all of us are familiar with:
A penny saved is a penny earned (my emphasis).
Most of the marketing for PV (or any energy cost-savings/efficiency devices) focuses on the initial cost of the system and utility savings over the life of the system. In those presentations, tax credits and the potential for re-selling the excess energy back to the utility company may or may not be a factor. The goal is to show the system will pay itself return a positive cash flow after the payoff point. They obviously want to sell the system.
For residential real estate appraisers valuing a home with an owned PV system, the cost of the system is immaterial; It is a sunk cost. The benefits are the potential (a) savings and (b) resale of excess energy. The risk of earning income in addition to the savings is too uncertain: Denis doesn't consider that in his NPV analysis of the system. Denis does consider the savings. That benefit can be calculated. Further, the assumption that the system will be held for the remainder of its economic life is not part of Denis' analysis either because (IMO) the assumption of the next buyer valuing the system as a benefit may not be the same as today. I previously quoted the average holding period of a home in the West as 13 years; if the system has more than 13 years remaining in its economic life, then those out-year savings are not part of my consideration.
There are three considerations when determining NPV:
A.
How long is the period? I'm using a maximum of 13 years or the remaining economic life.
B.
What is the cash flow that is brought to present? It is the anticipated savings in the utility expenses, annualized. I've adjusted this for a maintenance cost; the maintenance cost figure, BTW, was obtained on my utility's (PG&E) website, which I've adjusted for the holding period.
C.
What is the discount rate to apply? The discount rate for any DCF is always subject to some disagreement. In the article I cited, it uses a discount rate that is equal to the average 30-year mortgage. I see a good argument for this. In real estate analysis, the discount rate is usually assigned to reflect the risk associated with the investment and the discount rate explicitly assigns a risk factor. However, risk is also implicitly considered in the assumptions of holding period, reversion, and the cash flows themselves. In my analysis, I assume no reversionary value to the benefits of the system that are longer than the holding period and no increase in energy costs (and a subsequent increase in the savings or cash flow). While it is possible energy costs could fall below the current rates that is unlikely; every forecast I've seen assumes energy costs to increase. There is an argument that the savings will decrease as the system gets older due to the system losing some of its efficiency. One could calculate that into their analysis (and some calculators do that); I don't- I'm fine with making the assumption that the stable savings considers this loss in efficiency over the holding period.
I said I applied the "safe rate" to the discount. I apply the safe rate because I argue, given the assumptions I've used, reducing the utility expense has no significant risk. However, I am persuaded that an alternative discount rate using the average 30-year mortgage rate may be a better. Why? Because I could argue that I have a choice when valuing this residential PV system: I could buy the house with the system and get the expected savings or I could use that money and buy a more expensive home. Since it is reasonable to assume the typical buyer is going to finance the house, if I am going to buy the house with the PV system, I want to discount that benefit by at least what it would cost me to purchase the more expensive home.
Back to the original problem: how do I analyze the value of a PV system without paired sales to make a conclusion? One way is to calculate the value based on the present value of the savings the system will generate.
For residential appraisers, the significant challenge is trying to consider any feature that doesn't have a match in the market. Even when we are convinced there is value for the feature, we are loath to make "across the board" adjustments because we believe they will be rejected out-of-hand.
Likewise, when a feature that many stakeholders believe should have value in the market isn't considered, this creates real issues for us as well. Most would intuitively think that a home that is less expensive to operate than another (all other things being equal) would have a higher value. It is hard to argue with this logic; our (residential) appraiser problem is providing support for what intuitively makes sense.
That is why I suggest the process I've outlined. It is an acceptable method to translate future benefits to a current value. That is also why I suggest that it be dealt within the reconciliation rather than an across-the-board adjustment. The final application (in the reconciliation rather than on the grid) has its own logic and reasonableness and is (IMO) unassailable if put into a report:
Ideally, if comparables with a similar system were available for a matched pair analysis, they could be used to analyze the contributory value, if any, of the subject's PV system. Such sales were not found. I do consider the reduction in utility costs to be a benefit and I do think a buyer, intuitively, would be inclined to pay more for the lower utility-cost house all other things being equal. One way to evaluate this issue is to discount the utility expense-savings over a holding period to conclude a present value. While a specific buyer may not go through the mathematical calculation, I've concluded a buyer would consider the savings a benefit. In the absence of sales comparables, this analysis is a reasonable method to analyze that benefit. Therefore, I've employed this analysis to establish two factors in my valuation of the subject:
1. The PV system reduces operating costs which create a savings over the holding period.
2. Those savings have a calculated positive present value; a positive present value is a benefit vs. the other homes analyzed in the grid and should be considered in the final valuation analysis.
The system is 10 years old. The total economic life of the system is 20-years and the average holding period for a home is 13-years. Therefore, I am assuming the system will provide a positive benefit for the next 10-years.
The system reduces the utility costs by $150/month. Although rates typically increase, I am assuming no increase in rates. Further, I am assuming that maintenance costs are 10% of the annual savings.
The discount rate reflects the risk of the investment. The forecasts of the amount being saved is fairly conservative; an argument could be made that the safe rate is reasonable. Alternatively, an argument can be made that the rate should at least equal the rate paid for a mortgage since an alternative to paying more for this system is to pay more for an alternative with some other benefit. I find the argument to use the mortgage rate as the discount rate persuasive and have therefore applied it (4.5%, based on a 30-year fixed rate).
From this point, the calculation is mathematical: 10-years of cash flows ($1,620) discounted at a rate of 4.5% equals a present value of $12,818, say $13,000.
The adjusted range of the comparables is $510k to $535k. Comparables #2 and #3 are most similar and adjust to $520k. I then considered the positive benefit of the PV system analysis and have concluded a final value opinion of $530k. This conclusion at the higher-end of the adjusted range explicitly reflects consideration of the benefits of the subject's PV system.
This process works for me. It may not work for others. One could argue the discount rate, holding period, etc., should be different. Any DCF analysis has weaknesses (usually boiling down to the same thing: imprecise data and uncertain forecasts).
"How do I value this PV system when there are no comparables....?" is a common forum question. Here is a process that can be employed.
- The math isn't that difficult. I've simplified it as I think is consistent with a typical residential assignment.
- The process eliminates the need to make an across the board adjustment (although I might make an across-the-board adjustment in some cases; I don't necessarily advocate for others to do that if they are not inclined).
- This process considers the value of the PV system; consideration of the value isn't just an expectation of the stakeholders, it is a requirement of the USPAP.
- If one doesn't think a PV system adds any value, then that is fine as well. Just make that case. But don't state, "I couldn't find any comparables and therefore I am not considering any value to the system." Sales comparables, while the primary method in residential appraising for analyzing values, is not the only method.
- I would always advocate taking a broker/agent survey of such systems and ask them if they think a system that reduces energy expenses would be valued in the market? They may say "yes", "no", or "it depends". The survey can be used in conjunction with this analysis to strengthen the logic and rationale used to determine how the system fits into the valuation of the subject
In the end, the analysis has to be credible, and the conclusions and how they impact the value have to be reasonable. IMO...
Analysis = Credible
Appraiser's Judgment = Reasonable
The analysis gives an indication. The appraiser's judgment determines what, if any consideration, the analysis warrants in the valuation of the subject.
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