Payback Period: Poor Metric or Useful ?
I’m looking for ideas to help build a case that “Payback Period” is poor metric to use when evaluating performance upgrades on a house.
The first thing most contractors and homeowners ask when contemplating any energy related improvement (HVAC upgrade, insulation, air sealing, windows, PV, solar thermal…..) is “What’s the Payback Period.” And invariably if the period is more than 5 or 10 years they won’t go forward.
Here are a few responses I use:
Calculating ‘payback’ based on today’s energy costs doesn’t factor in energy costs 5 or 10 or 20 years from now. They may be twice or more.
Energy performance improvements increase the value of the home even if the owner doesn’t stay until the ‘payback’ point is reached. They’ll recoup the cost of improvement plus some on resale.
When an improvement is financed the equation changes. Monthly costs (loan interest plus utilities) are often lower than before the improvement. Payback period is a moot point.
The owner benefits in ways other than $. Insulation, air sealing, windows, HVAC increase the comfort, IAQ and quietness of the house.
Any other ideas?
How about any ideas in support of Payback Period?
Replies
Depends if the structure is a home or an investment.
The shorter the foreseen ownership, the more important the Payback Time.
SamT
A Pragmatic Classical Liberal, aka Libertarian.
I'm always right!
Except when I'm not.
Somehow all the $$$ figuring never seems to take into account the pleasure of being comfortable.
Being warm in the winter is a hell of a lot easier if you're not worrying about how much that comfort cost.
Joe H
"Being warm in the winter is a hell of a lot easier if you're not worrying about how much that comfort cost."
...... guess that's why my folks kept sending me out to the woodlot.
"There can be no doubt that Socialism is inseparably interwoven with totalitarianism and the abject worship of the state…Socialism is in its essence an attack not only on British enterprise, but upon the right of ordinary men and women to breathe freely without having a harsh, clammy, clumsy tyrannical hand clasped across their mouth and nostrils" -Winston Churchill
Edited 8/20/2009 11:37 am by jc21
So who pays for the upgrades? If you lower your electric bill $50.00 a month but your loan payment goes up $100.00 a month don't you worry more?
I know I spent a bit of a premium building with SIP's and radiant floor heat on my vacation home in NH but I know that I can heat it comfortably and affordably going forward in case I ever decide to move there. I use less than 280 Gals of propane a year to heat 1600 sq ft with a drive under garage and the place is quiet and comfortable. I don't ever plan ever plan to sell it though so that was a major part of the decision process, though I never made an attempt to calculate "payback" time.
a good half my customers only live here from two to seven months, so payback is even less of a consideration. Comfort and reduction in maintainence costs is high on the list.
In a culture where payback is a selling point, I would sell based on estimated expected energy cost, point that out, and pick a figure that makes the investment look good
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>Calculating ‘payback’ based on today’s energy costs doesn’t factor in energy costs 5 or 10 or 20 years from now. They may be twice or more.<
and the costs of those improvements goes up since the percieved and real value is higher. So it will cost them more, even with adjustments for inflation.
The idea of a payback period is at best arbitrary and at worst counter productive..
It's one of the reasons American business is in the trouble it is..
Exactly! So you would you frame an argument to counter someone who wants to use the payback metric?
Just that! Life is a once around thing.. we can either do the very best we can or we accept mediocracy.
Ask them if they want whatever they are given or they strive for the best..
I think you are correct sir.
"Energy performance improvements increase the value of the home even if the owner doesn�t stay until the �payback� point is reached."
Do you have an proof of that?
Many potential buyers won't have the slightest clue.
Have you checked with any realestate agents.
Have you looked at the increase value of improvements published by Remodeler. I think that widow replacement was well less than 100%.
http://www.realtor.org/rmohome_and_design/articles/2008/0812_costvsvalue_2008
It looks like windows are in the 77-79% range.
William the Geezer, the sequel to Billy the Kid - Shoe
I love the Remodeling report. Not sure how accurate it is but nothing else like it.No, I don't have anything other than anecdotal evidence for the increased value of energy improvements. It is likely if Remodeling did a separate survey on a variety of energy improvement scenarios the results would show something in the 60% to 90% increase in value after 1 year like other improvements.But savvy RE agents are promoting the value of energy performance. Unfortunately most don't have a clue ("and over here is the wonderful spacious master bath...") Some area MLS listings now have input lines for HERS Index, Energy Star Home Rating and Green Certification. What's your opinion of 'payback period' as a metric to determine the viability of an energy improvement?
Mike,
Economists and finance professionals frown on using the payback period and would recommend calculating the net present value of the project -- calculate the present value of the after-tax cash flows arising from the project and subtract the initial cost. The result is the amount undertaking the project would increase (decrease) the present value of the household's wealth if the result is positive (negative).
However, surveys of actual business practice show that even large businesses make use of the payback period.
Steve
Edited 8/20/2009 12:56 pm ET by smllr
If a home improvement is indeed an improvement, it should have some tangible benefit, be it comfort or cost savings.
An energy saving improvement payback analysis is important to do. Doing things cost money and if I do improvement A, what will it save and what is the payback should be evaluated-it helps prioritize how you spend your money.
I can easily sell foam insulation on most of my projects because I have physical data that demonstrated in our area, a 3000 sf ranch home payback is three years. Clients jump all over it.
Frankly some improvements do not make sense in my mind. I just looked at a 1920 vintage bungalow. No attic insulation, no wall insulation, bad HVAC, old windows. In my opinion, a limited budget would set the following priorities,
1) attic insulation,
2) wall insulation
3) windows
4) new hvac
I believe this order would hlep the client the most in terms of $$ spent and $$ saved. PV or a new HVAC right off would not help this client in the least.
If rising energy costs are certain, include that in the ROI calculations.
Just some of my thoughts
Bruce
Edited 8/20/2009 12:57 pm by Hiker
Unfortunately, an improvement that "pays for itself" by reducing expenses will not always increase the resale value by enough to justify the outlay.
I agree with the poster recommending net present value, but really, NPV, ROI, "bang for the buck," and payback period are all different ways of saying the same thing.
Higher future costs are a guess on your part, and the rational response to that argument is, "well, if costs go up I'll make the improvement then."
Not really. The NPV takes account of the time value of money by discounting future cash flows, the payback period doesn't.
Maybe payback period as commonly calculated doesn't use a discount rate, but it certainly could, and should. It's not literally the same thing, but basically the same thing. A statement of cost/benefit.
Yes, it is true that "payback" is a poor methodology, because it doesn't capture terminal value. It just gives a very rough shorthand for the cash flow ROI until payback is achieved.That said, everybody uses it to some extent or another, so it is a kind of measure of relative return. Also, trying to get people who are not used to financial math to understand discounted cash flow and ROI is no easy matter -- and getting anybody to agree to a set of future assumptions about energy prices is probably a losing proposition.I think the sales pitch has to be:1) you will still have this thing saving you money for years after "payback"2) Your quality of life will improveCheers!J
At least for the energy improvements that will make for a notably more comfortable house, ask the guy what the payback was when he bought his upscale Beemer vs. the basic Ford he could have bought, or the same on the granite countertops his wife wants.
I used the idea you suggest last night in an audience of real estate agents during a discussion of green building principles. I asked who considers payback period on the new car, kitchen or jewelery. I got puzzled looks and one comment - "I can see all those other things and enjoy them; I don't see or enjoy cellulose in my walls." I brought in the comfort issue as a benefit and the response was "I keep my heat at 74 in winter and AC at 70 in summer and I feel very comfortable. I spend about $3000 a year to heat the house; how much will it cost insulate the walls and attic and how long will it take to get my $ back?"Tough crowd exhibiting common sentiments. Hence my query here.
My idea of a payback period is weeks or months.
Of course will not get gouged by any 'green' promulgators either.
Watch form my fall special:
Pay for your own backhoe in a year by doing a DIY GSHP<G>
I don't have any real definitive answer. But I think a lot of what we take for granted is just someone elses idea of what is real.
Bean counters think they have the last answer on just about everything.
But I say nonsense to a lot of what they say.
It's like statistics used in medicine.
You have such and such chance of getting sick because of this and that.
It's just a guideline. When you are sick how does the % explain you are the unlucky so and so?
It doesn't really.
The same thing goes for improving houses. People are always looking at nice houses like they just appeared out of nowhere.
Nice houses are there because somebody got off their butt and worked hard. They also took a chance that down the line it would pay off. Meanwhile they get to live in the nice house.
So many people live in so-so houses yet spend money on all sorts of junk that wears out or breaks in no time. It's money spent that never appreciates.
But it's hard to convince people that investing in their house is a really good idea if they don't see it and just follow the heard.
I live in a nice neighborhood that is in a great location. But people are just living in them and not fixing them up. Their idea of getting a nice house is to move into one.
But in order to do that they move out of the prime location. Stay in hour house and fix it up. Duh!
Will Rogers
I agree, good answer.
Larry B
I feel that one negative thing for the quality of our housing stock was when people decided to look at a house as an investment that they'd be gone from in 7 years +/-
Remember energy tax credits
The arguments you gave were all good.
Depending on your values, consider whether to mention potential wast of dumping product with a good remaining life
Perhaps: "the quality of life isn't measured in payback periods"
Perhaps ask "what's the payback period on a new car?"
(actually - negative args don't work in selling)
Ask questions: "What other factors (besides "paybeack period") are you concerned with?"
The "argument" will depend on what your qualifying questions of the buyer have revealed.
Sales pitches have to be fluid and adaptive.
What are the buyer's goals? - what aspects bring out their "emotional" responses - not "weeping" but what are their values which don't rely on straight economic analysis?
If a couple -who is/seems to be the decision maker - sales studies indicate often its the woman and salesmen too often try to sell the men.
"Ask not what the world needs. Ask what makes you come alive... then go do it. Because what the world needs is people who have come alive."
Howard Thurman
http://rjw-progressive.blogspot.com/
One of your points is really important and one I never considered:" Negative arguments don't work in selling" So responses like "what was the payback period on your BMW or new kitchen?" may turn people off.
I think return on investment (ROI) is a much better metric, and more palatable.
If a client is contemplating an insulation upgrade that costs $1,500, and it will save $150/year, the annual ROI is around 10%.
Sure, the payback period is 10 years, which seems like it could be a long time. But if I could offer you an investment that could practically guarantee you a 10% ROI (let's assume that my name is not Bernie) I think most would jump at that. The likelihood of energy prices climbing in the future (which increases ROI) and the comfort benefits are just gravy after that.
Jon Blakemore
RappahannockINC.com Fredericksburg, VA
Your point on ROI and how to introduce it is great! I've thought about ROI before but couldn't put my finger on the angle to take. I think you unlocked a powerful sales tool for energy improvements.
I think you have to thank Shelternerd for that one. He said something 6-12 months ago that got me thinking along those lines.
Jon Blakemore RappahannockINC.com Fredericksburg, VA
Do you have anything to add to this discussion?I would think that, having done it many times, your perspective would be beneficial.
Jon Blakemore RappahannockINC.com Fredericksburg, VA
JonThanks for asking. I've been writing about this over at GBA http://www.greenbuildingadvisor.com/blogs/dept/business-advisor/3000-bathtub-its-emotional-thing and http://www.greenbuildingadvisor.com/blogs/dept/business-advisor/how-we-sposed-t-get-paid-fer-green-stuff for the full scoop.In a nutshell I approach payback by asking what number the client wants to use for the cost of gas and electricity in five and ten years and then asking if it's reasonable to look back five and ten years and extrapolate from those numbers. But I just ask the question, I don't answer it, because the real issue is do you want quality or mediocrity? When building a home you have a huge number of choices to make that impact the budget. Some things such as insulation and siding you only get one chance to do it right, others like solar panels and heating equip can get upgraded later but at the cost of some inconvenience and some like decks and landscaping are almost better to leave off until a later date. When selling energy upgrades I think it is useful to compare to that fancy bath tub. There is a feeling you get when you walk into the master bath and your bride is leaning back in that classy tub with a trashy book and a hot cup of tea and all is right with the world that is similar to the feeling you get when the wind is howling and you are leaning back all toasty and warm in your high performance home. Some decisions just make you feel good for years after you move in to the home. Maybe even smug. I love it when the cost of fuel goes up because I know that my customers are smiling about their decision to get the building envelope right. The trick is to sell that smile in the first place, and the leverage is the knowledge that when we hit retirement we'll likely be looking at a fixed income for an unknown amount of time. Planning ahead to minimize those later costs can seem like a better investment than the stock market in many ways especially when it comes with enhanced comfort. Sell the snugness and the smugness? m------------------
"You cannot work hard enough to make up for a sloppy estimate."
Thanks for bumping SN - the guy is a plethora of knowledge in these areas. I took a NAHB 2 day seminar taught by him. It was awesome! I really like his realist approach - if the LEED archi snobs think weighing trash is a good use of resources - then fine let them. ;-) The only disappointment was that the "selling chapter" was at the end and didn't receive the focus I would have liked it to. Or maybe I was just a little overloaded at that point. Who cares how much knowledge we have or how good a building we can build if we can't sell it....
That's good to know that he's not a 13 year old girl living in his parent's basement with a lot of web site talent.I do think realism is critical. I think the ivory tower types will quickly be ousted when the economy picks up and demand equals supply. I think a lot of people are on the green bandwagon because they think "green" will translate to green. Well, I don't think the ivory tower types will be eradicated, but they will certainly not get placed in the front row anymore when their fresh "ideas" are not new and fresh anymore.
Jon Blakemore RappahannockINC.com Fredericksburg, VA
There are some things where payback is a valid thing to push but they tend to be the passive things like insulation and better windows/doors. When you start getting into mechanicals like HVAC and solar PV you also have to factor in maintenance and expected life. I had the motor in my TWE variable speed air handler go out and I was given the choice of $1000 for a new one with the board (supposed to be a deal) or a couple hundred for a relay and a regular motor. The payback would have been longer that I expect to keep the system.
In the case of solar PV we really don't know how long it will last or how many problems we will have with it. Maintenance might kill your savings. Every time they make something cheaper, I suspect it won't last as long.
You're right, relatively short life-span improvements and high maintenance items are harder to justify than static zero-maintenance items like insulation and air sealing. Then things like windows fall somewhere in the middle. Kind of means each improvement needs a different approach to justify.
How about comfort and enjoyment?
Larry B
I've always figured that rising energy costs roughly cancel the "cost of money", so you can figure fairly accurately just based on whether the savings per year (at current prices, and deducting out any maintenance costs) is more than the device cost (at current prices) divided by the expected device lifetime.
It's not real precise, but I tried it with a few known examples and it worked out pretty well.
I started figuring it this way when I noticed that a lot of evaluations weren't assuming rising energy costs, but were figuring in the "cost of money".
>> Energy performance improvements increase the value of the home even if the owner doesn’t stay until the ‘payback’ point is reached. They’ll recoup the cost of improvement plus some on resale. <<
I'm not gonna give you my opinion - but rather a very current story. 2 Months ago DW and I bought a new (to us home) vintage 2005. I was rather delighted when I went up in the attic and saw the radiant barrier sheathing... I was the only one there who even knew (or cared) what a sealed CS was, and that the house had it. I didn't even actually find out that the windows were Low-e until after the purchase. (not code required at the time) The jumper ducts in the ceiling... I didn't even try to find an audience for that one except that I had to explain to the HI why the "return grill" in the hall ceiling didn't have a filter. Obviously none of this stuff was in the MLS RE listing. I'll bet you a $100 that the sellers weren't aware of these things or at the very least didn't see the value in them....
Did we pay more of the house? NO. It is a down economy. Our RE agent beat the sellers down mercilessly. I think "bleeding them dry" was mentioned....
Me - smiling....
Were the sellers the original owners?Your house, while not maybe at the pinnacle of high-performance homes, sounds like it has a lot of high value upgrades (although I shouldn't call them upgrades according to Shelter). Being built in 2005, the builder was probably at or near the forefront.
Jon Blakemore RappahannockINC.com Fredericksburg, VA
Yes - they were the original owners.
Sad thing is the RE said she knew the builder and that he had moved on to building starter homes saying that the other market nich didn't appreciate his product. I talked too my boss about this scenario. His response: "the buyers didn't appreciate my product" is code for "I couldn't make money doing it".... He is a very smart man - incumbent state HBA president.
The realestate agents, bankers and appraisers are a big part of the whole value of green building problem. We've been out to our NC state appraisers group at least three times and have developed and IMPLEMENTED! a model green MLS that has check boxes for energy star, green certified, geo-thermal, sealed crawl, spray foam etc. We've also done a lot of outreach through Branch Bank and Trust such that they are the preferred loan source for most of the green and high performance builders around here. Shoe leather on the ground, face time, what passes for elbow grease in the white collar side of town (bad neighborhood).M------------------
"You cannot work hard enough to make up for a sloppy estimate."
I know about the check boxes in the MLS - (I'm in GHBT) - and I know you all worked really hard to get that stuff in there. In the case of the scenario I related, the check boxes may have been part of the problem... For example when we were selling our previous house it had some energy efficient features similar to the one we bought. I asked the RE agents to include them on the MLS listing but was told that the check boxes didn't accommodate my situation of low-e windows, 18 seer heat pump, extra insulation (R40 attic) etc. and that hardly anyone would know what these things even meant. BTW - I built that house 10 years ago before the ES program for homes was even out (I think) - or at least it was in it's infancy. This time after doing some research, I found we would get a better deal to buy existing than build... We needed to downsize in part because of the local building economy.
As long as we are talking about the check boxes I just looked at the MLS to see exactly what the "check boxes" produce:
Green Building features: SOLHW, TLSWH, GEOTH, SEALS, NLVOC, SRYFI, ENGWP, ESAPP, ESLIT, EPAPL, COMFW, SOLPR, ADVFR, INFIL, RAINC, PLANT, FAVNT, RECYC, RADHF
(may have some type-os in there)
Green Building certifications: ESHOM, GHBTH, HCHBH, LEEDH
You are right though, it is an education thing. Wonder how many of the hundreds (thousands) of the real estate agents in the triangle are know what 1/4 of that first set of acronyms mean... Thing is though that as I think you said in one of your GBA articles the average home buyer could care less if the house has low-e windows, for example.
So, you all got the tools in place, but as you say, now we got to get people to use them.
BTW - I'm more of just the lowly superintendent on site building houses who wants to do the right thing, but must be funded to do so... I know you say that you are not hit hard by this recession, but I respectfully suggest that you are maybe in the 10% or so who are not. And I greatly respect that you have built your niche market and niche clientele. OTOH I'm in with the 90%(?) who are hit, but at least we are still in business... Right now I'm just damn lucky to have a job and won't be doing any meet and greet with the people employed in spin off portions of the new home industry. My nose is to the griindstone.
Personally I'd like to bury a few REs and Appraisers..... ;-) You know - with a trac-hoe... :-)
For example while we were looking at homes we visited a new home development and the on-site agent (?) proudly told us that this was an ES neighborhood. I asked to see an ES chert (I wanted to see a HERS rating) - blank look. She said she didn't know anything about certifications. Then I asked what ES features the home had and was told ES dishwasher some florescent lights and the sealed CS. I went up in the attic to look around and could see no house wrap (a hot button for me) and a batted attic insulation job that looked total cr@p. This was hardly an ES home.... DW told me to chill out when I said the onsite agent was a total DA... :-)
And the thing that makes me throw up is the REs like to present themselves as "house experts".
LBJ took the IRT down to 4th St USA.
As I stood before the gates I realized that I never want to be as certain about anything as were the people who built this place. --Rabbi Sheila Peltz, on her visit to Auschwitz
???
When he got there, what did he see? The youth of America on LSD.
As I stood before the gates I realized that I never want to be as certain about anything as were the people who built this place. --Rabbi Sheila Peltz, on her visit to Auschwitz
OK - I finally got it - and I thought you were referring to the excessive use of acronyms but wasn't sure.... BTW - I didn't make up any of those. I hate it when people make up acronyms.... SN understood the posting though...
But that was part of my point, putting all those acronyms in front of an audience of real estate agents may not work too well. But it is a step in the right direction.
Michael:
I stand corrected. The fields in the MLS show the text - not the acronyms as I thought. For example, looking at one house in MLS I see:
Green Tankless waterheater Spray foam insulation
Green Certs: ENERGY STAR Homes
So, when entering the stuff the RE can either use a dropdown off of which he/she selects the items or just enter the acronyms.
OTHO, on the above example, it looks to me though like the RE left some stuff out... I'll bet $5 that the house has engineered wood products in it, a few florescent lights, a sealed CS and fresh air ventilation, ES appliances - I am a little familiar with this house.
Edited 8/23/2009 8:45 am ET by Matt
Matt
First we make the tool (mostly done) then we train the Realtors to use it (making good progress but still much to do) then we train the appraisers to assign value to the different elements based on a combination of up-front cost and perceived value in the marketplace as well as on return on investment (well along on this), then we train the mortgage loan officers (Got BB&T and Wells Fargo on board so far) to advocate for the improved appraisals to the "un-touchable" bank underwriters who generally are out of state and anonymous (and there is the real log-jam, need to take this up with NAHB national when I'm up there in October). Should be a piece of cake right? ------------------
"You cannot work hard enough to make up for a sloppy estimate."
Sounds like a tough row to hoe...
These days - we are having difficulties getting our "conventional" properties to appraise - especially in the starter home market where these young people often have next to nothing to put down....
Great story. Can I borrow it? I teach a course for agents and brokers on green building so they have a handle on it. Your example is perfect; it illustrates that there are lots of homes where the builder or remodeler took time and effort to take steps beyond the basic code to improve the performance (call it greenness if you want) and it's not until the agent can assess and address those that the seller will benefit. But as you note in your case, the buyer wins sometimes.
Ok - whatever you want to do. I don't think it was a fluke though... There is another house in the neighborhood that is the same as ours, only with a few more upgrades and it is Energy Star certified. And it just sits there with a for sale sign on it - MLS says it has been for sale for 351 days. If you want more specifics, E-mail me.
those are pretty much what i think.....i don't think payback is very useful at all
on complex systems.... i think that maintenance costs are vastly underestimated
hey.. i was in the Jamestown Town Hall the other day... there was a painting / print by Mike Guertin on display..... dat you?
Hey Mike! No, not me. Only thing I paint are my end-cuts. I kept my eye out for you last weekend as I biked past your neighborhood. Too hot to bike around my house and figured the island would be a little nicer.