Payback period: do the numbers add up?

Payback period: do the numbers add up?



Estimated read time: 10 minutes
 
With the global push towards clean energy, the rising price of gas and chaotic energy markets, homeowners are wrestling with the choice about whether to upgrade their homes to be more energy-efficient and sustainable.
 
One of the tools frequently considered by homeowners in their decision-making is the payback period on the cost of upgrades.

The 10 second summary

  1. Payback periods are based on assumptions and forecasts that do not represent your circumstances or the real world with appropriate accuracy.
  2. Deciding to invest in energy upgrades based on payback periods is risky...and the small print often says so.
  3. A more reliable (but not perfect) metric to guide your economic decision-making is Return on Investment (ROI) for the capital increase in the value of your property
Payback period might seem simple at first glance. It is defined as the time taken to repay the initial cost of investment from the savings generated by the investment.
As a formula, payback period looks like this:
 

 
Where:
INV = cost of investment e.g. purchase and install price for upgrades ($)
SAV = savings from investment e.g bill costs before and after upgrades ($/month)
PP = payback period e.g. months to pay back investment (months)

Unfortunately, the payback period is more complicated than it seems. To help guide you to understanding it better, there are three parts to this article.
  1. In Part 1, we provide an introduction to payback periods. This includes comparing the varied outputs from different models, and we cover the disclaimers that typically hide in the small print.
  2. In Part 2, we evaluate ROI (return on investment) as an alternative way to evaluate economic benefits without the risks of using a payback period for decision-making.
  3. In Part 3, we review of the pros and cons of payback period and return on investment, including a list of recommendations for whichever option you decided to use moving forward. If you're tight on time, skip straight to here.

Part 1: How payback period is used currently 

While payback periods have been used in the solar and energy upgrade industries for years to help homeowners decide if they should commit to purchasing, it is often not clearly explained that the payback period is based on a model. The model used is based on assumptions. These assumptions are subjective, and therefore can vary widely.
 
Let's begin by comparing the estimates of solar payback period from a range of different websites, as recorded in November 2022.

 

Source

Date of publication

Payback period

solarbright.com.au1

NA

3-6 years

theenergyexperts.com.au2

NA

as little as 3 years

energy.gov.au3

NA

3-5 years

domain.com.au4

February 21, 2018

Melbourne 10-15 years

choice.com.au5

July 10, 2018

Melbourne 5 years

solarquotes.com.au6

June 13, 2019

Melbourne 3.2-5 years

solarmarket.com.au7

February 24, 2020

1-4 years

simplyenergy.com.au8

2022

Victoria 7-8 years

gosolarquotes.com.au/9

June 16, 2022

3-5 years, with an average of 4

smh.com.au10

September 6, 2022

4+ years

finder.com.au11

November 11, 2022

4-6 years*

onestepoffthegrid.com.au/12

November 17, 2022

3 years

Variation = 14 years (!)

*it is predicted to reduce over the next two years. 

Why are we looking at such a broad range of results?

Each company has made a different range of assumptions as they've built their model, which has produced very different recommendations. And, all credit to most of these companies, as they have stated their assumptions. 
The assumptions stated on these websites include:
  1. Size of the system and number of panels
  2. Quality of the system
  3. Cost of system and installation
  4. Position of the panels and the amount of share
  5. Sunlight hours and number of sunny days
  6. Household's electricity consumption
  7. Energy prices
  8. Feed-in tariffs
Just to demonstrate the variability and therefore unreliability of these assumptions, we have broken some of them down.

Assumption: Household electricity consumption

Teenage kids? Live alone? Work from home? Feel the cold?
 
Payback periods vary significantly on a case-by-case basis due to home situations and domestic usage profiles, which may change significantly over a 15 year period (7 year olds become 22 year olds).
 
Usage also isn't the same over the whole year (to be fair, most models take this into account) but if November and December 2022 is anything to go by, it is difficult to predict what we will face. 14 degrees in November or snow in December, anyone?
 
Additionally, you might be able to gather historical usage data with your current appliances, but unfortunately that will be little indication of future levels of usage and running costs with new technologies performing the same functions.

This is where we see the classic disclaimer, "past performance is no indicator of future success".

Assumption: Energy prices

Energy prices fixed until 2037? A predicable change across years? Check out wholesale prices since 2011.
 
For gas:
 
Source: AER13

For electricity:
 

Source: AER14

These graphs are based on wholesale data, but variations in these costs eventually get passed on to homeowners. The important thing to note is the variability, especially since 2020.

Assumption: Cost of installation

The cost of appliances can vary widely based on supply chain issues and pricing variation between suppliers. Also, ever had a tradie quote you for a job and then add in "extra costs" when they were on site? 

Why disclaimers are not your best friend

This brings us to an important point. Because of their generalised outputs based on assumptions, models are typically propped up by disclaimers. These disclaimers acknowledge the shortcomings of the model and the risks associated with using them for decision-making, mostly for reasons of legal protection.
 
For example; how would you feel spending $20,000 based on this advice?
"The information on this page is for general information only. You should consider seeking independent financial or other advice to check how the information contained on this page relates to your unique circumstances. [This company] is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly, by use of this page."
This shows one thing very clearly; making a purchasing decision based on the general advice supported by payback periods is risky. By stating these disclaimers, companies are trying to shift the decision-making risks from them to the purchaser.

Why do organisations even bother creating a model that they discount in small print?

We don't know for sure. But putting our cynical hat on, we'd assume that companies are relying on potential customers to pay attention to the conclusions of the model and gloss over how these conclusions were reached. 
 
The end result for them is that they pick up a new customer, even if the route to get there was misleading and ethically dubious.

How can you make use of payback periods?

There's a simple process you can follow to validate the payback period that companies are telling you; check the data behind the model. Does the company provide links, or an explanation about the assumptions around things like forecasted energy costs and usage they have made to produce the result? If they do, compare them to your circumstance. Could the assumptions relate to your home and lifestyle?
 
If not, we'd advise not to trust their conclusions. Even if they do match your home and lifestyle, be wary. How do these assumption accommodate market trends? 
 
Hopefully by now you've got a healthy dose of scepticism about the payback period. However, we don't want to leave you feeling stranded, so in the next section we'll look at an alternative.

Part 2: An alternative to payback period

We've established in Part 1 that the main problems with payback period are the assumptions used in the calculations, which include forecasting variation in the cost of energy and predicting the amount of energy that you'll use with new appliances.
 
While it is less than perfect (and we'll explain why), we think a more useful economic decision-making factor is Return On Investment.

What is Return On Investment?

Return On Investment (ROI) is calculated as a ratio (or percentage) of the benefit an investor will receive from their investment cost. The higher the percentage, the greater the benefit.
As a formula, ROI looks like this:
 

 
Where:
IG = Investment Gain ($)
CI = Cost of Investment ($)
ROI = Return On Investment (%)
We're reasonably confident in ROI because of a recent report by Domain Group15.
We have attached Domain's report to this article and we strongly recommend you read it, but with a critical eye.
In the report, they gathered data from a range of properties across Australia with and without energy upgrades. They discovered that properties with energy upgrades, on average, increased in sale price by 17.1% and this was even higher in Victoria.

What's an example of ROI?

Using rough numbers from the report and Domain's website in an illustrative example, this is how we'd work out ROI:
  1. Assumptions:
    1. Sale of property after 15 years
    2. No upgrades require replacement during that period
  2. Initial value of a 2-bedroom unit in Melbourne (postcode 3000) = $540,000
  3. Price premium increase from energy upgrades = 24% or 0.24
  4. Increase in capital value of the property after upgrades = 0.24 x 540,000 = $129,600
  5. Cost of energy upgrades* = $30,000
ROI = $129,000 / $30,000 = 4.32 = 432%
 *Includes insulation, draft proofing, electrifying heating, hot water and cooking, installing solar
That's a pretty astonishing ROI from an up front investment!
Here's how it compares to other investments over a 15 year period:
Savings account = 3% year on year = 45%
Superannuation = 5.5% year on year = 82.5%
Bonds = 5.3% (average return per investment since 1926)
Stocks = 10.1% (average return per investment since 1926)
We'd be very sceptical of those conclusions if it weren't for the substantial amount of real world data (not forecasting) that supports these numbers.

Why is there so much data behind these conclusions?

Primarily, due to the volume of property sales. Our research indicates better data availability for houses bought and sold than energy upgrade retrofits completed in homes. No-one is compiling and presenting the data for energy upgrades in the same way that companies are doing with the housing market.
 
Secondly, due to access. Because a house is the biggest investment most people will make, they want as much data as possible to make an informed decision and reduce their risk. That's why companies like Domain collect and present vast amounts of historical data to support people to make informed decisions...something sadly lacking from the energy upgrades space.

What are the issues with ROI?

As mentioned before, ROI isn't perfect. We'd caution uncritically using ROI for the following reasons:
  1. ROI does not factor for time. This is actually to its detriment, as the benefit in capital value increase occurs as soon as you upgrade your property, rather than over the course of many years. In investment terms, an immediate return is a huge benefit.
  2. The property market (whilst being more stable than energy markets) is still subject to fluctuations. This is a weakness of ROI's lack of time factoring.
  3. It's easy to fall into the trap of using generic house prices as the basis for your planning. Make sure you adjust values to match your suburb and property type as closely as possible.
  4. Appliances will require replacing over time. If you purchase a new hot water system tomorrow, you run the risk of purchasing a replacement as soon as it is out of warranty. This will add on to your Cost of Investment and decrease your ROI. This is one reason we strongly encourage you to factor product warranty into your decision making, with mid- to long-term warranties reducing investment risk.
Even with these drawbacks, we view ROI as a more reliable and useful metric than payback period, but that doesn't mean you should not consider both.

Part 3: Which metric should I choose?

Let's help you decide if ROI is a useful alternative to payback period by looking at the pros and cons for each.

 

 

Payback Period

ROI

Pros

Based directly on cost/benefit of upgrades

Based on real-world data

Backed by a high volume of data

Demonstrates a tangible immediate benefit

Fewer variables reduces complexity

Cons

Misses critical benefits to upgrades

Based on unreliable energy market forecasts

Based on unpredictable future energy usage for new appliances

and assumptions

More variables produce wider variation in recommendations

Estimates the cost of purchasing and installing appliances

Indirectly estimates benefit from property value

Subject to property market fluctuations

Estimates the cost of purchasing and installing appliances

Appliance replacement timeframes and cost are unpredictable

 
Depending on your decision, we'd make the following recommendations:

Payback period recommendations

  1. If following someone else's recommendations, make sure you can see all the assumptions that support the model. If assumptions are explicit, ask the question; are these reliable enough to justify a $20k+ investment?
  2. If building your own model, make sure you tailor it as closely as possible to your circumstances. Find and use reliable data sources like AMEO to forecast electricity and gas costs. You'll find a link to their website in the reference list.
  3. Factor in a 10% contingency to your estimates for the cost of purchasing and installing new appliances.
  4. If you've got any friends or colleagues who have already installed the appliances and systems that you're planning to upgrade, chat with them about their running costs to base your estimate of future running costs on real-world historical data.

Return On Investment recommendations

  1. Use Domain's database to estimate the increase in capital value of your property based on your postcode and property type.
  2. Review the last 15 years of property price variation to get a sense of how the value of your property might change. There will always be risk from unpredictable future events and while the property market is more predictable and steady than energy markets, you still need to have a sense of the broader trends.
  3. As for payback period, factor in a 10% contingency to your estimates for the cost of purchasing and installing new appliances.
  4. If you are planning to live in your house for a long period (e.g. 20 years) then make sure you evaluate the worst-case scenario of replacing an appliance that fails as soon as the warranty finishes. You can also estimate a realistic scenario based on the average appliance life span. This will be even more realistic if you know which type of appliance you want to purchase (small plug for us - we can help you out here if you sign up to the concierge service).
So there you have it! Hopefully, you feel well-equipped to evaluate your upgrade options and commit to a decision providing you with financial benefit for an acceptable amount of risk.

Next steps

Of course, there are many more benefits to energy upgrades beyond the economic, but they won't have the same black and white conclusions. We refer to a property that enjoys these benefits as an Energy Freedom Home.

Interested to find out more about these benefits? Check our article, 'What is an Energy Freedom Home?'

Wondering what other problems beyond price may relate to gas? Read our article, 'Is gas bad?'

Want to fast-track home electrification? Join an Energy Freedom Homes Masterclass and learn to identify your needs, gain expert installation advice, and meet trustworthy tradespeople. Check your Masterclass readiness now!

References

1 Solar Bright. (n.d.). Calculate your solar panel payback period with these simple steps. SolarBright's blog & news. Retrieved  2022, from  https://solarbright.com.au/calculate-your-solar-panel-payback-period-with-these-simple-steps/

2 the energy experts.com.au. (2021). How long does it take for solar panels to pay for themselves? Retrieved  2022, from  https://theenergyexperts.com.au/how-long-does-it-take-for-solar-panels-to-pay-for-themselves/

3 Australian Government: Department of Climate Change, Energy, the Environment and Water. (2022). Solar PV and batteries. Households. Retrieved  2022, from  https://www.energy.gov.au/households/solar-pv-and-batteries

4 Domain. (2018). How long does it take for solar panels to pay for themselves? Retrieved  2022, from  https://www.domain.com.au/advice/how-long-does-it-take-for-solar-panels-to-pay-for-themselves-20180221-h0vrvb/

5 Potter, A. (2018). Solar panel payback times. Choice. Retrieved  2022, from  https://www.choice.com.au/home-improvement/energy-saving/solar/articles/solar-panel-payback-times

6 Brakels, R. (2019). Simple payback time for 6.5 kW of rooftop solar by Australian capital - June 2019. SolarQuotes blog. Retrieved  2022, from  https://www.solarquotes.com.au/blog/solar-power-payback-2019/

7 Solar Market. (2020). What is the expected return on investments (ROI) time-frame? Retrieved  2022, from  https://www.solarmarket.com.au/residential-solar/pay-back-periods/

8 Simply energy. (2022). What is the cost and payback time of a home solar system? Retrieved  2022, from  https://www.simplyenergy.com.au/blog/what-is-the-cost-and-payback-time-of-a-home-solar-system-0#:~:text=Solar%20PV%20system%20payback%20period,as%204%20or%205%20years.

9 McInerney, B. (2022). Compare solar panel quotes now. GoSolarQuotes. Retrieved  2022, from  https://gosolarquotes.com.au/solar-payback-period/#:~:text=The%20average%20payback%20period%20of,4%20years%20being%20the%20average.

10 Collett, J. (2022). Solar payback times narrow as electricity prices rise. The Sydney Morning Herald. Retrieved  2022, from  https://www.smh.com.au/money/planning-and-budgeting/solar-payback-times-narrow-as-electricity-prices-rise-20220902-p5beth.html

11 Gabaji, M. (2022). Solar power payback calculator. Finder. Retrieved  2022, from  https://www.finder.com.au/solar-power-payback-calculator

12 Vorrath, S. (2022). Rooftop solar payback set to shrink to three years, thanks to costly coal and gas. One step off the grid. Retrieved  2022, from  https://onestepoffthegrid.com.au/rooftop-solar-payback-set-to-shrink-to-three-years-thanks-to-costly-coal-and-gas/

13 Australian Government: Australian Energy Regulator. (2022). Gas market price. Retrieved  2022, from  https://www.aer.gov.au/wholesale-markets/wholesale-statistics/gas-market-prices

14 Australian Government: Australian Energy Regulator. (2022). Annual volume weighted average 30-minute prices - regions. Retrieved  2022, from  https://www.aer.gov.au/wholesale-markets/wholesale-statistics/annual-volume-weighted-average-30-minute-prices-regions

15 Domain. (2022). Domain sustainability in property report 2022. Retrieved  2022, from  https://www.domain.com.au/research/domain-sustainability-in-property-report-1147058/