What 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:
IG / CI = ROI
 
Where:
IG = Investment Gain ($)
CI = Cost of Investment ($)
ROI = Return On Investment (%)
 For example, if you invest $5 (your cost of investment) and it produces $10, then your investment gain is $5. This means the return on investment is 100%.
 
If you invest $5 and it produces $20, then your investment gain is $15. This means your return on investment is 300%.

How does ROI relate to me?

ROI is important when considering the investment of a house.
 
While the house you live in is your home, it is also an investment. This means, you are hoping that you will receive more money when you sell your house than what you purchased it for - you are wanting a positive ROI.

How does ROI relate to home energy upgrades?

There are many factors that influence ROI. One of these is the appliances that are in your home. A recent Domain Group1* report that examined house prices compared the sale price of homes with and without energy upgrades.
*We have included a link to the report at the bottom of this article and we strongly recommend you read it, but with a critical eye.
The findings of the report showed that there was an increase in sale price for houses with energy upgrades by an average of 17.1% and this was even higher in Victoria (up to 24%).

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:
Assumptions:
  1. Sale of property after 15 years
  2. No upgrades require replacement during that period
  3. Initial value of a 2-bedroom unit in Melbourne (postcode 3000) = $540,000
  4. Rate of capital value increase from energy upgrades = 24% (or 0.24)
  5. Investment gain after upgrades = 0.24 * 540,000 = $129,600
  6. Cost of investment (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! 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.
 
Here's how it compares to other investments over a 15 year period:
  1. Savings account = 3% per year = 45%
  2. Superannuation = 5.5% year on year after 15 years = 82.5%
  3. Bonds = 5.3% (average return per investment since 1926)
  4. Stocks = 10.1% (average return per investment since 1926)
Why is there so much data behind these conclusions?
  
Primarily, due to volume. As far as we know there are a lot more houses bought and sold than energy upgrade retrofits completed in homes. We have to assume that, because 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?

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 why, at Energy Freedom Homes, we ensure you are aware of the warranty options before making a choice on an electric appliance or system. Mid- to long-term warranties are a good investment.
Even with these drawbacks, we view ROI as a reliable and useful metric, but that does not mean you should use it uncritically. Your home, your suburb and the property market will influence your ROI. No one can guarantee your ROI or the sale price of your home, including us.

Next steps

Of course, there are many more benefits to energy upgrades, but they won't have the same black and white conclusions. If you're interested to find out more, you can read about them here.
 
If you are ready to move ahead with energy upgrades, 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

1Domain. (2022). Domain sustainability in property report 2022. Retrieved  2022, from  https://www.domain.com.au/research/domain-sustainability-in-property-report-1147058/