Energy Efficiency - A paradigm shift in your personal investment strategy.
In today's world, there are a diverse range of wealth creation products available to potential investors looking to maximise their return on equity. The most common options considered by small scale investors are probably shares, property or superannuation. What if I were to suggest another obscure but frequently overlooked investment available to every home owner in the country that is zero risk, tax free, automatically indexed to inflation and frequently realises returns on equity in excess of 15%? Whilst it does require a change of thinking, these returns are available to all property owners who renovate with a view to reduce or eliminate monthly power bills.
In order to assess how this category of investment operates, it needs to be recognised that this is not a one size fits all approach. For the purposes of this article, I am going to use some simple figures I believe would be indicative for an average middle income Australian family. Such a family living in a standard North Queensland home could expect an electricity bill of about $850 per quarter, are on a tariff of 25c per kwh the total bill being of $3400 p.a.
The question now is, how is this bill to be paid? Firstly let us look at what this bill represents in its most fundamental form and convert it into a reflection of labour. The time it would take to work and earn that sum. In making this estimate, remember that it would require a gross income of about $4,400 so we can first pay tax before settling the account. Let us assume a wage of $30 per hour before tax, paying the bill will consume about 146 hours, or nearly one month of full time work per year based on a 38 hour week. This represents a not insignificant portion of a that family's income. A further consideration is that over the past decade, power prices have been significantly outstripping wage growth so each year an increasing amount of labour is required just to pay the power bills.
Let us assume for this exercise that we are content to work, earn and pay 10% of the bill ($400), but want to pay the remaining 90% ($4,000) using a residual income stream. What are the options for our average family? Cash invested in a bank account yields interest and that could be used to pay the bill. How much money is required to earn $4,000 p.a. in interest? Based on the current rate of 2.25% p.a (figure based on CBA term deposit over 12 months, interest paid six monthly at at 18/12/2016) we would need a bank balance of around $178,000 to earn $4,000 p.a. to first pay tax, then pay the $3,000.
A second option is shares. A safe blue chip stock like the National Australia Bank (ASX.NAB). According to ASX data as at 18 December 2016, this year, the stock paid a fully franked dividend of about $2 and has a share price of about $30 (figures rounded up from $1.98 and $29.97 which was the closing price on 16/12/16). The advantage of shares is that the tax is already paid in the form of a 30% franking credit. So to pay the remaining $3,000 from share dividends, I would need to own 1,500 shares at a cost of around $45,000. This is a significantly better option than the bank account in the terms of return on equity yields about about 6.6% p.a.
What other option does our average family have? Could an investment in alternate energy yield a better return? Some of the comments I have heard when I suggest this approach are things like, "it's too expensive" or "it doesn't make financial sense, especially if I'm only getting a feed in tariff of 6.5c" or "the payback period is too long". Yet these same investors are happy to spend their money on renovating their homes with a view of trying to improve the capital value and here is where the paradigm shift has to occur. What if we were to approach investment in alternative energy products with the same tests as we would a traditional investment and consider what our returns on equity might be?
It is my view that any homeowner looking to renovate should approach alternative energy in a holistic manner. I advocate a "reduce" before "produce" then "modify" approach (RPM). The principle is simple, first reduce electricity consumption. Then produce our own energy. Then modify behaviour to slash the amount purchased off the utility company. To go into more detail, each of the steps is outlined below.
Step 1- "Reduce": How is consumption reduced? There are many ways this can be achieved and the most effective generally is hot water. The facts are that a standard electric hot water system generally costs around $800-$1200 p.a. to run (See, example Rheem Australia - hot water running cost calculator). Significant savings can be attained by investing in a solar hot water system or a heat pump and further gains can be achieved by insulating the roof, walls and floors, by ventilating the ceiling cavity and replacing incandescent or halogen light bulbs with LED's and potentially skylights. There are others, but these are just examples.
Step 2 - "Produce": How do you produce your own power? The most common option is using a photo voltaic power system (Solar PV) either with or without batteries. If you're fortunate enough to be on a generous government tariff (such as the 44c feed in tariff) batteries are something you may not need, however if you are selling to your utility provider at 6.5c and buying the same power back at 25c it may well make sense to generate and store for use during peak consumption instead of generating and exporting for a pittance. Currently the cost and reliability of wind power is not viable for domestic purposes.
Step 3 - "Modify": What sort of behaviour do we modify? Again there are a myriad of ways to modify our habits. For example, if you have a pool, use a timer so the pump runs during the day when your solar generation is at its peak. If you use a clothes dryer (though I would suggest use a clothes line), again run it during the day when your energy is free from the sun. You may also find that because we have already done "R", you now only need to run your air conditioners at 24 degrees instead of 20 to achieve the same cooling effect. There are many other options open to you and you depending on how far you want to go but the only limit is your imagination.
The next question is how much will the RPM strategy return? Again this will vary depending on home to home, but I will do my best to give ballpark estimates just for the purpose of the examples. To exchange an electric hot water system for a heat pump or solar hot water system is around $4,000. To retrofit insulation in the roof of an average home costs about $1,000. To install one solar powered roof vent will probably cost $1,000. LED's $500. That comes to a total of $6,500 to "Reduce" our consumption.
What about production? Like the "reduce" stage, there are many options, but lets assume a 5.2 kw of tier 1 panels and a premium system that will be compatible with a Tesla Powerwall 2 if we want one later on. A system of those specifications is going to cost around $10,000. If we this to our total from the "Reduce" stage that gives us a total investment of $16,500.
This $16,500 combined with proper modifications in behaviour would all but eliminate a utility bill of $3,000 p.a. (remember it's tax free so that's the same as earning the $4,000). This is a return on equity of more than 18% p.a. What about inflation? RPM makes you immune to electricity price rises which compounds the effectiveness of your investment (Note that over the past ten years electricity price rises in Queensland have increased by over 100%). What about the level of risk? The only risk to your investment is if the power utilities start giving away power for free. The return is such that even if you have to finance it out of your mortgage, the amount to service the loan will be significantly less than what you were paying to the energy company (borrowing at 5% to save 18% leaves you 13% on the right side of the ledger). This investment generates revenue and is cash flow positive from the outset.
More importantly, with the bill gone, what are you going to spend the money that you earn for those 130 hours at work on? It is now free to be used for something that really matters to you and your family, perhaps a holiday, a new car every few years or so, a fantastic Christmas every year, or if you're one of those economically responsible people, you could would probably invest the extra cash flow into your super or your mortgage. Logic suggests if you put that extra money into your home loan, you save yourself an additional 5% in interest on the balance and over the course of 10 years funnel an additional $30,000 of extra payments into your mortgage. It should be noted that this may be of particular benefit for seniors as it reduces their asset base and as well as increasing cash flow may increase their entitlement to an aged pension.
I haven't yet spoken about capital gains, feed in tariffs or liquidity, but will do so now. Let's talk capital gains first. The most common source of capital gains are property or shares. Let's look at shares first and if you bought your NAB shares on 6 March 2009 and picked the bottom of the depths of the GFC, about 8 years later you would have made a tidy capital return. If however, you bought the same shares on 4 May 2007, you would have paid $44,17 and still now, 10 years later be holding a capital loss of $14 per share. The question is then, what sort of capital gain (if any) can I expect from RPM or any other home loan renovation? To be honest the answer appears to be equally uncertain. When it comes to real estate, what one person considers an asset, another may consider a liability. I have bought real estate and can say that if there were two houses in the same street, both exactly the same and one cost $20,000 more and had solar hot water, insulation, LED's and a PV, system? As a buyer, believing as I do, I personally would probably go for the one that is going to cost less to run, but that's just me and you may have your own ideas.
What about feed in tariffs? If you're on the 7.5c tariff, if you have any extra capacity you might be able to buy yourself a pizza and a bottle of wine every quarter. Though if you use RPM the goal is to use what you produce and export as little as possible because if you're buying at 25c it makes no sense to sell at 7.5. The only difference is if you're fortunate enough to still be on the 44c tariff. If that's the case, the same principles apply only you want to use RPM to maximise the amount you're selling back to the utility company (note your "M" will be exactly the opposite to someone with batteries). If you're on the 44c tariff for example and still using electric hot water you are potentially using around 4,500kwh of electricity per year (ibid). By using RPM and replacing your hot water system with an energy efficient system you could reduce this by up to 80% and pocket an additional $1,500 p.a. from the utility company.
What about liquidity? Cash can be withdrawn and if I have shares I can simply sell them if I need extra funds. This is true. Any home renovation will have the same drawback, but instead of simply benefiting from a possible capital gain like a standard renovation, this renovation emulates a residual income stream that potentially yields significantly higher returns than having your money in cash, shares or even your mortgage.
So what is the next step if you like the sound of RPM? First I'll start with a disclaimer. The information I have expressed in this article is freely given, but is just my own personal opinion about the possible returns this strategy could yield. It should not in any way be construed as professional financial advice. I would urge you to be sceptical. Why? because that's smart. Whilst RPM may look good, even compelling on paper, before you spend a cent, seek independent financial advice. Talk to your financial planner, talk to your accountant but get independent expert advice. If you believe after that, that RPM still stacks up, to fully and properly advise you, like any other investment, you need an expert. Find someone who has a proven track record of honesty, professionalism and integrity and has a broad range of knowledge in a wide range of solutions including as a minimum, options on energy efficient hot water, insulation, ventilation, lighting and energy generating systems, because in my view, only a business that deals in all those areas will be able to fully advise on the synergies that truly makes the RPM ethos effective. I can recommend a company that I am currently working along side by the name of SuperGreen solutions in Townsville North Queensland whom I believe meets all these criteria.
In closing, if this article has done nothing else, I hope it has kindled a small spark of inspiration as to how alternate energy investment can help you, your family or your clients emulate a residual income stream to free up some additional cash flow. It is important to realise that RPM is not a strict recipe but more of an ethos. It doesn't have to be done in that order or even all at once. You may choose to do as much or as little as you like depending what you feel is best for you. The added bonus though is that proper broad implementation of RPM by as many of us as possible will pave the way to a clean, green energy future and help us reduce our carbon footprint and leave a better environment for our children. So, on behalf of ALine Consultancy services I wish you all a safe and Merry Christmas and a wonderful and prosperous New Year.
About the Author:
Richard Scholl is the director of ALine Consultancy Pty Ltd and has a passion for helping people and businesses convert to the RPM energy model. If you have any comments or feedback on this article, please feel free to contact me by e-mail at Richard@alineconsultancy,com.au.