Our homes may well become energy and water efficient much faster if mortgage valuers start taking into account the energy & water performance of a house in their valuations. I find it difficult to believe that both here and in the US, this is not already being done.
With the rising cost of energy, the average UK gas and electric bill is around £1300 according to Uswitch. According to the Energy Saving Trust, this can be easily reduced by 30% saving £390. By plugging back the savings into other energy saving measures, over a few years' time, the home's energy consumption could be cut by 50-60%.
A 50% saving on energy consumption and water consumption would result in an annual saving of £806 which should be enough to make one monthly mortgage payment a year. Surely that's worth something to a bank. Over the 25 years of a mortgage, the saving would amount to £20,150. Taking into account inflation of energy prices at an average of 5% a year*, the saving would be around £38,500. It is difficult to say how this embedded saving should be factored in to the value of a property. The easiest way to measure it is to look at similar trends in the US. A study in California reveals that buyers are willing to pay an extra $20 for every $1 saved on permanent home energy efficiency investments ** (1). This is a far cry from what buyers are willing to pay in the UK. The Energy Saving Trust (EST) have assessed from market studies that buyers are willing to pay on average an extra £3,350, whilst some are willing to pay up to £15,000 for energy efficient homes. They found that 68% of people don't want a highly energy inefficient F or G rated home. Unfortunately, they don't have any info yet on what home improvements buyers value most. This makes it very difficult to determine whether or not home improvements are worth more than what people pay for them as they seem to be in the US.
The fact that some are willing to pay up to £15,000 seems like a reasonable premium but, mathematically, it's odd that they are a minority.
Their valuations certainly makes more sense than the current valuation of properties. At 28 times their annual average rental potential, the prices are far out of touch with reality (3). If a similar valuation were to be used for energy savings (money that stays in your pocket is as good as or better than money that comes into your pocket), taking into account 5% inflation over 25 years, the increment to the property's valuation should be £43,000!!
But we will not advocate such a high valuation. Current property valuations in relation to equities are unsustainable. They indicate that a property crash or a dramatic slow down in the increase of property prices over a number of years must occur to bring them back to reasonable levels in relation to their earnings potential. Of course, markets can stay irrational for extended periods of time so when prices will fall or stop growing could happen in a year or in 20. Nobody has a crystal ball to determine that.
Going back to our valuation problem, I think that a reasonable valuation for the moment would be 7-10 times the amount saved on permanent energy efficiency improvements. This in equity valuations is considered to be a bargain and 10-15 times the earnings (savings in this case) potential is considered to be fair value. Our valuation indicates that energy saving are incredibly undervalued in comparison to the valuations given by people surveyed by the Energy Saving Trust. But then again, average Joe hasn't a clue as to how to value stuff scientifically. The value of something is not just what people are willing to pay for it. This is one area where modern finance has come up with a better alternative: the value of something is equal to the present value of its discounted cash flows plus its value on disposal.
Our yardstick valuation of 7-10 times the energy savings would leave enough margin for the madness that usually takes place when it comes to valuing assets and allow for prices to get out of hand and valuations to climb up to 20 or 25 times the amount saved***. Energy saving investments will one day become fashionable. Everything in the press and on telly points to this. The latest round of EST adverts coupled with the government's adverts are going to have an impact and property buyers are going to become savvy to the presence of energy saving installations on properties. Once energy saving investments become fashionable, it is possible that their valuation will get out of hand, just as property valuations got out of hand as a result of greater availability of credit.
Looking back at the Californian valuations, we are not surprised at all that permanent energy efficiency improvements are valued at 20 times each $1 saved and that they effectively beat stock market returns and other investments. Indeed they should. It isn't rocket science: valuing energy savings is easy and straight forward. Once your cavity walls are filled, the work will last for the life of the property. Same for loft insulation and a host of other measures. Compare that to trying to value the future earnings stream of Intel, Dell, Dow Chemical, Shell or British Airways. Even pension fund manager who are supposed to be experts aren't very good at their jobs due to its complexity (90% of fund managers can't beat the performance of indexes). Take into account the recent stock market crash and you'll get it: stock market investments are insecure because they assume linear valuations and are vulnerable to 'Black Swanns' which makes valuations approximate and vulnerable to fear and greed. Property prices too are difficult to value. They are vulnerable to bank's willingness to lend, lending terms and the health of the economy. Now look at energy saving investments: what are they vulnerable to? Nothing. Their only caveat is that they decay. I have a boiler in my home that is 25 years old. It is woefully inefficient and the landlord won't replace it until it completely stops working. A new condensing boiler would save us £170 a year according to the Energy Saving Trust and around £200 according to my calculations. If it lasted as long as the old clunker we have, it would save us £4250-5000 over its lifetime, paying for itself twice over. Where else can you get such a straight forward easy to value return on investment? Permanent energy saving investments should be worth a lot just because of the security of the cash flow stream they provides in the form of savings.
The main reason why people invest in energy saving measures at the moment is because they can save money by implementing the measures. But not everyone believes the energy savings are possible and some people seem to be paralyzed or in no hurry when it comes to spending money on this. They're happy spending money on trivialities, things 'they like' but not on dull old energy saving stuff. And there maybe a good reason for that: take 2 fridges that look exactly the same, one is priced at £300 and the other at £500. The only difference is that one is more energy efficient. Which one is the buyer most likely to go for? The £300 one of course, because they see the extra £200 as an indulgence, even if it saves them money. People think short-term not long-term. The fact the £500 fridge is worth £300-600 as a fitting because it saves £30 a year isn't understood and the fact that it will pay for the extra cost in less than 7 years is not taken into account enough. With this kind of psychological blockage, it's no surprise that enthusiasm for energy efficiency isn't picking up speed faster. We prefer cheap, not running cheaply.
We've noticed from experience that the people who invest in energy saving measures tend to be quite savvy. The rest are perfectly happy to pay the utility bill when it comes in the post and look at forking out £250 for cavity wall insulation as something that means spending money now with no real assurance they'll get it back in the form of savings. That's probably why you hear politicians saying: "people won't invest in energy investments" whilst in the same breath mentioning the necessity to build incinerators. There's a very simple way to deal with the problem:
1) Get mortgage valuers to value the property's energy performance into the cost of the properties. The government should be ruthlessly lobbied about this by FOE, Greenpeace, EST and any other organization who understands that the reduction of our carbon emissions is intimately linked to the attractiveness of energy saving investments. If energy saving investments improve a property's value and save money: that makes them far more appealing than if they just save money.
2) Securitize energy saving investments (we've already posted on this topic) and enable people to pay for their energy efficiency investments through their bills. Utility companies could estimate the savings on each bill and bill the difference to people who've had improvements made. That will deal once and for all with the problem of a large proportion of the population who won't invest in energy savings.
There is one thing that flies in the face of government with regards the whole energy efficiency issue: people don't do it because it's boring and they don't believe in it. Our values are against conservation. It may have been easier to sell energy savings in the 30s or the 50s but not now because of the comfort and convenience culture. We don't have time and we don't really care about saving a few hundred. There's only one way to get the message through: by appealing to our greed. The day that people understand that they can take equity out of their homes through energy efficiency investments is the day that demand for that type of improvement will soar and that property speculation on that type of improvement will also kick in. Waiting for fuel prices to go up to motivate people to make improvements in energy efficiency will take too long.
Sources and notes:
* Energy prices have increased dramatically in the last few years however prior to that they were relatively stable. With world population growing and getting richer it is quite reasonable to assume energy prices will grow at a faster pace than inflation which historically has grow at 2.5-3%. Oil reserves are decreasing and so we should see an increase in demand for replacement technology. It is expected electricity demand will increase dramatically as a result. Gas prices which are correlated with the oil price should also increase as a result of increased oil scarcity.
The growth in energy prices could be countered by improvements in renewable energy technology but new technology may also increase demand for energy. An example in point is electric cars.
** We believe this "aberration" is due to Californian culture. California has been the cradle place of renewable energy technology for the past 40 years. The Governor is pro anything that has to do with green measures and Silicon Valley is becoming a major intellectual pole for the development of clean tech. Why Californians have historically been so interested in everything green, we don't know but one thing's for sure: with the threat of uncontrolable global warming looming the rest of the world is catching up quickly. If anything, what happens in California right now is the best crystal ball we can use to determine what to expect in the future.
*** It should be noted here that the best energy efficiency investments are invisible. For example, you cannot see cavity wall insulation but it is far cheaper and more cost-effective than solar panels. Yet people will attach more value to poor performing, 20 year old solar panels than to the existence of cavity wall insulation. This is just amazing! People have a tendency to overvalue what they can see and undervalue what they can't see. That's how property developers get away with making huge profits from implementing quite simple measures.
When looking at energy savings, people will attach disproportionate importance to what they can see such as the condition of the double glazing or the state of the boiler. They'll bearily notice that the toilet has been converted to a highly water efficient version or that the running cost of the house is half the national average. We are dealing here with a public transfixed by aesthitics. Selling a house has become an artful exercise in the manipulation of people's perception.