So often it seems that energy efficiency is a part of the capital expenditures (CapEx) plan and typically not deemed worth-while if the annual payback is greater than 5 years. Furthermore, limited CapEx budgets may mean that other “more pressing” projects often take priority over energy efficiency projects.

What if instead of thinking of energy efficiency as CapEx, we think of it as an investment opportunity? After all, unlike most CapEx projects, investments in energy efficiency have a measurable ROI (return on investment) and this ROI typically far exceeds the discount rate of most organizations.

Discount Rate

While discount rates and how they are calculated vary by institution, most discount rates are a combination of the weighted average cost of capital (WACC), risk, and opportunity cost. Many organizations would typically calculate their discount rate to be around 7% – 10%.

Risk

Unlike the WACC and the opportunity cost, which once calculated are the same for every investment strategy, the risk factor may vary depending on the type of investment. Types of risk that a firm typically considers are volatility risk, liquidity risk, currency risk, and absolute risk, to name a few.

Most firms typically invest in stocks and bonds, real estate, and, of course, reinvesting capital back into their firm. For this reason, the most significant types of risk they face are market volatility and liquidity. Most of these risks are reduced when a company diversifies its investments. For example, real estate is very stable over the long run, but the capital is hard to convert to cash quickly. Whereas stocks can typically be sold quickly and converted to cash but are affected more by market volatility. Another strategy, also commonly used, is to invest in mutual funds which are made up of many stocks and bonds. The expectation is that some investments will do well offsetting others when they struggle. However, all stocks are typically affected by absolute risk, such as we are currently seeing with the impact of the Corona Virus.

Return on Investment (ROI)

The other side of the risk coin is ROI. Typically, if an investment is high-risk there is also an opportunity for a higher ROI. For example, a stock portfolio that is made up of mutual funds typically yields an ROI around 8% when the markets are healthy. Whereas, a Treasury Bond, which has virtually no risk, yields a much lower ROI, about 1% – 2%.

Investing in Energy Efficiency

What if there was an investment that had very low risk like a treasury bond, didn’t tie up large sums of capital for decades like real estate investments, and had an ROI greater than the stock market? Everyone would want to invest in it right? The fact is most energy efficiency investments have very low risk, and readily achieve an ROI of 10% – 30%. In addition, the annual yield is practically guaranteed to increase as the costs of conventional fuels rise over time.

The Donald Danforth Plant Science Center (DDPSC) is an example of an organization that has viewed energy efficiency as an investment. From 2005 through 2011 the DDPSC invested around $600,000 or about $100,000/year. The average annual savings from these investments were $200,000 yielding an impressive ROI of 34%. For more details on the type of energy efficiency investments at the DDPSC click here.

How much should a company invest in Energy Efficiency?

To be clear, ERG is not advocating that any organization pull all their investments out of the market and invest solely in Energy Efficiency. The reality is that typically a small portion of a firm’s total investments can fund the organization’s energy efficiency opportunities. For example, the median size of most endowments for Colleges and Universities in the U.S. is $65,000,000. Therefore, if these institutions invested only 0.5% – 1% of their total endowment, they would have $325,000 – $650,000 to invest.

Businesses that do not have endowments or large investment portfolios may want to invest more than 1% of their liquid assets. This would not only yield a better return on limited funds, but it would also reduce operating costs thus improving the profit margin and making the business more competitive in the marketplace while also reducing the strain in times of economic uncertainty.

In addition to a company’s own capital, there are incentives offered from the local utility companies that often reduce the cost of energy efficiency investments by 20% – 80%. There are also various funding sources, such as Property Assessed Clean Energy (PACE) loans that can provide 100% financing, Rural Energy for America Program (REAP) grants and loans from the USDA and the MO DNR/DE State Energy Loan Program, just to name a few. Incentives and funding opportunities such as these can reduce the WACC and opportunity cost therefore reducing the discount rate that should be applied when considering energy efficiency as an investment.

Non-Monetary Benefits

Unlike investing in the stock market, there are other significant benefits that are not necessarily easily quantified. Here are some examples:

1. Improved Employee Efficiency. Energy efficient buildings have better quality lighting and are more thermally stable, which means that occupants are more comfortable and therefore more productive. Workers are also attracted to businesses that are more environmentally and socially responsible, which boosts employee morale and job satisfaction. Businesses like this are also more attractive when trying to recruit future employees.

2. Reduced Operating Expenses. In addition to the energy savings already discussed, energy efficient buildings often require less maintenance. For example, LED lamps last 2 – 5 times longer than fluorescent, halogen, and metal halide lamps. Fans and motors also last longer since they are typically operated at much lower speeds under variable speed control. This results in less maintenance and increased life of the equipment. When equipment is replaced at life cycle, having reduced the heating and cooling requirements, the next generation of equipment purchased can be smaller and less expensive. As a result of the occupied spaces being more comfortable, there are fewer occupant complaints for facilities staff to respond to.

3. Increased Property Value. Buildings on the market that are more energy efficient often sell for more because the buyers know they will spend less in operating costs. A property analysis showed that a $250,000 investment ($50,000 in equity and $200,000 as loan) saved $100,000 in annual energy costs (40% ROI). At a CAP rate of 8%, this added $1,000,000 to the value of the property, since $100,000 dropped to the bottom line as profit.

4. Improve Brand Image. Consumers are constantly looking for companies that are socially and environmentally responsible. Energy efficiency can be used as a marketing tool to differentiate your business in a competitive market which allows you to charge a premium price and create stronger brand loyalty. Examples include Patagonia, Tesla, and Ben and Jerry’s.

Conclusion

It’s time to shift the thinking of how we view energy efficiency. It is a practical investment opportunity that offers better returns than current investments with very low risk.

To learn more about building your Energy Efficiency Portfolio, contact us at 314.644.0000