Cash Flow vs. Payback in New Home Construction

by Marc Rosenbaum, P.E.

A version of this article first appeared in the Journal of Light Construction.

One question commonly asked of those doing energy efficient design and construction is, "what's the payback of this energy efficiency measure?" Since the vast majority of homes are financed by long term mortgages, I steer clients to the concept of cash flow instead. Cash flow analysis looks at how much money will be spent annually on both energy and the mortgage. What the homeowner should be looking for is positive cash flow from the energy investments - that is, the value of the energy savings realized should be greater than the added cost to the mortgage payments of implementing the energy efficiency upgrades.

Not long ago, a young couple I know were having a starter home built, a typical story-and-a-half Cape. They were on a tight budget and chose a local builder who had a well-deserved reputation for building affordable homes. However, this builder's homes were also known for using a lot of fuel. I proposed to my friends a package of energy upgrades that I felt would give them positive cash flow (or at least break-even cash flow), and offered to detail and specify the changes at no charge. The specific measures I proposed, listed in order of best return on investment, were:

air sealing the home, a package of measures including effective sill sealer, caulking the bottom plates, sealing plumbing and electrical penetrations, sealing around the chimney, and sealing the attic hatch.
upgrading the single glazed window with storm window package to windows with low-e, argon-filled glass.
insulating the floor above the basement (this builder uses no insulation in either the floor or on the basement perimeter - not uncommon in New Hampshire, even though it is against code)
changing the wall insulation to blown-in cellulose, or at least high density fiberglass batts.
insulating the headers (and eliminating headers in the gable ends), insulating the corners and interior/exterior partition catches, insulating the rim joist area.
upgrading the typical, useless bathroom exhaust fan to a model capable of being used to provide ventilation, and installing a 24 hour timer to control it.
I estimated the cost of these measures at between $2500 and $3000. My calculations showed that the savings would be about 350 gallons of fuel oil annually, which would cost $262.50 per year at $0.75 per gallon. To add $3000 to a 25 year mortgage at 7% interest costs $254.40 per year. So the total cost of living in the home is the same, whether or not the energy investments are made.

The interest rate on the mortgage and the cost of the fuel profoundly affect the cash flow calculation. A higher interest rate makes the cash flow worse; a more costly fuel, such as propane, makes the cash flow better. But the energy investments have some other tangible benefits which may be more difficult to value precisely in dollars.

The mortgage payment stays fixed over the term of the mortgage, but few people believe that the cost of fuel will remain constant. So, if cash flow is positive in the first year, it is virtually certain to improve every year after that - the savings mount up. Next, the owner of the energy efficient home has the security of being more protected against rapid fuel price increases. Thirdly, investments in the building envelope are expected to last for the lifetime of the building, without maintenance - how often do you have to get your insulation rebuilt? Next, comfort in the upgraded home will be significantly better, due to draft-free construction, better window glass, and insulation improvements. In addition, durability of the home will be improved. There will be far less condensation on the window glass, due to the better glass. And moisture problems in the attic and walls will be eliminated due to the airtight construction, which keeps moisture-laden air from entering the building cavities and condensing. Finally, the resale value of the home will be higher if it has a proven track record of low fuel bills.

One more benefit which accrues not only to the homeowners, but to all of the planet's inhabitants, is the reduced emission of combustion pollutants from the energy efficient home.

Once the building envelope has been upgraded substantially, other opportunities appear. Since heat loss is so drastically reduced, central heating can be eliminated, and comfort, which is what the homeowner wants, can be provided more cheaply. In my friend's home, the oil-fired forced hot water system could be eliminated, along with one of the chimney flues, and replaced with a sealed combustion, high efficiency propane wall heater, such as a Rinnai, or a similar unit running on kerosene, made by Monitor or Toyostove. Several thousand dollars can be saved on the heating system.  Now the energy upgrades are paid for up front by the savings in the mechanical system, and the fuel savings are just gravy (even with the more costly fuels.) The upgraded home costs no more (and maybe less).

So what happened to my friends? Well, they were sold, but they couldn't get the builder to go along with the improvements - too disruptive to learn something new, I guess. Their house has the usual leaks and drafts, and lots of uninsulated portions of the building envelope. The windows without low-e glass had the owners pulling their hair out the first year, because they were covered with condensation and turning black (the windows, not the owners). And they have an oil-fired forced hot water heating system, a woodstove hook-up, and a two flue masonry chimney. But these things only have value insofar as they can provide comfort - a boiler has no intrinsic value (how many clients have ever told you, "I really want a boiler," vs., "I really want to be warm"?) So they paid more and got less - less comfort, less durability, less value - and they will pay more every year to come.

- Marc Rosenbaum