I recently went through the process of having solar panels installed on my house. My motivation was to reduce monthly expenses and help the environment. This article analyzes the financial aspects of the panels as an investment. I live in South East Wisconsin so some of the estimates on costs, energy from the sun, and tax breaks are region dependent (your area might be different).

Looking at the cost per unit of power generated will let us compare systems of different sizes. This $/Watt ratio is similar to looking at houses in $/square foot. The typical cost in Wisconsin is 3$–5$ per Watt. I received multiple quotes through Energy Sage, and I ended up going with one that landed at 2.8$/Watt. The installer offered the best price, and they have been great to work with. As we shall see later, keeping the $/Watt low is critical in making the solar system a great investment.

It depends on your budget, your state’s net metering policy, and the size of your house. Energy Sage and the different contractors were helpful with recommendations on this and we discussed multiple options. We can do some analysis using some US averages. The median US house size is 2,261 sqft, consumes 10,715 kWh of energy each year.

My utility has a month to month net metering policy. This means that they will pay the full rate on any energy up to the level you consume, but only pay ~25% the normal rate on surplus generation. This means to maximize our return on investment we want to size the system to match our energy consumption for each month. We can estimate the total energy based on how much sun we expect to get (1,300kWh for WI) plus the efficiency and surface area of the panels (20.7%, 2.3 m²).

We would need 18 panels to cover our energy usage, which gives us a 8.64kW system size (480W/panel), costing $25,920 at 3$/Watt).

Currently, the Federal Government gives you a tax credit of 26% on the total system cost, after you file your taxes (goes down to 21% in 2023). The state of Wisconsin gives a 500$ credit come tax time, but this amount will vary by state. I also got a 5% discount by paying cash up front.

Yes, there are a couple options to do this. The best option I saw was to cash out equity from your home through refinancing. The rates you can get on a home that is your primary residence are about as low as it gets. Personal loans were another option I looked at, but the rates are typically higher the have shorter terms (15 years was the longest I could find). This made it difficult to have the solar panels be able to cover the cost of the loan and be cash flow positive. There are some credit unions that offer solar specific loans, but you need to be careful on the details as some include balloon or exploding payments in the loan terms.

I wanted to do some discounted cash flow (DCF) analysis to see how good of an investment solar panels can be. For those unfamiliar with this approach, I did a deep dive explanation of discounted cash flow analysis in a previous article:

An important point included in the DCF is that the solar panels output typically drops 2% after the first year and 0.5% each year after that over the 25 year warrantied life. Energy prices in Wisconsin have been increasing at 4.1% per year. I made the below chart from annual historical data and the last 2 years worth of my utility bills. You can see the value varies month to month, but year to year increases fairly consistently. You can also see the recent jump from $0.16 to $0.187 that is a result of inflation and rising energy prices globally.

Let’s do some worst case cash flow analysis with the 18 panel average example from above. Let’s assume no growth in energy prices, a discount rate of 7% (historical return of a large cap index fund), and assume the inverter breaks right after the end of its 15 year warranty. With these assumptions, we are buying the system just under its intrinsic value, with a 0.8% margin of safety. The return on investment is 5.5% over the full 25 years (9.2% while in operation). The system pays itself off in just over 9 years. This is pretty good considering we assumed a lot of things wouldn’t break our way.

Let’s repeat the analysis, but make some rosier assumptions. We can keep our discount rate at 7%, but lets assume the historical average energy price growth rate of 4.1%. I also assume the system runs for the 25 year warranty period of the panels. Under these conditions, the average ROI jumps to 13.1%, the panels are paid off 8 years, and we are buying the solar system at a significant discount to the DCF valuation ($41,500) giving us a margin of safety of over 60%.

This time, let’s assume we only get 20 years out of the equipment and energy costs only increase at 3%. Here, we are able to pay back the system in 8 years still, the ROI averages 9%, and we have a margin of safety of 32%.

My big take away is that given the warranties of the system and the low $/Watt price, we are virtually ensured to be able to achieve pay off of the panels even under worst case scenario. While running, the system should provide a 7–13% ROI with more stable returns than the stock market (no down years).

The math changes substantially if the system costs on the high end of 5$/W. Under the same “worst case” scenario from above you have no margin of safety and never end up getting the system to pay back.

The average case stinks as well, since you are paying more than the value of the discounted cash flows. The system pays for itself in 13 years, but fails to clear the 7% discount rate.

As Government tax incentives go away, you end up in a similar situation where the worst case barely breaks even and has a negative margin of safety.

Lets analyze if we paid for the system using a loan against our home equity. The current 30 year fixed rate is 5.5% at the time of writing. Because of the tax incentives, even with 0% increases in energy costs, you end up making money on this deal. The cash flow starts to get negative 9 years into the deal. If the inverter breaks right at the 15 year mark then you end up losing money paying off the loan for the last 10 years.

The situation improves if we assume the historical energy price rate increase, but if the inverter breaks after 15 years you end up losing money. Because the tax incentives are paid up front, in theory you could still come out ahead if you could invest the retained earrings over the 15 years.

Under the best case scenario, you end up making over $36,000 with no money of your own invested.

A credit union focused on renewable energy, offers a 15 year loan at 6% APR. The analysis doesn’t change much compared to the home equity analysis. The 15 year term means that you have more years of negative cash flow. At the end of the day, both types of loans are a bet that energy costs will go up over time. In order to break even on the deal, energy prices need to go up by 2% each year.

If you don’t have leverage, you don’t get in trouble. That’s the only way a smart person can go broke, basically. And I’ve always said, ‘If you’re smart, you don’t need it; and if you’re dumb, you shouldn’t be using it.’ — Warren Buffett

I include the excel file that I used for all the analysis in this article on GitHub.

If you can pay cash and the purchase price is right, then a solar panel system can make for a great investment. As tax credits go down over time, total installation costs will need to go down as well in order for the investment to make sense.

With a good purchase price and under worst case assumptions for equipment life and energy prices, you end up buying the equipment for less than the value of its discounted cash flow. Under optimal conditions the system has an average ROI of 13% and pays for itself after 8 years.

If you finance the cost of the installation, you are trading the spread in between the panel rate of return and the loan rates. If the equipment breaks down early or energy prices don’t rise, you can end up with negative cash flow and potentially losing money on the deal.

As in other types of investments, buying at a discount and avoiding leverage are both prudent rules to follow.

Join our network here: https://datadriveninvestor.com/collaborate

empowerment through data, knowledge, and expertise. subscribe to DDIntel at https://ddintel.datadriveninvestor.com

An engineer with a passion for machine learning, the stock market, and python projects.