Mandating bad investments


In my last blog I pointed out that the return on investment for a homeowner in Flagstaff if the energy code passes this Tuesday is poor to say the least. I cited data that shows a return on investment between 9.6 and 451 years.

I have to be honest, I have been utterly mortified by the amount of people that just don’t understand return on investment. I even received an email from a “wealth advisor” encouraging me to vote for the energy code. I replied, “have you done the math on this investment?” I have not received a response to date.

Someone was also kind enough to point out to me that there are not 451 year mortgages. I’d point out the real issue is that people don’t live to be 451 years old.

All kidding aside, I must fess up, there are not 451 year mortgages! And to this person’s credit, in the absence of perpetual mortgages, the loan should be paid off in 30 years. That is of course assuming you stay in your house 30 years and do not refinance the mortgage. Statistically though, 67% of Americans have a mortgage and many never pay it off, going from mortgage to mortgage or from refinance to refinance.

But let’s assume a homeowner pays off their mortgage in 30 years. They should expect to recoup their $5,872 initial investment due to the energy code after 30 years in this example? Not exactly.

Even in this scenario after 30 years a homeowner would recoup $13 per year for a grand total of $390 recouped by year 30. So that would leave $5,482 of your original $5,872 investment left to recoup. With an estimated $391 a year in energy savings* it would take another 14 years to make back your investment.

So in this case, 44 years to make back your “investment”. I would worry about someone’s financial future if they think putting up (through financing) $5,872 to get back $13 a year was a good investment.

If you think this is a good investment, I’ve got a bridge I want to sell you and if you are a politician and think this is a good investment I fear for our nation’s future.

—————————————

The math…
$391 (annual energy savings as per DOE study) –
$378 (annual increased mortgage, based off of $5,872 financed at 5% for 30 years) =
$13 (savings per year)

$13 x 30 years = $390.

$5,872 (initial investment) – $390(30 year savings) = $5,482 (remaining investment to recoup)

$5482 / $391 (annual energy savings) = 14.02 years.

30 years + 14 years = 44 years.

* I anticipate an email stating that over time energy savings per year will go up due to energy price increases. I did not factor inflationary pricing and all figures are in today’s dollars. It would take an entire book on finance, inflation and investment to delve into that subject.


20 thoughts on “Mandating bad investments

  1. Jeff,
    This is exactly what I argued with my Colleagues on the Council for years…This constant push to mandate how we live in Flagstaff has created, in part, non-affordable Housing. With the economy where it is, I suspect most don’t take into consideration of a Return on Investment. Most Folks Sell and move in 3-7 years statistically… actually, more frequently in Flag.
    Hang in there, appreciate your detailed and factual data…..

  2. The same logic would mean we should switch to 2X4 walls – that is all that is required structurally. The 2X6 requirement is solely to get more insulation in the walls. Alaska allows 2X4. And hey, while you are racing to the bottom – don’t stop! It is a code requirement that we ground outlets. BUT the return on investment NEVER happens? You don’t make a red cent for grounding outlets! But it costs money! It is a great, wonderful, happy side effect that reducing CO2 emissions SAVES you money. But the point is that a warmer world will not be hospitable for humans – it is morally reprehensible for this generation to trash the planet for future generations.

  3. Jeff by changing the subject from cash flow to ROI you muddle a simple decision. Even in your worst case scenario you are to the good $13 per year. The ROI is immediate. When you sell your home it will have more value than an under-insulated comparable – so the value is locked in. And of course you are all about the interest rate, but you ignore inflation (energy sector inflation has historically led overall inflation rates). You’ve got the books so cooked that it almost makes sense – until you unwind the logical fallacies – like your 451 year mortgage problem, like ignoring cash flow, like ignoring inflation, like ignoring global warming. Once you sweep all that pesky reality out of the way, um, sure – your analysis is OK (ignoring your fixation on the worst possible (and therefore not representative of reality) assumptions). Lots of ignoring Jeff. There are other words that share that root….

    1. Cash flow and ROI are directly related. I don’t know how else to explain this to you Tom.

      In this example, to get your $13 a year in savings, a homeowner had to put up, in this case through debt, $5,872. Thus the ROI in this example with a 30 year mortgage at 5% is 44 years.

      1. Jeff it is “free” money to the homeowner. They would have had to pay M O R E to the utilities -and you and I both know the $13 figure is tiny compared to reality – the $150 is more likely, and given inflation that will grow into real money over the 100 year life of the home. You ca play your ROI game to rationalize this to yourself and other true believers – but the fact is if you ask anyone if they would like free money, that grows over time, they would say yes.

        You are cash flow positive from DAY ONE! – Let’s take a simple test from ethics – is it generalizable? Would a rational person do this if they could? Yes, of course. Would it work if EVERYONE did this? Yes, of course.

        So your position nets out to encouraging people to waste money (and waste more over time) while ALL THE WHILE causing our planet to be less hospitable for our kids and future generations (inter-generational theft of the worst kind). Not sure what you are missing here. Saving money and reducing CO2 at the same time is a win for all involved.

        You could argue against it based on the “coercion” aspect of it – and be wrong for different reasons – but your economic argument fails on economic grounds alone.

      2. It’s not free money!

        To get the $13 per year, or $150 as you claim or whatever amount it turns out to be you have to invest through cash or credit $2325 to $5375 up front. The financial side of it is what I’m arguing and you still have not proven to me through math the ROI. This has become a circular argument and you are not presenting any data to back up your claim.

        There’s no such thing as free money!!!!!!!!!

      3. Jeff once you decide to buy the house with a mortgage you can either pay $391 (planet polluting, ever-growing amount) or 378 (really 228) – fixed cost. We could quibble about what “free money” means, but to most people saving money while saving the hospitable environment for our children is the no brainer answer. Whether you look at the morality of poisoning the atmosphere for future generations, or just having more spendable dollars in your pocket every month – this is a no brainer.

  4. Let’s take a moment and analyze cost of owning a home in Flagstaff. The choice is
    1000 (monthly mortgage without worst case analysis)
    391 (extra cost for energy without code upgrades (note this is a yearly figure))
    $1,391 Jeff Oravits plan for Flagstaff

    OR (this is such a hard word for some!)
    $1,378 (cost of mortgage plus code upgrades (note the $378 is is a yearly figure))

    Which is cheaper? Which would you rather pay? Given that it is really obvious – why do you want to pretend you are making housing more affordable? You are making housing more expensive. Gee, thanks.

    AND – mortgages are FIXED costs – energy prices are variable, with the trend being up. Do you want to bet that energy costs will drop (counter to reality)? If not you start out making housing cheaper, and over time it gets even cheaper.

    Kind of no brainer territory – once you include energy costs.

  5. Tom, feel free to do anything you want with your own home but please don’t use the force of government to mandate that others reach your extremely expensive standards.

    Admit it, you don’t care what the cost is because you are fanatical about this issue. Just like you are fanatical about a carbon tax. You’re not even a city resident. Your brand of extremism is not wanted in Flagstaff.

    Thank you Jeff Oravits for having some common sense on this.

    1. Elisha there are plenty of ways to solve global warming – a carbon tax is one of them. My “brand” of extremism is to be deeply conservative. Brand it however you want – I believe in leaving things for our children at least as good as they were when we got them. If that is extremism, I am proudly so.

      As I said, the coercion argument at least makes sense – but to be intellectually honest, you should also be in favor of ending all code requirements – after all a ground wire NEVER pays for itself – if people want to get zapped who are some bureaucrats to stop you? You could be SAVING money!!

      Your arguments are inconsistent because you don’t think them through. The proposed code changes are not some environmental extremists coercing you to waste money – they are the result of THOUSANDS of hours of work by the nations most talented builders – based on hard-won experience in the field and a cold analysis of what will save money.

      The fact that it helps prevent us from poisoning the earth for future generations is a bonus from the code writers point of view. As I am an “extremist” – I switch it around and put the focus on not poisoning our future. The result is the same. Save money, save future generations from a radically lower standard of living – adopt the IEC.

  6. I’m wondering where the authority to mandate how much or how little a house uses comes from? TLW, your example of grounding outlets is invalid, that is a safety issue. What is being discussed now has nothing to do with how safe a house is or is not. Safety was the driving force behind building codes in the first place. Building codes that were in force in the mid west a couple of decades ago made sense to those that passed them but have resulting in houses that were built in a way that PROMOTES the growth of mold and will eventually destroy the houses. What appears on the surface to be a good idea can frequently have unintended consequences.

  7. The sad part, Jeff, is that even after you explain it, the council will still vote in favor of it. They may have been guilty of ignorance before it was explained to them, but after the explanation it can only be stupidity or they are in on the scam.

  8. Jeff I just want to highlight your logical fallacy in coming up with 44 years – it simply isn’t true, and it weakens your argument to pretend it does. Let me walk you through it – in your worst case example the homeowner is spending ~$5k to meet the code. What does that $5k buy them? It buys them the ability to NOT spend $391 per year on utilities. In a strict financial sense – that is what they are paying for (obviously ignoring increased comfort (being cool in July for example), less CO2, more J O B S for builders, a higher home value, etc).

    You then pretend they are only getting $13 in benefit (because they would have had to, in your extreme worst case, pay $378 to the utilities). But they don’t. And you keep ignoring that fact – you can check your logical fallacy by the fact that you have the homeowner STILL paying after their 30 year mortgage is up. They took the $13 AND the $378 and applied it to paying down cost over 30 years. So obviously they are not STILL paying for it after the mortgage is done.

    You enjoy saying ROI – here is the simple ROI that any builder, any homeowner would use:
    Cost: $5872
    reward: $391 per year
    break even: 15 years (no interest/no inflation).

    If you want to get fancy and think about the ROI over the life of the investment – for a 100 year home it would be 6.6% per year on your $5,872 investment
    total value 39,100 (100 years of 391/year)
    total cost $5,872
    value divided by cost 6.6

    divide by 100 to convert value/cost/year 6.6%

    That is tax free and guaranteed. Unlike the stock market. Inflation will work for you instead of against you as it does with any other financial investment (you will save MORE money as prices go up – you lock in the costs today, but reap ever-increasing rewards).

    I realize your brain is locked into this bogus $13 figure. I urge you to think about it carefully – it isn’t $13, it is $391 – and that makes the ROI very, very different. If you ignore 96% of the benefit – you get analysis like 451 years, and homeowners paying for their house for 15 years after they’ve paid off the mortgage – which is math’s way of telling you your missing something.

    1. Yes, if you pay cash for the house, the $391 per year savings in energy with an upfront cost of $5872 to get that savings would get you an ROI of 15 years.

      I AM GLAD YOU ARE FINALLY GETTING ROI BUT Unfortunately you are only getting it when applied to a cash purchase and you aren’t getting it with regard to financing the home.

      When you finance the home you PAY $378 more per year to finance the $5872. $391 (energy savings) – $378 (extra mortgage) = $13.

      For 30 years you will save $391 per year in energy but pay $378 in extra interest. So after 30 years you have recouped $390 of your $5872 that was financed. You need 14 more years at $391 savings per year to recoup the rest.

      1. Let’s take this slowly. You are close to getting it.
        If I do nothing – I have a mortgage that is 5872 lower. – let’s say 100k
        If I invest in energy savings – the mortgage is 105,872.

        The difference is $378 annual (I am pretty sure you are with me this far). Now, please go through this next part slowly, without the mental path you have burned to $13 – that is where you are wrong.

        What does the 5872 buy me? It buys me a stream of payments worth $391 (in your worst case scenario). I USE that 391 to pay down the 378 – leaving me with $13. Your logic ignores the fact that the stream of payments pays off the original investment out of cash flow.

        Read that again Jeff. I don’t have $13 to apply to the 378 (ie the $5872) – I have $13 extra AFTER I pay the 378 – cash flow positive from day one.

        You can verify your logic is flawed because it led you to 451 (which you acknowledged was in error – BUT that same flaw in reasoning is leading you to claim the 5872 is not paid for when the mortgage (which CONTAINS the 5872) is paid off!.

        You are buying a financial shovel. The shovel doesn’t hold $13 – it holds $391.

        The ROI is 6.6% – and that will grow with inflation. And not be taxed.

        There isn’t much difference between cash basis and mortgage in terms of the analysis – if you assume your opportunity cost is 5% they analysis identical. In today’s market a guaranteed 5% would be a very good investment. Here we are earning 6.6% – tax free and growing. But don’t worry about that yet – get your head around the flaw that has you still paying after the mortgage is paid off. Who would you write the check to?

  9. Jeff – I think people can get confused with the mortgages, stream of payments, ROI, etc, etc. So let’s make a simple example.

    I will give you $20 at the end of the month if you give me $15 today (the $5 difference represents the $391 savings of the Energy Code for the startup investment of $5,872- all compressed into a month).

    You go to the bank and borrow $15 (the 5,872), agreeing to pay $19 (all the mortgage payments) at the end of the month (this is the 5,872 plus interest).

    All of the above happens. You give me $15 (paying for the energy saving improvements) on June 1, I give you $20 (your benefit – the energy savings which are greater than the cost to build) on June 30, you give the bank $19 (mortgage payments). The $1 difference is the $13 annual savings.

    Now – do you still owe the bank $19? Of course not. And you don’t owe anyone $5,872 after you paid off the mortgage. Your analysis has us paying off the $5,872 twice – once through the mortgage and AGAIN after the mortgage is paid. Not what happens.

  10. Jeff I trust you were able to see the logical flaws in your approach with the simpler model I posted yesterday. Will you change your position based on your better understanding of the value of energy efficiency?

  11. I cannot believe you can justify your “math” without taking energy inflation into account. I have never seen such blatantly biased statistics. You seem to have done quite a bit of financial, etc. research to back your own point, but possibly do not care to learn about an opposing viewpoint.
    I think I can put this quite simply (though I could demean others as you have in your comments, implying they are not capable of understanding the points you are trying to make). I have a degree in business and math, but do not need to draw from that to make this simple point: the day a corporate monopoly goes to the ACC (Arizona Corporation Commission. They regulate the amount of money the company’s shareholders should be making) to ask for a rate decrease…I can’t even fathom how to end this sentence.
    The portion of your post where you were “kidding” disgusted me. This is a serious political issue.
    I would like to thank you for inspiring me to become more involved in my community. I have lived here since 1996 and consider Flagstaff my home town. I travel quite a bit for work, but will be making a point to come to as many council meetings as possible. I will also be volunteering on the campaign of whoever will be running against you when your time is up.

  12. Jeff congrats on your win in the Council vote. I hope none of the votes were based on the faulty logic you presented. You are not alone in getting confused by complicated word problems. I asked my friends on facebook to either find your error or find mine. They all found yours. One forwarded on your logical error in a different form – maybe you will be able to see it this way:
    http://www.snopes.com/inboxer/trivia/dollar.asp

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