Using real estate market fundamentals to determine the correct discount rate for decentralised energy investments

Abstract

Decentralised renewable energy production (on-site energy) is potentially more profitable than commonly believed, especially in urban areas characterized with well-functioning real estate markets and low property yields. Traditional calculation methods, such as the levelized cost of energy, ignore the value on-site energy production can create to property owners through capitalizing the decreased energy costs. Past research has found that these methods are very sensitive to the discount rate, whose selection is very difficult. Evaluating the profitability of on-site energy as part of the underlying property has two major benefits: property yields, defined by real estate markets, can be used as accurate discount rates and economic value created to the property owner is quantified. To justify the use of property yields, risk profiles of energy and property investments are compared in this paper. Subsequently, a theoretical framework of on-site energy investment risks is created and demonstrated with geographical information system analysis modelling the profitability of rooftop photovoltaics in all buildings in the city of Vantaa, Finland. The findings question the traditional way of equalising the discount rates of on-site energy investments in larger geographical areas and suggest that property yields can be used as discount rates for on-site energy investments.