A water heater includes a storage tank communicating with a cold water supply pipe and a hot water supply pipe for the respective supply of cold water to, and removal of hot water from, the tank. The water heater also includes an insulated heat recovery module communicating between the cold water supply pipe and the tank. The heat recovery module defines a cavity, and the cold water supply pipe communicates with a lower portion of the cavity. The heat recovery module has a smaller surface area-to-volume ratio than the cold water supply pipe. When water in the tank is heated, some water is thermally displaced from the tank and into the cavity. Consequently, water is displaced out of the lower portion of the cavity and into the cold water supply pipe. Therefore, only the coldest water is displaced out of the cavity, and thermal energy loss is reduced.