Plan to Live Forever!
OK, not you — we’re gonna talk about your buildings here. I’ve personally accepted the fact that people are sadly mortal.
‘Useful Life’, the term instigated by CPA’s, FASB and the IRS, is hardly a definition of either usefulness or life. For example, I live in a house constructed in 1913, a whole lot older than any accountant’s notion of useful life. Although it has a few maintenance items, I plan on enjoying life here for many years to come (usefully, even).
What’s the best advice for planning and funding a building’s perpetuation?
Fortunately, I had a collaborator on this subject. Mort Engstrom of Morten Engstrom Consulting, the most thoughtful of Capital Managers, was my trusty guide for many years, while we both toiled away, wrestling with this subject virtually every day.
First, let’s define some terms:
This is the ongoing, annoying stuff you have to take care of to carry on business: replacing burned-out light bulbs, fixing the leaky washers in the faucets, oiling the pumps, moping the floors, etc. This is what you do every day to keep up.
- Deferred Maintenance
This is the accumulation of all the broken or worn out things fundamental to the operation and function of your building, which you should have taken care of already; but, for whatever reason, you have let go. This is ‘Capital Maintenance’ that you failed to do when it was called for. See below.
- Building Upgrades
Codes and Standards change. New technologies get incorporated into business and institutional practices. What was acceptable in 1930 is perhaps not acceptable today. Sometimes the use of a building changes altogether. These changes must be paid for.
- Capital Maintenance
Unless preserved in giant hermetically sealed bubbles, buildings wear out. Roofs have to be replaced. Windows no longer open or shut. Brickwork must be repointed. Pipes are corroded. Floors have been sanded to the point where there’s hardly any wood left.
Close Your Mind — Briefly
Forget (for now) about three-quarters of the preceding. Routine Maintenance, Deferred Maintenance and Building Upgrades, while important, are not crucial to the message of this exercise. Planning for Capital Maintenance is the topic. Properly administering this important component of your facility's budget is crucial to perpetuating its life.
Many years ago, principals of Pacific Partners Consulting Group (PPCG) based in California presented very good papers on this subject to the Society for College and University Planning (SCUP) and the National Association of College and University Business Officers (NACUBO).
They identified four commonly used methods of establishing budgets for Capital Maintenance:
Percent of Capital Replacement Value (CRV)
In their paper, they methodically graded the merits of each approach. We’ll save you, and cut to our view of the respective values:
- Plant Audit: Essentially worthless.
When used correctly, Plant Audits (usually called Facilities Condition Assessments or FCA’s) have good value for quantifying Deferred Maintenance, not projected Capital Maintenance. More thoughts about FCA’s can be reviewed in No Left Turn’s November 2009 Newsletter.
Darn it – Forget ‘Useful’
- Depreciation: Also essentially worthless.
Depreciation is typically an accounting practice for ‘expensing’ the investment in the capital assets of an organization. While it may be of value for companies and institutions to actually ‘fund’ their asset depreciation with monetary set-asides (it’s better than doing nothing), that funding bears little relation to actual need. What, for example, happens when the depreciation has been fully expensed? Do the buildings no longer need maintenance? Not likely.
- Percent of Capital Replacement Value: If you don’t know what else to do, do this.
The bases admittedly may be crude. Estimated Capital Replacement Value is sometimes subjective (e.g., replacement in kind, or with budget construction), and the percent of CRV is the inverse of what some insist on calling ‘useful life’ (i.e., set aside 2.5% of CRV for buildings you deem to last 40 years).
There’s not much verifiable science behind this approach, and the rules of thumb are arguably intuitive; but at least it ensures the creation of an account upon which you can draw to maintain your facilities. You may have to live with the uncertainty that it’s adequate.
- Sub-System Model: Finally, something worth sinking your teeth into. A better tactic that requires somewhat more effort to effect.
PPCG outlines an approach in their NACUBO paper, describing the generics of the method, and correctly stating “…that it is based on sound theory, benchmarked against industry standards, and tailored to fit the institution.”
Specifically, this approach uses facility type, defined subsystems, replacement cycles and accurate cost estimates to calculate refined Capital Maintenance set-aside recommendations.
We are often prodded to assign buildings a ‘Useful Life’, but in reality it is the individual components which age and become dysfunctional at different points in a building’s life. Some elements, such as moving parts, wear out rapidly. While others, like foundations, remain functional for long periods. It is therefore of little value, except as a convenience, to discuss the “Useful Life” of a building.
It is more appropriate to think of a building as an ongoing entity, with no defined life, assuming that components are replaced as they break. However, there is a point at which the user should have spent an amount equal to the replacement cost of the building. This can be considered a ‘Life’ of sorts; call it the ‘Financial Life’ or ‘Cost Accumulation Period’.
Note that the Financial Life calculated with the Sub-System Model can differ, sometimes significantly, from a standard or accounting life. It’s a consequence of taking into account the type, quality and details of the building. The budget recommendations for Capital Maintenance consequently differ from the other approaches.
Now Budget — And Spend!
Simply dividing the Capital Replacement Value by the number of years in the Financial Life provides the amount which should be set aside annually. This average annual amount represents the users’ true consumption of the building, and as a matter of equity, each year’s set of users should pay for their consumption, irrespective of whether the money is actually spent in any given year.
Converting the Financial Life Calculation to a %CRV per year is also possible:
%CRV per year = 1/Financial Life years
Voila — a %CRV that actually has backup. Use it.
Stash the money away in a safe place. Then, when building systems require proper maintenance, the funds are there to do the work. Failure to make this set-aside, and spend it appropriately, is the principal cause of increasing Deferred Maintenance.
The Ohio State Model - Updated
Mort and I have arrived at a similar place to PPCG. However, we believe there is a better way to coordinate with common specification and cost estimating practices. We have found that Constructors and Construction Cost Estimators are typically entrenched with standard Construction Specifications Institute (CSI) categories.
In the early 90’s, Ohio State University, in an attempt to refine its capital budgeting process, adopted a version of the Sub-System Model. By tweaking that approach into a CSI-consistent format, we can productively engage affiliated professionals into the process, producing more reliable and defensible Capital Replacement Value and component life estimates.
In any event, variations of the Sub-System approach are possible; and are likely to be superior to other methods.
Keep Your Hands Out Of The Cookie Jar!
All four of the defined terms require needs-based budgets. Unfortunately, combining them has become commonplace. Consequently, it’s not unprecedented to see Capital Maintenance money used to fund Deferred Maintenance. Worse yet, some business managers have been known to pay for new construction from Capital Maintenance accounts, in complete opposition to the principles of recommended practice.
Sometimes, too, people with more brains than common sense will optimistically rationalize many Building Upgrades and functional updates as having offset components of Capital Maintenance. Often their conclusions are neither accurate nor wise. Too much manipulation makes for murky management.
The fundamental principle: those who use the building should pay for it, year after year. Otherwise they are shifting the burden of bearing the cost to others.
Discipline is a worthy trait.
Miracles Are Possible!
Perpetual life — forever useful. All it takes is sound money management.
Remember — buildings, not people.
Missed earlier newsletters? Find them here:
November 2010 “May I Have A Plan, Master?”
September 2010 “How do we choose?”
July 2010 “Good People Behaving Badly”
May 2010 “LEED: LEADing or Dead Weight?”
March 2010 “Why does it cost so much?”
January 2010 “Design/Builders show us your softer side.”
November 2009 “What the Facilities?”
September 2009 “Why Do Architects Make Good Owner’s Reps?”