By October 19, 2010 1 Comments Read More →

The Capital Renewal and Deferred Maintenance Rule of Thumb

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Capital PlanningI’m not a big fan of the ‘rule of thumb’ for anything except to point you in the right direction. It’s more important to understand the underlying reasons for the rule so when you break it, you do it right.  One of those rules of thumbs is recapitalization or capital renewal.

The figure of 1-2% per year is the one I see the most. On average, this probably makes sense, but who is average?

In the first place, the real lifecycle schedule isn’t evenly spread over the years, it has some major peaks. In the second place, like the typical BOMA, ASHRAE and RS Means life estimates of building systems and components, they can’t take into account your specific operating conditions, which impact the use and load on equipment and finishes, affecting their condition and ultimate life and reliability.

As usual, and rightly so, it’s all a matter of priority. Some equipment you want to replace when it begins to be unreliable. Others should wait until they fail, which may be well beyond their theoretical useful life or may be much shorter than you think it should be. It depends on your specific conditions, run-time and other factors such as your maintenance / refurbishment schedules.

In my experience managing large portfolios, capital replacements are often stretched beyond the theoretical life for economic reasons. A deciding factor for some of the higher cost items to get them done earlier rather than later is increasingly becoming the energy conservation benefits after the retrofit – and is factored into the economic decision.

What it means is that in any given year, you will need very little or a lot of capital renewal funding, so your organization needs to be able to plan for the spikes. And instead of using averages, you are better off doing a replacement capital plan based on the systems and individual components, which will tell you in what years the money needs to be spent, then work from that to determine how to fund your capital replacements. The approach taken in condominiums, where they put some money aside each year in a reserve fund to pay for future requirements, is worth looking at. It’s an approach I helped one of my non-profit clients put in place. If you can’t do that, at least a long term capital plan will prepare your organization for the upcoming costs.

Of course as mentioned, when you are determining your capital requirements, you need to go beyond the standards identified by BOMA/ASHRAE and other sources.

For instance:

  • How old is the building and related components?
  • What is your ownership plan (i.e. how long will you be there?)
  • How much replacement has been done already?
  • How much usage does your equipment get (9-5, 24 hours, AC all year round, Bitter cold temperatures, sandy/dusty environment, etc.)
  • What are the environmental / energy consumption impact of old equipment?
  • How well has the equipment been maintained?
  • Have you been having chronic problems/failures already?
  • What is the risk of failure?

Remember that the capital plan will have peaks and valleys. A reserve fund starting on day one should take that into consideration, but if you start late in the building’s life, the amount you need each year will be higher. That’s why many organizations identify a very high deferred maintenance amount – for things they figure should have been done but haven’t, sometimes based on the theoretical requirements, not the practical ones. The real needs are somewhere in-between and to get attention from your organization, you need to manage the requirements to a ‘need to do’ level.

The best way is to do a capital study (using an engineer if possible) that looks at the effective age (condition) of the equipment. This isn’t a science – it takes someone with experience. This process takes real life conditions into account to decide when it is likely to need replacement. Just because ASHRAE or BOMA says a chiller has a typical life of 25 years doesn't mean you have to replace it at 25 years. These days, energy conservation considerations sometimes drive replacement timing as well, so the decision may depend on some economic analysis of maintenance and energy savings relative to the capital investment. Otherwise known as Lifecycle Costing.

With the capital plan and related capital replacement estimates for the equipment in the year it is planned for replacement, you can then figure out how much should be funded. Then, add in the risk related to failure for each item to prioritize your list. Based on these factors, develop a year over year plan and update it annually based on the funding you’ve achieved from your business cases and justifications.

If you want to go one step further, do the lifecycle analysis. It’s a process with inputs and decision making that takes into account replacement costs, running costs (energy, consumables) and repair costs in addition to assessments of condition/useable life. This will strengthen your business case. If relevant, also include the chance of failure and the cost of failure as well as the incremental cost of replacing the unit under emergency conditions instead of a planned replacement.

If you can use Excel and the Net Present Value formula that’s built-in, you can do financial lifecycle analysis yourself. It's getting the inputs and developing a process around it for decision making that is more challenging, so focus on larger equipment with higher maintenance costs or energy consumption.

And as I always say, be sure to understand why you are doing it and the decisions you expect to make before starting the process. If you will be making a case for funding, think about what you need for your business case from the beginning.

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