FSP0005 – Capital Replacement Planning – Facility Science Podcast #5

Notes for FSP0005 – Capital Replacement Planning

• Every building, piece of equipment or machinery, mechanical or structural component, surface, door, floor covering, roof, piece of furniture, sidewalk, electrical device, pipe, elevator, even the trees, everything, will eventually need to be replaced or substantially refurbished or rebuilt.
• It will be expensive.
• We have a choice, we can wait until something fails and creates an emergency situation, run around with hair on fire when surprise surprise that expensive thing we’ve been relying on doesn’t last forever.
  • This is the default “plan” and is used by many businesses
  • Can result in unplanned business down time, unplanned expenditures, loans, etc.
• Or we can predict when these things will need to be replaced and make a plan to replace them ahead of time.
• This is called capital replacement planning. Sometimes called “recapitalization” or “capital renewal”
• In this context “capital” is any durable property that has economic value to the business.
• I should note that this isn’t a maintenance plan. You should have that too, but this is a plan for what to do after maintenance.

1. Assess the facility, systems
   • In order to make a plan for how you are going to replace everything, you need to know what “everything” is. You need an inventory, and you need to know the current condition of each thing so you know when it will need to be replaced.
   • If you have a CMMS and use it, you might already have an inventory.
   • Facility Condition Assessment (FCA) is the name for the process of analyzing the condition of the facility and all of its component systems. This is a topic by itself so I might cover later on the podcast. Can also create an inventory if you don’t already have one.
     • Proper FCA requires expertise in a wide array of building concepts, typically performed by architects, engineers, tradespeople.
     • Can hire consulting firm to do the FCA. Experienced firm will have access to all of the relevant resources and knowledgeable professionals to do a proper FCA.
     • FCA consultant can help prioritize imminently needed repairs or replacement, recommend maintenance to prolong life
     • If you can’t afford to hire a consultant to do a proper FCA, you might have expertise in-house or with your maintenance or repair contractors to do a partial, piecemeal FCA, making sure to cover the most critical systems first.
2. Determine useful life of each item.
   • You’ll need to know the general useful life of a new item of each type and also, initially, the remaining useful life of the in-use items in your facility.
   • Useful life can be determined by consulting industry organizations, manufacturers (with a grain of salt), experience with a type of asset (your own or that of trusted experts), your FCA consultant can also provide insight.
   • Various criteria contribute to an item no longer being useful (what does it mean for something to be past its useful life?).
     • Most obvious is wear and tear/break down.
     • Technological advancement makes certain things obsolete, so no longer useful – newer technology might be much more effective or efficient.
     • End of manufacturer support might increase cost and risks associated with use. Especially relevant for items with specialized parts or for software and computer systems that need regular updates (especially relevant for IT security).
   • Generic useful life values (in years) are a starting point. Actual use case will affect actual useful life.
     • A item that is heavily used will wear out faster, while an item that is lightly used item may last much longer. Consider that a high quality, lightly used door in a favorable environment could last 100 years or more while a heavily used door in harsh conditions might need to be replaced after a few years.
     • Environmental conditions. Example, a rooftop air handler will deteriorate much faster in a salt air environment (so near the ocean) than in a dry area away from the ocean.
     • Maintenance – well-maintained assets will last longer than neglected assets.
     • Quality – a high quality item will last longer than a lower quality item (though life cycle cost should be determined to see how more frequent replacement with a lower initial cost compares with less frequent at higher initial cost)
     • Construction/Installation methods

• With the useful life data and current age and current condition, you can now determine a replacement date for each item and make a replacement schedule.
• You should look 10-40 years (maybe more depending on industry and facility type).
  • 0-10 years will be accurate,
  • further in the future will be less certain, but still important to forecast. The most expensive to replacement components last a long time, some might last 30-40 years and you then incur massive expense (roof, parking lots/garages, building structural components).
• Some items may need to be replaced immediately (safety, code compliance, failure imminent), your FCA consultant or contractors can help you identify these.

• Next step is to determine the replacement cost for each item.
• Replacement costs include obviously purchase, installation, commissioning of new equipment
• Also include removal and disposal of old equipment.
• Several ways to get cost estimates:
  • Ask contractors or suppliers for estimates (not looking for firm quotes, just ballpark estimates)
  • FCA consultant firm might be able to provide reliable estimates for many items.
  • Contractor estimating guides – tools and other resources contractors use to estimate the cost of work.
  • Past experience in your organization
• Other costs of replacement might include, design/engineering work, relocation or accommodation of normal users of area if replacement project affects normal use, project management or other use of staff to facilitate replacement project
• When considering replacement cost, quality of replacement will affect useful life. Consider that a higher quality replacement might cost more, but also last longer, while a lower quality item might cost less but need to be replaced more often. Life cycle cost analysis can help decide which is better.
• Will need inflation adjusted estimates for budgeting in future years. Ask your accountant how your business handles this.

• Now that you have a schedule and estimated replacement costs you can make a budget that will tell you how much you will need to spend on capital replacement in each future year.
• Many useful life estimates are in divisible by 5 or 2 or are given as a range. You can smooth put the estimated budget by moving some things to other years, year 13 or year 17 or year 7 or choosing convenient years in the ranges.
• Tools to use
  • Can be done reasonable well in a spreadsheet
  • Purpose built budgeting application
  • Functionality is built into many cmms/fm software packages. they can take your inventory, installation dates, useful life estimates, and replacement cost estimates and generate this type of budget automatically.

• Now get your plan approved. Your presentation goes something like: Here’s my capital replacement budget forecast for the next 25 years, here’s how I arrived at this forecast, and here’s why you should take this seriously.
• Does your organization do this kind of planning already?
  • Good for you. If you’re well-prepared, your plan should get approved.
• Your organization never did this before?
  • You’re telling them that you plan to spend a lot of money to replace stuff that still works. They might not like this idea. Speak their language: risk management, predictable expenses, benchmark and metrics.
  • You can tell them about the consequences of not spending money
    • Story: Air conditioning unit for a small data center failed catastrophically after >15 years of service and had been limping along for several years. No good solutions available. New unit was ordered with couple months lead time. Rented portable air conditioning for intervening period cost more than the replacement.
    • Surprise unplanned down time.
    • Surprise capital expenditures
    • Extra costs of dealing with emergency
      • Example, a lot of equipment has long lead times, have to make temporary provisions to keep business running while waiting for new equipment. Temporary provisions cost money.
      • Surprise end of life might happen right in the middle of production, while planned end of life can be scheduled at most convenient time.
      • If you’ve been in the business for a while, you can probably dig up some examples to quantify this, to give them an actual number.
    • Impact to image of business.
    • Impact to employee morale or perception of employer (have to work in this dump where everything is breaking down all the time and the bosses don’t care).
  • Tell them about the benefits of your capital replacement plan
    • This stuff id going to need to be replaced eventually, let’s do it on our terms instead of being surprised and dealing with an emergency every time.
    • We can do a proper job spec and bidding process each time instead of only initiating replacement as response to emergency situation
    • Replacing equipment at “the right time” can maximize the economic life of the old equipment and maximize the benefits of the new equipment. Old equipment has higher maintenance costs and lower efficiency, new equipment hardly needs any maintenance in early years (this can be quantitatively demonstrated by comparing life cycle cost analysis of new and old equipment and finding the theoretical “optimal” year for replacement). Older equipment might have harder to get parts and service making reactive maintenance more expensive. Example: I mentioned R-22 refrigerant before….if you have AC/refrigeration equipment with CFC refrigerants, it might still be working great, but a refrigerant leak (which happens) is going to be a very expensive surprise, where a refrigerant leak in newer equipment will be a minor inconvenience.
    • We can plan replacement down time instead of being surprised by it (what is the cost of surprise down time).
    • We can have a predictable facilities capital budget year after year instead of always having to make emergency expenditures.
  • Benchmarks and metrics (you can’t manage what you can’t measure and business managers like things they can manage)
    • Facility Condition Index (often FCI) is the ratio of current facility deficiencies (outstanding maintenance, repair, and replacement costs) to current building replacement value. In other words that’s the amount of money required to bring the facility to “functioning like new” condition divided by the amount to build the facility from scratch. . So an FCI of 0 means the building is in perfect condition, while an FCI of 1 means it would cost the same to repair the facility as it would cost to replace it (so you might as well replace it). Used to compare the condition of facilities relative to one another
      • CMMS might be able to calculate this number
      • from fmpedia (IFMA knowledge library), vallues of FCI are commonly interpreted as follows:
        • 0 to 5 percent (0-0.05) – Good
        • 5 to 10 percent (0.05-0.1) – Fair
        • 10 to 30 percent (0.1-0.3) – Poor
        • greater than 30 percent (>0.3) – Critical
      • Present current FCI, agree that it is a reasonable metric. agree on a target, show improvement year to year. Can also be used to justify spending on maintenance programs.
    • Replacement spending as percentage of replacement cost of entire building.
      • A common reference is that each year you should spend 2% of building replacement cost on capital replacement.
      • 2% number is somewhat arbitrary and you shouldn’t expect that you will really spend 2% every year, just that over the lifetime of the facility you might average 2%. Some years will be less and some more.
      • Also 2% might not be right for your facility and industry. maybe it 1.5% or maybe it’s 3-4%.
      • Number will be higher to catch up if building is older and assets have been neglected
      • Good article about this:  “Recapitalization and Capital Renewal – what’s the number” linked in notes: https://www.tradelineinc.com/reports/2010-5/recapitalization-capital-renewal-whats-number
      • Point is that this spend percentage can be used as a benchmark and it can be tracked and managed and averaged and adjusted from year to year based on the performance of the capital replacement program.

• The method of funding your capital replacement plan depends on accounting and investment philosophy of business, also potentially regulatory restrictions on allocation, investment, spending (public sector, non-profit, etc)
  • Have a “sinking fund” or “capital reserve fund” to pay for planned replacements
    • Using your budget forecast, you can calculate an annual or monthly dollar amount to add to the fund that will cover replacement plan given the expected expenses for each year. This allows smooth, consistent allocation of funds out of revenue while actual expenses might come in large, not consistent chunks.
    • Fund can be invested with investment return potentially augmenting deposits. Investment can also offset inflation.
    • Could retain only a partial fund to cover years with higher than average capital replacement cost and use revenue or financing to cover normal or less expensive years.
  • Fund capital replacement from business cash flow or income.
    • depending on your business philosophy with respect to investment and cost of capital, your organization might not want to set aside a large amount of cash just for capital replacement. They instead want to invest in business growth while potentially retaining some earnings for general use.
    • In this case it might be more important smooth out the annual replacement to make allocation more predictable…basically try to keep capital replacement allocation close to the same percentage of company revenue each year. This can be done by shifting things forward and backward a few years, spreading certain expenses over multiple years, prioritizing (talked about this earlier).
• Sometimes there won’t be enough money to cover everything in the capital replacement plan. In this case you need to prioritize.
  • Highest Priority: Life Safety, Structural Integrity, Legal Compliance (probably in that order) – first replace things that risk hurting someone or destroying the building, or getting your business shut down. (FCA consultant can hep you identify these things)
  • Next Priority: High return replacements – Some replacement will have a clearly superior financial benefit in terms of efficiency or savings in maintenance or whatever. Doing these helps free up more money for next year’s budget.
  • Next Priority: Productivity, morale, business mission – These are things that will help your business make more money, which is good for everyone’s budget.
  • Next Priority: Aesthetics, company image, historical preservation, advance strategic plan
  • In evaluating priority of a replacement or deciding whether something needs to be replaced this year, look at the actual condition of item at. If an item has reached the end of it’s “useful life” but is in relatively good working order, replacement could be postponed until next year if funding is tight or more urgent priorities surface.
  • Also consider the impact of failure before replacement. Replacement of a mission critical item or one where premature failure would cause harm to people or  incur massive amount of additional expense shouldn’t be deferred too long, while replacement of out of the way item or convenience item or item with redundancy might be more safely deferred.

• Review and Revise the plan annually
• Each year you can evaluate the accuracy of your forecasts, your assumptions about useful life and replacement costs (compare that to what actually happened) and revise the plan accordingly.
• You want your budget for next year will be well-informed by experience and past performance of the program rather than by the assumptions you made in the initial plan.

• You’ll be taken more seriously at budget time
  • Without a capital replacement plan you go into budgeting time with a list of things that you think need to replaced next year because you think they will probably break down soon. They say, “yeah but that stuff is still working, so maybe you can do three of them (and the approval may or may not ever come through).”
  • With a capital replacement plan, you already have buy-in on the concept, management has already seen your long-term budget forecast and justification in their language, so budget time is just a formality to iron out the details. You’ve given them the information they need to understand where the money is going and why, so they can manage the costs (which makes them happy)
• Morale of facilities staff and contractors
  • It’s demoralizing to the people who actually physically keep the building together to watch it fall apart around them.
  • Nobody likes doing a bunch of extra work to clean up an emergency, especially when they know the emergency could have been prevented if the equipment had been replaced 3 years ago when they warned you that the thing was falling apart.
  • Everyone would rather schedule replacement at the most convenient time rather than perform emergency replacement work at whatever time it has to be done.
• Make FM a strategic partner in the business
  • In many organizations FM is viewed as the on-call janitor or mechanic.
  • FM is seen as overhead, constant source of problems.
  • Success with this type of planning can help you be seen, instead of as a janitor or mechanic, as a competent manager of valuable company assets.
  • Can be a stepping stone to moving your FM program into a more strategic role with the company.