Capital replacement plans typically focus on depreciable assets. However, every component of a building will need to be replaced, repaired or maintained over time. As buildings age, expenses tend to compound, and you can suddenly find yourself without adequate funds to fix problems. Learn what you need to include to properly budget for the future.

by John H. zumBrunnen, CEO, zumBrunnen, Inc.

An effective strategic capital replacement plan requires that a facility owner consider their business model and objectives as primary guidelines in the process.  Decisions to replace capital budget items are often based on your business model or objectives in conjunction with other drivers.  These may include available funds, competition, changing demographics, efficiency, obsolescence, and failure, to list a few.  Since business models and objectives will vary greatly from facility to facility, it is crucial that each facility establish their priorities to effectively plan for their capital replacement needs.  With sufficient financial underwriting, owners will have the ability to execute an effective strategic capital replacement plan.

Fundamentals:

Capital replacement budget plans are no better than the data entered and how well the data is organized.  Most organizations develop their capital plans internally or hire an outside consultant to prepare and deliver a plan.  However, the best plans are developed in a collaborative effort between the owners’ management teams and independent consultants.  The lead consultant should be an engineer, qualified to provide industry standard property condition assessments with a capital replacement budget, known as a PCA.  Having PCA consultants drive the process helps to ensure a comprehensive, accurate, and objective capital replacement plan.

Getting Started:

First, outline your business model, goals, and objectives that will directly impact your capital replacement needs.  Ask the question: what is unique about our business model and objectives that drive decisions to replace a capital item, other than following industry standard data for effective useful life (EUL)?  For example, a progressive senior living retirement community, per their contract with the resident, will replace unit carpet, paint, and appliances for new residents or at a minimum of every 7 years; a far more frequent replacement schedule than would be expected based on EUL data.

Next, identify your capital replacement plan objectives; such examples are: do you need to bring your facility up to a higher level; provide unit cost analysis to assist with vendor negotiations; improve operational efficiencies; improve quality and lower costs by coordinating projects; identify total per unit cost data by activity or area; or have the ability to model data?  Modeling is a powerful tool for decision-making related to consideration such as are we to repair, renovate, reposition, or replace?

Finally, what questions do other stakeholders, such as boards, investors, lenders, or other consultants, need answered?  These groups, in addition to the above questions, must be assured data is comprehensive, accurate, and objective so they can manage liability (their own and the facilities’) and determine short- and long-term financial viability.

The PCA consultant should guide this process to help align it with your business model and objectives. When they understand your needs, they can then determine the required data, term of the data, and properly format the data so it can be filtered to generate the analysis and reports needed.  Your team should include your President and CFO, department heads, PCA consultant, and any other specialty consultants that may be needed to address special and complex facility issues; such as geotechnical, structural, environmental, energy conservation engineers, etc.

Facility Assessments:

By commissioning a comprehensive property condition assessment, you will be able to form a short- and long-term list of the improvements and replacements necessary for your facility.  These would include items such as identifying deferred maintenance, poorly executed or designed construction details, non-compliant construction, and outdated or underperforming systems.  Property owners tend to get “numb” to flaws in their facilities; they may walk past the same crack in a wall every day, and after a while, even fail to notice it.  Meanwhile, that crack may be caused by moisture intrusion, which could eventually lead to costly mold-related issues.  It will prove beneficial to find an experienced PCA consultant to perform your facility assessment.  Consultants should identify areas for improvement and provide efficient and cost-effective solutions.

Hiring a seasoned PCA consultant should more than offset the cost of future improvements or repairs.  As your PCA consultant will have limited time and budget constraints, the more seasoned the engineer doing the fieldwork is, the higher the probability will be for them to identify critical issues.  Be sure they have several years of direct field experience in construction and renovation, and understand your business model and can work effectively in a team environment.

I often advise newly hired executives and facility directors to commission a facility assessment during their first year.  Understanding the health of your facility’s plant is as important as understanding its financial health, particularly if you are stepping into a job.  If problems arise early in your tenure, you may be considered at fault; if you prevent them from happening, you are the hero.

Developing Your Strategic Capital Replacement Plan:

A variety of items should be included in your capital replacement plan.  Administrators often overlook the fact that everything has a lifespan.  Be sure you include major repairs, recommissioning of systems, overhauls, etc.  Since these are not depreciable assets, they are frequently missed as capital expenses, when in fact they can prove to be the major expense in any given year.  For instance, you may not know that you will need a new motor-control center, because your current one has never been a problem.  However, motor-control centers have a life of about 30 years, and yours may be at the end of its lifeline.  On the other hand, you may budget for a brand new generator, while a less expensive overhaul could buy you another 10 years. Remember that, eventually, every component of a building will have to be replaced, repaired, or maintained.  You may not have to replace a brick wall, but you will certainly have to maintain it.  Even sidewalks can be damaged by extreme climate change or cleaning.  Those kinds of factors need to be considered in a capital replacement budget.  Careful examination of a system’s condition, lifecycle, and various options for replacement will aid you in planning for long-term capital replacement funding.

Long-Term Planning:

Executives should take a long-term view when developing a capital replacement strategy.  Apply a forecasting formula to each capital item to ensure sufficient reserves.  Your budget term and financial analysis should include at least one replacement cycle of all major equipment and systems and, too, include the worst total year in the foreseeable life of your facility, which frequently takes more than one cycle.  For example, the typical wood-framed building today, 80% of total replacement costs are incurred around years 10 and 20; some major equipment and systems may have life cycles as high as 30 to 40 years.

As buildings age, expenses tend to compound, and you can suddenly find yourself with a year or two of compounded expenses with little ability to fund those costs.  The more buildings you have, the greater the probability for this to occur.  This could prove to be a stake through the heart.  So, never look at less than a 20-year view, looking forward as much as 40 years, to capture the depreciation, repairs, overhauls, and recommissioning of all major equipment and systems.

Conclusion:

In summary, establish the goals for your strategic capital replacement plan and create a roadmap to achieve them.  Secondly, engage your entire management team in a collaborative process with an experienced PCA consultant.  Assess and collect data for all assets, regardless of the remaining life cycles.  And finally, fund a replacement sinking fund to ensure adequate funds for the life term of your facility.  If you follow through with this program, you should never have to compromise your strategic plan for the lack of funds.

John zumBrunnen is Founder and CEO of zumBrunnen, Inc., an independent construction and building consulting firm founded in 1989. zumBrunnen has a BS in mechanical engineering from the University of North Dakota, completed the US Army Corps of Engineers Training Program in 1972, and is a member of LeadingAge and Community Associations Institute on national and state levels. zumBrunnen has 40+ years of experience in construction, property assessment, development, and reserve budgeting. He is the inventor of the FacilityForecast® software system and a respected author and speaker in the industry.

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