When asked about budgeting practices, surprisingly most managers report they typically develop only 1-year budgets, approximately 20-30 percent do 5-year budgets and less than 10 percent do 20-year budgets. The most common reasons quoted are:
- “We do not see value in budgeting beyond five years.”
- “We do not have the time, dollars, or the expertise to devote to long-term budgeting.”
The reality is annual budgeting expense totals are not the same year after year. The larger and more complex the facility, the greater the potential for large fluctuations in expenses and budget shortfalls. The only way to know what your expenses will be is to budget out far enough to incorporate all major long-term expenses. The tools and resources for long-term capital replacement planning are readily available and affordable.
Plan for the future
Using long-term budget forecasting tools, management can stay ahead of their needs by ensuring adequate funds for all capital expenses. Since expenses can fluctuate dramatically from year-to-year, how far out one should budget becomes a critical question. The term of years on which to base your capital replacement budget should allow, at a minimum, for replacement of the most expensive equipment and building systems (the years with the most in total expenses). As a minimum, budget for at least 20 years; in many cases, 30 or more years are necessary. Most large pieces of equipment, such as boilers, chillers, generators, elevators, etc., and building envelop systems, such as roofs, windows, exterior finish systems, etc., typically have life cycles (or require major repairs or overhauls) of at least 30 years.
There are three basic components to the budgeting process:
- Facility condition assessment
- Complete and accurate data
- Data forecasting techniques
Facility Condition Assessment: A comprehensive physical assessment of your facility is critical to the process. Assessments should be conducted by senior-level consultants. All too frequently, inspection companies keep pricing down by utilizing junior staff to do the fieldwork, which is then reviewed in-office by a senior engineer. You will be best served in the identification of latent construction problems, poorly executed construction details, code violations, recommendations for improvements, and proper evaluation of remaining useful life when fieldwork is done only by experienced field inspectors. Our experience proves this is typically an engineer with 20+ years of on-site construction and quality control experience coupled with a facility inspection background.
Complete and Accurate Data: Accurate cost data should already exist in the records of most facilities. If a facility is 10 or more years old, the majority of capital expense items, including effective useful life data, should already be recorded and available as a good starting point. It then becomes a matter of reviewing and updating the data. For those cost items not yet encountered, or for new facilities, data is readily available from various outside sources such as contractors, vendors, and even Google.
Most capital expenses happen over a longer time horizon
Most residential and light commercial-type facilities, during a 20-year life cycle, will encounter 70 to 80 percent of the total capital budget in years 10 and 20. Higher end commercial construction will be 15- and 30-year cycles. This is especially true for large, complex facilities, such as retirement communities, churches, and schools, where building exteriors and common area interiors take a lot of abuse/use and must be kept fresh and in good repair to remain attractive. Common area paint, carpet, and wall coverings often require replacement every 10 years at a minimum, and facilities such as progressive retirement communities may have unit refresh programs averaging 7 years. Schools and churches have similar needs.
A Capital Reserve Analysis & Budget Study conducted for a progressive 15-year-old CCRC in North Carolina revealed that 45 percent of the total 20-year capital budget was accounted for just by the costs of maintaining paint, carpet, and wall coverings! Other major costs that fall in the 20- or 30-year cycle include replacement or major service of paving systems, HVAC and refrigeration equipment, generators, elevators, life safety systems, and security systems, to list a few. In addition, one of the largest expenses you will probably encounter is your roof systems. If poorly installed, you can expect major repairs within the first 10 years, though the average life of the typical roof is 20 to 25 years.
For these reasons, long-term capital expense projections of at least 20 years are a necessity to identify and accurately amortize these capital expenses. Once detailed listings of repairs, code issues, overhauls, routine capital replacement, recommissions of systems, and recommended improvements are made, the next step is to apply proper forecasting techniques.
How you plan is just as important as the plan itself
Data Forecasting Techniques: As to our third point about forecast techniques, the most important factor here is this should be a collaborative effort between the client and consultant. Most capital replacement forecasting software modules/packages and consulting firms primarily rely on standard industry published effective useful life (“EUL”) data, such as published by HUD. The reality is most replacements or repairs are driven by other factors such as climate, quality of maintenance, obsolescence, original quality, budget constraints, timing, efficiencies, competition, etc., to name a few.
Forecasting replacements is not a cookbook process of plugging in an EUL value. The individual doing the forecasting needs to understand your business model, as well as how tall these other factors will drive the decision-making process for replacements. The critical point being: replacement schedules need to meet your needs/reality as much as possible. There is no point in forecasting, say, a replacement of a roof in a particular year if you cannot do it at that time. You may find you can phase the replacement or make repairs so the replacement can be scheduled for a later date. Forecasting schedules need to consider budget limitations, the ability to execute the work, and the other factors related to your business plan.
If you follow these three fundamentals of (i) a proper facility assessment, (ii) assemble complete and accurate data, and (iii) utilize proper forecasting techniques, you will have a capital replacement budget reflective of your business model. This is your best protection to manage the unexpected and to achieve your goals…and you will find that your allowance will be enough!
About the Author:
Rob Milam is the CEO of zumBrunnen, Inc. He has more than 25 years of diverse experience in the construction industry. Rob has worked in multiple market sectors and in all phases of construction management. During his career, Rob has worked on a broad range of facilities including senior living, residential, multi-family, industrial, office, and healthcare.
Rob Milam
Project Manager and CEO
