Capital Budgeting in Facility Expansion Projects

Capital Budgets: A Step-by-Step Approach

Capital planning and budgeting go hand in hand: “Capital planning is a way of defining how you’re
going to spend money to get the most impact for your organization and its mission,” says Ray
Dufresne, vice president of consulting services, VFA Inc., Boston. “Capital budgeting is knowing
what you’re going to spend your money on in the next year (or two or three). In many
organizations’ budgets, [facilities spending is] second only to labor.”

An all-inclusive capital budget covers the entire property and serves as a means to evaluate its
physical condition, pinpoint existing and anticipated needs, determine upkeep/modernization costs,
and find ways to address these needs within financial limits.

Abiding by these principles when developing a capital plan can help ensure that your capital
budget is more thorough, accurate, and meaningful:

Define the needs of your facility, preferably over a period of 3 to 5 years.

Identifying facility needs is best done via a comprehensive evaluation of all facilities and their
systems - otherwise known as a facilities condition assessment. Some facilities professionals
choose to outsource this task to an independent firm; others choose to take on the assessment
themselves. “Outsourced facility audits are always an option,” says Charlie Dismore, training
director, Capstone Real Estate Services Inc., Austin, TX.

However, dependence on outsourced services can ignore the expertise you have with both the
organization’s mission and its physical premises. But, he points out, “There is no substitute for
experience in being able to accurately predict costs for capital projects. If you don’t have it, try to
hire it.”

“It should be a very property-specific inventory of what exists, including an assessment of current
conditions, a projection of remaining useful life, etc.,” says David Whiston, president, On-Site
Insight Inc., Needham, MA. Condition assessments can also create the foundation for an effective
preventive maintenance program, help make decisions regarding short- and long-term needs, and
differentiate between actions that should be handled by the operating budget vs. those that
require new capital. (The worksheet featured in a link below may help you get started with your
own condition assessment.)

As data is gathered during a condition assessment, it’s sometimes collected without a clear
understanding of its objectives. Keep your goals and intentions in mind: What do you want to
establish with this data? If you know how you’re going to use the information, it may influence how
(and in what format) you collect it.

Databases can be useful in this process: “They can be analysis tools. They can look at the effects
of the decisions you make. They can create scenarios and play out those scenarios to see - based
on the decisions you make today - what the future’s going to look like,” says Dufresne. However,
Whiston cautions facilities professionals against the widespread, excessive enthusiasm he has
seen for automated solutions. “Before worrying about slick manipulations of automated data, you
should care about the quality of the baseline assessment,” he emphasizes. Do you understand the
real physical circumstances of the facility over time? Have you found opportunities to make
equipment more cost effective?

Distinguish between costs for operational and capital expenses; estimate the costs and timing of
the work.

Whiston says he often sees a much more limited scope to the capital-planning process than makes
sense. “[Facilities professionals] want to concentrate on 10 or 15 big-ticket systems and think
about the costs and remaining useful lives associated with them. But, if you’re only focusing on big-
ticket items, you’re missing an opportunity to optimize the assets.” A perfect example: The boiler.
If you think about a boiler but nothing else in the boiler room, you’ve missed the opportunity to
operate the system more efficiently. Paying attention to the relationship between the “big” things
and the “little” things really warrants notice. Dufresne agrees: “Seeing capital budgeting as, ‘I’ve
got a budget of X million dollars for next year; what am I going to spend my money on?’ and
focusing on that - without looking at the big picture and how needs are going to change over time
- is a big mistake. It’s not the initial cost that’s going to kill you, it’s the cost you put in on a
periodic basis that [ends up being] the majority of the money you’ll spend from capital.”

Dismore says that life-cycle costing is one of the least understood (but most significant) aspects of
a capital budget. “The wise manager will understand and apply the concepts of not only acquisition
costs, but the necessary expense of design, installation, maintenance (both preventive and
anticipated corrective), training, projected longevity, and any recovery opportunities at the end of
the life of the equipment or product.”

Prioritize capital projects and identify those that should be addressed in the order of need or
perceived value.

Many experts suggest that facilities professionals prioritize capital-equipment purchases and
projects in this order:

Start with projects that pose health, safety, or code-related issues.
Move on to the items on the list that will have adverse consequences if they’re deferred.
Next, undertake the tasks that will help you reduce future capital and operating costs.
Lastly, think about the marketability of your properties and the projects that will add
perceived value to the organization.

When making decisions about which capital projects and equipment purchases to tackle first,
remember that there are standard useful-life assumptions for virtually everything in commercial
real estate. “Certain kinds of roofs have a 25-year useful life, for example,” explains Whiston.
“But, we’ve seen 2-year-old roofs that are effectively bathtubs; they won’t achieve anything close
to an industry-standard useful life. If you rely on industry rules of thumb in the capital-budgeting
[and prioritization] process, you’ll miss the mark far more often than you hit it.”

Define the annual capital program for the next fiscal year with guidance from senior management.

Ideally, capital planning should be a year-round process. In reality, most organizations don’t have
that luxury. As much as possible, think about the budget as an ongoing course of action - even if it’
s something that really only happens once per year.

Dismore recommends a continuing, long-range capital planning program that’s validated and re-
estimated every year: “Anticipated projects [should be] evaluated and either moved into the
coming fiscal year to be addressed, moved further into the future, or scrapped if no longer
viable.” He emphasizes that evaluation notes should be compiled throughout the year for
consideration by the capital-planning team.

He also recommends that facilities professionals plan for between 5 and 10 percent of estimated
total project costs to be available for contingency. “The single most difficult aspect of [a budget] to
control is change orders. These have a way of blowing the budget out of the water.” If you can
plan in advance (as much as possible) for these events, your budgets will be more realistic.

Solicit bids from qualified contractors or vendors for new equipment, projects, etc.

This step in the process can make your capital budgets even more true to life. Whether you’re
talking a simple lighting-system purchase or an office renovation, make certain that the
contractors and vendors you’re working with have ample time to respond to bid requests; rushing
this process can increase the amount of the estimate if the firm doesn’t have enough time to
deliver the needed product or services.

Enlist professionally qualified assistance to help you determine the actual needs and relative costs
of design, construction, and oversight of large projects. “Attempting to save soft costs up front
may result in higher overall expenses for a capital improvement project,” says Dismore.

Throughout this process, pay attention to the details: What’s it going to cost to remove your
existing roof before you install the new one? How difficult will it be to get the existing boiler out of
its space before you replace it? Include the answers to these questions in your budget. “Be
rigorous about the uniqueness of your property in terms of the quality of materials, how well it’s
maintained, environmental impacts, how the systems are used, etc.,” says Whiston.

Leah B. Garris (leah.garris@buildings.com) is senior associate editor at Buildings magazine.

Key Concepts

Although there’s an entirely
different expectation for owners
seeking long-term appreciation of
a building vs. those interested in
selling a property in short order,
any operating budget reflects the
priorities of the business and the
resources necessary to
accomplish those priorities.

Outsourcing
Your Capital Budget?

Some facilities professionals opt to
bring in a consultant during the
capital-budgeting process.

“Consultants provide an
advantage by giving you
additional resources to collect
information in a very consistent
manner,” says Ray Dufresne, vice
president of consulting services,
VFA Inc., Boston. “You’ll be able to
make decisions across multiple
portfolios.” Once the information
has been collected for the first
time, you can maintain that
information internally or have a
third party continue to collect it.
Another advantage of a third-
party assessment: Your budget
may have more sway if it comes
from someone outside the
organization.

Decide whether capital planning is
an exercise for you to take on
yourself. “Many facilities
professionals conclude that they
have holes in their skill sets when
it comes to being able to do this
well,” says David Whiston,
president, On-Site Insight Inc.,
Needham, MA. However, he
emphasizes that if you do decide
to recruit help, the third party
shouldn’t be working in a vacuum.
“You don’t want to hire someone
to look at the portfolio, pull
together what they think makes
sense, and send you a report and
bill that says, ‘Here’s our answer
and our bill. Good luck!’ It should
be a collaborative process where
you bring the objectivity of a
consultant together with your
knowledge of the facility.”