In both cases it is important that the assessment techniques provide a consistent approach that allows for a like-for-like comparison of costs and performance.
The establishment of the Occupier Property Databank (OPD) Total Occupancy Cost Code, with the categorisation and identification of cost elements, is a major contribution to achieving a consistent measurement of occupier performance. This ensures that we are all talking the same language. However, there are three other components that we need before we can undertake a full cost analysis:
1 a method of comparing and equating capital expenditure to revenue expenditure (or running costs)
2 the correct analysis of the organisation's service requirements and standards
3 an understanding of the occupancy life cycle and the propensity for change throughout the cycle.
These three components are examined below, with the life cycle component covered in greater detail to reflect the importance that a clear understanding of this has on decision making. The aim is to arrive at a realistic cost appraisal of all of the components that comprise an organisation's occupancy.
Cost in use
The technique for evaluating both capital and revenue expenses on a building is often referred to as cost in use. This technique has been in existence within the building and property industries for over 30 years, but is infrequently used. This is because the information available on building performance is very limited and most developments have been developer or builder led, with the facilities management elements taking a lower profile.
The basic method is to use a discounted cash flow model to evaluate upfront capital investment, ongoing running costs and future capital expenditure. In this way capital costs can be balanced against revenue costs. For example, the case for higher initial investment on a building can be evaluated against lower ongoing expenditure.
The available techniques for cost evaluation tend to be primarily building-related; however, the basic methods can be applied to the occupancy life cycle. The overview of the techniques described in this section can be found in greater detail in Facilities Economics by Bernard Williams (Building Economics Bureau, 1994).
The main cost categories used for all the methods, are those included within the OPD cost code. In addition there are other costs that arise out of the occupancy, such as IT or support staff, or, say, the provision of staff season tickets for car parking, which need to be included.
The main methods of life-cycle analysis are:
This method is intended for a basic analysis as it involves the aggregation of all the capital costs and all the revenue costs throughout the occupancy life. Although the method ignores inflation or the rate of return a business requires on its capital, it could be an acceptable approach for a shorter-term project. In addition it is often useful to highlight that the total annual running costs can be significantly higher than the upfront capital spend.
The NPV method involves discounting all of the costs throughout the life cycle back to the start point using normal discounted cash flow techniques.
The key to the outcome of this method, apart from ensuring that all costs are captured, is to set the discount rate at the correct level. One approach could be to use a discount rate based upon the cost of money such as interest rates. However, the preferred option is to use the organisation's internal rate of return (IRR).
The IRR is the return that an organisation requires from its investment and enables like-for-like comparison of the spend or investment for any area, whether property, marketing, human resources or IT.
In theory, with lower inflation and corporate returns failing, the internal rate of return should also reduce and this would favour more capital investment to produce savings on running costs. However, in practice, internal rates of return are still likely to be at a high level as businesses look to protect cash flow and in the government's case, it seeks to protect the Public Sector Borrowing Requirement.
The conclusion that can be drawn from this is that it is nearly always difficult to justify higher capital expenditure in order to reduce ongoing running costs. This also explains why, inevitably, today's maintenance costs will be under pressure, even though reductions in spend will lead to higher costs in the future.
This method is used to equate both running costs and capital costs to a total annual amount. The capital costs are broken down into an annual figure by the application of an interest rate on the capital employed and a sinking fund to replace that capital at the end of the period.
This method is useful for taking a snapshot at a given point in time and also for comparing, say, a rental option on a building with a purchasing option.
Service performance standards
The correct analysis of an organisation's service requirements and standards is needed so that this can be applied consistently to the various options for occupancy. The aim is to arrive at a cost comparison of options that have a similar service performance and which meet the principal requirements of the organisation.
Inevitably in practice the options will have different characteristics making the comparison subjective. Notional adjustments can be made to the cost base for each option, to allow for variations in the service performance, however this often produces a false picture.
It is usually advisable to leave the cost analysis unaltered and highlight the non-tangible differences. In this way a consistent cost assessment can be reported and the areas of service non-conformity are identified. Often when comparing one occupancy solution with another, both might meet the basic service performance standards—but one may may also have perceived enhanced occupancy qualities (even if it is more expensive).
With this approach the cost of overperformance can also be quantified. Armed with this type of analysis and a reasonable level of information, a meaningful value engineering process can be implemented. In theory, by undertaking a value engineering exercise on each occupancy option a level playing field can be created. This enables the final comparison to be made on cost only. That's the theory, but evaluating occupancy performance is an imprecise art and not an exact science.
The three life cycles
The first task when undertaking a whole life costing analysis is to understand the various elements and phases of the life cycle. There are three life cycles to be considered: building life cycle, occupancy life cycle and business unit life cycle.
Historically the whole life approach has been considered only from the building perspective, with the life cycle consisting of design, construction, repair and/or refurbishment and then demolition followed by redevelopment.
The length of the building life cycle is determined by the obsolescence factor. The generic forms of obsolescence can be described as:
The life of the building can be extended at various stages by refurbishment but there will come a time when usually all three obsolescence factors combine to signal the end of the cycle.
Over the last 20 years the concept of the building life cycle was considered to be central to understanding the economics of property costs in use. However, if the property industry now intends to embrace the occupier, it is apparent that any consideration of whole life costing needs to be based on the occupier's life cycle. Until now there has been an overemphasis on the building and the user has been virtually ignored.
The fundamental difference between the building life cycle and the occupancy life cycle is that the occupancy life cycle has a wider number of factors that affect it; these non-property factors include sociological, political and macroeconomic influences.
The occupancy life cycle, as its name suggests, is based upon an organisation's occupancy pattern and its business cycle and this is not directly related to the building life cycle. For example, a business might plan to use a building for a limited period before it requires larger or different accommodation. The building in this case may not be obsolete but the organisation's requirements have changed.
As stated above there are a number of factors that affect the characteristics of occupancy and, in the next issue of TheFB the demand side of occupancy is examined. An important area to highlight is the distinction between owned properties and rented properties — an owner-occupier business has an additional interest in the asset value of the property, whilst a tenant's main interest is in the cost in use.
Therefore a crucial part of the cost analysis is the interpretation of the organisation's business plans and how these relate to an accommodation strategy. Its accounting policies are also relevant; any cost analysis has to fall within the financial framework of that organisation.
The term 'business unit life cycle' has been invented for this article and is intended to convey the concept that within an occupancy life cycle there are individual business life cycles that are related to a particular business unit or project.
The whole life approach is still relevant, as the cost assessments of the business unit life cycles will contain the same elements of time, service and standards and equalisation of capital and revenue expenditure. The measurement of cost and service performance is just as important at the micro level as the macro level.
Source
The Facilities Business
Postscript
Fred Guscott is head of the RICS Facilities Faculty and director of Eurica. This article is an extract from a paper given by Fred Guscott to the third Occupiers Property Databank conference on defining, measuring and achieving occupier performance. The OPD can be contacted on 020 7643 9250.
