Corporate America has over $4 trillion in property, plant and equipment on the balance sheet. These physical assets are paramount among organizations’ most valuable assets and are typical their biggest expense items, accounting for an average of 20 to 30 percent of annual capital outlay. If effectively and efficiently managed, these physical assets can become a powerful source of operating leverage. Unfortunately, more often than not, the complexity and sheer volume of information about these assets simply overwhelms financial managers, preventing fact-based strategic capital planning and adversely impacting decisions concerning new capital expenditures.
When Beth Israel Deaconess Medical Center in Boston wanted to expand its Francis Street parking garage to accommodate a growing number of patients and visitors, the hospital was faced with a difficult decision. Was it worth investing in the renovation and maintenance of the existing facility or did it make more sense to demolish the current structure and rebuild?
Just as the baby boom generation is entering the ranks of retirees, many buildings in the United States that sprung up in the building boom of the 1950s and 1960s are showing their age. Organizations from hospitals to universities to corporate institutions are weighing the benefits of continuing to maintain existing facilities or investing in a new building. One important factor to consider is the level of spending needed to replace major building systems in the existing facility that are reaching the end of their useful lives. The case for rebuilding is stronger if many such systems, ranging from boilers to electrical systems to roofs, will need to be replaced in the short term.
Another major consideration is long-term operational cost. A new building may provide opportunities for operational cost savings that can justify the initial cost of new construction. Savings can come from better energy management through more efficient heating systems and better insulation. A new facility may also reduce operating costs by consolidating offices previously spread across multiple buildings. For example, by relocating several smaller administrative offices to a single larger facility, an organization may be able to achieve significant savings by decreasing the number of security personnel, or reducing the amount of office equipment, such as copiers and printers, that it needs to support its staff.
Deriving the comparative costs of maintaining an existing facility versus building new is more straightforward for organizations that operate several facilities of similar types and have reliable historical data about their costs. The Virginia Department of Corrections, which operates more than 45 prisons, considered data from its existing facilities and from prototype new facilities it had recently built to determine that it cost less per bed to build a new facility to its standards than to maintain some of its older facilities over a 10-year period. Greater energy efficiency and reduced security staff requirements from a reconfigured layout contributed to ongoing cost savings in the new facilities.
While Virginia had detailed data on the operating costs of its prisons, many organizations do not have similar, reliable information, or may operate a much more diverse group of buildings. In such cases, organizations often turn to market studies in their particular sector to estimate costs, and employ industry standards, such as the Experience Exchange Report and other benchmark data from the Building Owners and Managers Association or benchmarks studies from the International Facility Management Association.
With or without detailed historical cost data, the potential for more efficient use of space is often a driving factor for major renovation or new construction. If the current facility makes poor use of available space, an organization will often need to occupy more square feet than if the space was more efficiently configured. By designing new space that addresses this issue, an organization may be able to operate with less overall square footage, and even justify a higher cost per square foot. Building new may also provide an opportunity for relocation to an area that offers better access to materials or labor, thereby reducing transportation costs. A call center might be staffed more readily by relocating to an area where the available talent pool is larger. Or an organization may realize opportunities to generate new revenue by relocating an outpatient facility to a location accessible to more potential patients.
Another significant factor in the maintain-or-build decision is the organization’s cost of capital. If, for example, a donor is making funds available for a new university library or medical research center, the capital equation will probably be more attractive than if the construction will require a bond issue. Financing costs should be included as part of the annual operating costs associated with new construction.
Certain peripheral considerations can complicate trying to quantify dollars spent or saved through new construction, but may have a significant impact on the decision. If the current facility is not well suited to its current use, for example, a new design could dramatically improve the productivity of its staff, or its attractiveness to customers. In the Massachusetts Institute of Technology’s new Stata Center, for example, the design provides more common space for staff from different research labs to interact than was available in previously existing buildings. The resulting increase in productivity could have benefits that outweigh initial operating cost comparisons.
Sometimes modifying a building in the existing portfolio will result in the highest cost savings. For example, when the Texas Department of Mental Health, which manages 1,500 buildings statewide, was considering building a new facility, it instead repurposed another building. Although it needed to invest in a renovation, the agency ultimately realized savings in its operating costs over time.
A final consideration is the impact of construction on ongoing operations. How many times will employees need to be relocated in the course of a renovation? How much inconvenience will customers incur? The cost to an organization of this kind of disruption may be hard to quantify.
In the case of the Beth Israel Deaconess Medical Center parking garage, the hospital not only compared the costs associated with construction, operating and funding renovation versus new building, but also weighed the inconvenience to visitors of taking a 24-hour parking facility offline. Ultimately, the organization chose to renovate the existing garage rather than rebuild.
