Planned Replacement or Major Renovation - Effective Building Maintenance: Protection of Capital Assets - page 56

4. Would replacement reduce maintenance costs, reduce energy costs,
and/or reduce water costs to an extent that an acceptable payback
period can be achieved? If so, the cost of replacement may be justified.
The best approach to budgeting for replacement/renovation main-
tenance is to apply the concept of fundeddepreciation to each building com-
ponent. This concept is often called “re-capitalization” or “reinvestment”
(though it's known historically as a “sinking fund”) and it requires build-
ing owners to set aside funds each year, usually placed in an interest-
bearing investment, that will be available in the future to pay to the cost
of major replacement or renovation of a building component when that
component reaches the end of its RDSL. This approach, adopted by many
industrial firms and even some state governments (such as Minnesota),
ultimately eliminates the need for borrowed funds (loans or bonds) and
corresponding debt service obligations. And, as shown by the following
discussion, thisconcepteliminatesdeferredmaintenanceandlowersthecostsof
replacement/renovationmaintenance.
Using this concept, the current cost of replacement or renovation of
each component, y, is determined, along with an estimate of its RDSL. Di-
viding the replacement/renovation cost by the number of years of RDSL
yields the budget amount that must be allocated each year between now
and the time of the replacement/renovation.
Future replacement or renovations costs will be higher than current
costs due to inflation and, thus, a costescalationfactor(CEF) must be in-
corporated into the calculation. Inflation has a significant affect on future
costs and under estimating the impact of inflation is the “kiss of death”
for adequate funded depreciation.
Construction cost inflation is almost always greater than the general
inflation rate, as illustrated by the data in Table 2-2 comparing general in-
flation and construction cost inflation rate in the United States over each
decade since 1970.
Thus,itisgoodplanningtoassumethatconstructioncostinlationwill
be30-50%higherthanthegeneralinlationrate,aconditionthathasexisted
forthelast(almost)40years . Otherwise, the funds available at the end of
the component's service life to pay for replacement/renovation could be
woefully inadequate.
For school boards and county commissioners, the “sticker shock”
associated with needed replacements or renovations is a key cause of de-
ferred maintenance—a roof replacement that would cost $1,000,000 today