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MSc Seminar on capital and revenue funding of facility investment with a case study from the Department for Education in the UK.
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The Strategic Move
Finance and OperationsKeith Fraser BSc(Hons)(Lond) MSc(Lond) MIFMA
The Strategic Move
Business Case
Starting point for all investment decisions that should consider:
•Business drivers and benefits;
•Funding options (Capital);
•Whole Life Costs (Revenue);
•Risks (internal and external);
•Opportunity Cost;
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Revenue Funding of assets
• Funding for procurement of a facility and its running costs from cash received (income).
• Most likely funding stream for investment in rental properties and therefore potentially a short term asset.
• Paid from “Net Receipts”, i.e. cash balance after Corporation and Capital Gains Taxes have been paid
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Capital Funding
• Money set aside from income that is used to purchase an asset that has a disposal value to the company.
• The value of the asset has to be maintained over a defined period of time and the costs can be set against profit as a way of reducing exposure to Corporation Tax;
• The asset can be liable to Capital Gains Tax (CGT) when profits are set aside to improve its asset value
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Capital Funding issues
• Procuring new facilities is expensive and requires considerable “up front” investment
• Current economic climate many businesses & government do not have money to invest
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Capital Funding - PFI
Exists as 2 main types:
Traditional PFI: Financing the build and operation through financial structure where debt and equity are paid back through the project cash flow
Real Estate Partnership: Outsourcing the transactional (OpEx) costs of an existing asset and leasing it back over a long period
Typically PFI is taken as Design, Construct, Manage and Finance (DCMF)
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Procuring PFI
• Complex process that is ultimately dictated by the financial backers – a significant element of the cost profile is debt finance
• Client is buying a “service” during the life of the contract where the capital asset is delivered through the delivery of that service
• Therefore the client has to accept that the design will be based on service optimisation based on the PFI provider’s model and not necessarily suited to how the client would operate the asset – a significant problem should the public sector opt to run the asset at the end of the PFI contract
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Typical PFI Hierarchy of Relationships
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Competitive Dialogue
• This process is used most frequently in PFI and is allowed for where it is impossible for the client to adequately define a specification but where they can adequately articulate the desired outcome
• The dialogue process seeks to refine and clarify the bidder’s response, knocking out bidders who’s developing solution will not deliver the outcomes, until all sides are clear on the brief that emerges out of the process
• Bidders are then invited to tender against that brief
• A “Preferred Bidder” is selected and contract negotiations begin
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Competitive DialogueOJEU Notice
Issue PQQ
Select PB& “Stand Still”
SelectBidders
Evaluate Tenders
Final Tender Post-Tender
Negotiation
DialoguePhase
Invitation todialogue
ContractAward
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PFI Procurement Timetable
• Identify and Articulate Need and BC Approval 18m
• Treasury Approval to invest 6m
• Seek tenders and appoint PB 12m
• Post Tender Negotiation 9m
• Construction phase 24m
• Commission & Operation 6m Total: 6 Years 3 Months
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Downside of PFI
• PFI prices on shared risk where a service is costed and the risk of any variation is (often) borne by the Government
• This risk should show as a liability on the Government’s balance sheet
• Balance Sheet Liabilities can affect the Standard & Poor credit rating (currently AAA)
• Criticism of PFI is that these liabilities do not always show up – “off balance sheet recording”
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Adaptive re-use
• Linked to the Hoyt Sector Model of zonal use:
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Obsolescence
• Categorize buildings according to level of obsolescence:
Conditional Obsolescence: building deteriorated to a point where repair is not financially viable against alternatives
Utility Obsolescence: intrinsic value that the building offers has deteriorated to the point where constraints out-weigh benefits of remaining
Value obsolescence: facility depreciates to the point where replacement is the most cost-effective option
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Relative value/obsolescence
• Downes classifies buildings into 3 categories:• Class A: New building stock either bespoke or
speculative development that meets user needs;• Class B: Considered obsolete by first occupant but
has sufficient flexibility & infrastructure to attract new entrants to the market
• Class C: low grade building that can be easily
converted to another use e.g. storage
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Measuring obsolescence
M = f([P],[B])
P is the physical system (building) and the associated constraints, where the higher the value the greater the constraint
B is the behavioural system that is created by the physical system with the higher the value the less organisational behaviour is consistent with the desired culture, process, productivity, or outcome
M is the vector mismatch of the functionality of P and B. The higher the M value the greater the need or drive for a new facility.
Nutt B and Sears D (1972): Functional Obsolescence in the Planned Environment; Environment & Planning, Vol 4 pp13-29
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Interpreting the measure in decision making
• A different threshold of “M” tolerance will come about depending on the financial strength at the time of decision making
• “M” can be applied against buildings in Classes A, B and C which then becomes a function of affordability
• Cost element of P will be based on depreciation and operating costs
• The greater the weighting of B the (likely) greater running costs of P
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Interpreting the measure in decision making 2
•In the case of many organisations the strategic drive for a cultural change will dictate a high B value but will not be considered high enough to justify the costs associated with a new facility unless the P Value is also high.
• In other words, the decision to save money and potentially increase productivity by going into open plan and flexible working may be cost prohibitive in a building with lots of interior walls and poor ICT infrastructure and this, added to the productivity loss of not moving forward may be enough to justify leaving one building for another
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Conclusions
• Organisations typically fund new developments in a number of ways
• Increasingly in the state sector this is through PFI rather than direct capital investment
• Financial constraints force re-evaluation of obsolescence and tolerance of building constraints
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Case Study: Department for EducationDarlington Accommodation Project (DAP)
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Background
• Currently occupy an obsolete (conditional) facility in Darlington:
Mowden Hall: Early 20th C boarding school adapted to office useEast Wing: 1960’s built office block in need of extensive upgradingPodium: 1960’s low-rise extension to the East Wing in same condition
• The Podium is rented to other non-departmental agencies who vacated in June 2010
• Current total space at Darlington is 68,250 sq m which was planned to reduce to a combined 43,515 sq m with the new Sheffield site and Darlington projects sharing functions/facilities.
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Mowden Hall – Existing site
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High Performing Property Strategy
Office for Government Commerce’s “High Performing Property” strategy wants to increase occupancy and improve building stock and design factors to improve productivity
Strategy built on
4 pillars:
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Business PlanOptions appraisal:• New “Crown Build” on a site identified as offering optimised access
and size
Funding: Capital budget funded from cost savings by occupying smaller, flexible site and reduced running costs offset by disposal of Mowden Hall
Contract type: 2 stage Design & Build. Competition for architects develop design to RIBA Stage D, competition for constructors to tender on Stage D on pre-construction contract to Stage E before construction award
Procurement route: 2 Stage PQQ and ITT
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Design Drivers to influence Behaviours
The atrium is a fundamental component of the internal environmental control strategy and the way in which the organisation of the Building supports the new ways of working
Natural buoyancy of warm air in the atrium provides a passive mechanism for moving fresh air through the workspace areas and maximising natural daylighting.
The atrium is the vibrant ‘heart’ of the building, providing views between levels that promote an awareness of what other people are doing in different departments on different levels and promoting informal and sometimes unplanned meetings
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Eventual Position
• Project cancelled in June 2010 by the SoS
• Mowden Hall to be retained pro tem and part of the site to be mothballed
• Remaining part of site to be repaired and upgraded.
• “M” tolerance increased dramatically because of cost pressures and notion of behavioural change through the physical system no longer key decision driver.
