A few weeks ago I wrote about the Facility Condition Index (FCI), its definition, application and benefits. In this article I will take the FCI analysis further by applying a “Risk Management” approach to its application whereby the FCI will be transformed into a practical tool for prioritizing and filtering real estate capital management projects.
FCI Refresher – A Macro Tool
FCI is a method of measuring the relative condition of a single facility or group of facilities and is used in setting annual funding targets and the target for duration of the level of deferred maintenance. The FCI is the ratio of (1) the level of deferred maintenance and cost of remedying facilities; and (2) the replacement value of the facility(ies).The higher the FCI, the worse the condition.
FCI = Current Amount of Deferred Maintenance
Current Replacement Value of Base Building
In terms of categorizing and prioritizing FCIs the most widely accepted industry accepted FCI standard is:
• 0 to 5% considered Good.
• 5% to 10% considered Fair
• Greater than 10% considered Poor
Having determined the FCI for each building, the capability (1) of prioritizing investment locations can now be undertaken; and (2) estimating the organization’s medium and longer term capital investment requirements.
While the FCI is a useful macro benchmark in prioritizing buildings within a real estate portfolio it is not useful as a micro decision making tool with respect to pinpointing which specific assets or pieces of equipment should be prioritized in terms of replacement. In order to transform the macro data into micro decision making it is recommended that the FCI analysis be integrated into a comprehensive risk management process.
The Real Estate Risk Management Process
The Risk Management process is typically composed of five distinct but inter-related, steps which I have adapted to its application in a real estate capital management setting.
- Risk Identification. Identification of those real estate assets which could be critical in exposing the organization to potential risk.
- Risk Assessment & Quantification. On an individual asset and equipment basis, the potential for risk needs to be quantified in terms of:
- Probability of Loss; and
- Severity of Loss.
This step in the process is perhaps the most important and but also the most difficult insofar as there may be thousands of individual real assets or pieces of equipment in the portfolio of a large organization. These two aspects will be more fully elaborated on below.
- Risk Control & Analysis. Focus is on avoiding, preventing or controlling risks or uncertainties and ultimately measuring the impact of their implementation on both the probability and severity of loss.
· Examples of risk control measures include: safety inspection visits, sprinkler and other loss control systems, emergency contingency planning, equipment spares and backup, accelerated maintenance of the most critical components, etc. These measures are particularly applicable to organizations with limited financial capacity to implement changes.
· Implementation of each of these risk control measures needs to be quantified in terms of its effect the probability of loss and/or the severity of loss.
· This analysis will allow the organization to quantitatively prioritize various risk control measures from a cost-benefit perspective.
4. Risk Treatment. Where major risks, in terms of its effect on revenues and employee safety, cannot adequately be eliminated or reduced by risk control measures the action is obvious: the organization needs to invest the necessary funds to replace the asset under consideration.
5. Program Administration. As in all processes involving continuous improvement, the above analyses need to be undertaken annually to ensure that the real estate database is continuously updated and that the priorities of the real estate organization are aligned with the priorities and risks of an ever-evolving organization.
FCI & Risk Management Integration Methodology
The key element in expanding the practicality of the FCI is to examine each individual asset (piece of equipment) and weight it based on both the Probability of Loss and the Severity of Loss (see Point 2 above), each on a weighting scale of 1 (low) to 5 (high).
Determining a weighting for the Probability of Loss of a particular piece of equipment can be purely objective based on local knowledge of the individuals working with that piece of equipment or it can be based on pre-defined rules and criteria. The latter is more practical for a portfolio with a very large equipment database and lends itself to computerized modeling. Weighting Loss Probability can be considered, as can a factor of an individual asset’s life and its condition. For example on a scale to 1 to 5:
· Equipment which is beyond its useful life but in “excellent” condition can have a weight of 3;
· Equipment which is beyond its useful life but in “poor” condition can have a weight of 5;
· Equipment not beyond its useful life but still in “fair” condition can have a weight of 3;
· Equipment which is not beyond its useful life but in “excellent” condition can have a weight of 3.
Determining a weighting for the Severity of Loss is similarly subjective and needs to take into consideration the impact of equipment failure and the impact of failure. Will failure result in operational disruption and if so for how long? What are the financial implications of the resulting business interruption? What are the consequences of failure on the health and safety of employees? Would failure negatively impact the Company’s brand and reputation? Having determined the answers to these questions each piece of equipment can be weighted from 1 to 5 and appropriately coded on the asset data base allowing for computerized modeling and analysis.
Having determined weighting for both Probability of Loss and Severity of Loss, the two weightings are multiplied whereby the product can effectively be considered as the “Consequence of Loss”. Sorting the Consequence of Loss from high to low will give real estate management a relative ranking of the priority of each asset.
Categorizing the Consequence of Loss into five weightings (1 to 5) can then be used to develop a risk weighted FCI for each building in the portfolio. This requires applying the dollar value of the deferred maintenance associated with the specific piece of equipment. This would demonstrate how each asset in the building contributes to the building’s risk weighted FCI – a calculation and methodology beyond the scope of the current article.
William Jegher is President of Wika Consulting, a consulting company specializing in facilities management and real estate benchmarking, communications and consulting. Contact him at wjegher@wikaconsulting.com
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