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Economic evaluation (EE) of the built environment

6. ECONOMIC EVALUATION OF BUILT ENVIRONMENT FACILITIES

6.2 Economic evaluation (EE) of the built environment

6.1 Introduction to chapter six

This chapter explains the theoretical underpinning of the literature related to the economic evaluation (EE) of built environment facilities. The first section elucidates the generic EE process usually undertaken for built environment assets. The second section describes the whole life analysis (WLA) process whilst recognising it as one of the strongest approaches to evaluating the economic costs and benefits of adaptable buildings. The same section looks at the appropriate EE tools and techniques required to perform WLA in adaptable building contexts. The last section conveys the benefits and hindrances of WLA in adaptable building considerations.

6.2 Economic evaluation (EE) of the built environment

The economic evaluation of built environment facilities is given a high priority in many investment decisions. In its wider contexts, EE is a method/process for determining the value of a policy, project or a programme (Litman 2006). It is also known as ‘an examination of the costs and benefits (monetary and non-monetary) expected to result from a particular course of action or from alternative courses of actions’ (Kirk and Dell’Isola 1995 p.35). The process determines the economic credibility of different alternatives whilst taking into account all costs, benefits and performances associated with a facility during its lifecycle (Department of the Army 1992). Presumably, EE can be proposed to identify the cost and benefit considerations of adaptations (a course of action) or to compare the total costs and benefits of adaptable and traditional (maladaptive) buildings (alternative courses of action). The EE process is usually exploited at the project feasibility or design stages in building lifecycles to

compare alternatives and then to justify whether the selected option is economically viable

Source: Adapted from Kirk and Dell’Isola (1995)

The particular course of action of adaptable buildings is to respond to potential built environment changes and the alternative courses of action are to explore different designs/plans to identify the best alternative. The difference between investment and design EE is based on whether ‘one particular course of action – do nothing – is a feasible alternative’ (Kirk and Dell’Isola 1995 p.37). Investment EE selects the best alternative within the framework of available funds/the budget and design EE considers different design solutions and selects the one that would better perform the required function(s) economically.

The following factors provide a logical sequence for undertaking EEs in built environment facilities (Hendrickson 1989):

1. Basic concepts

2. Economic evaluation methods 3. Factors affecting cash flows

4. Effects of different methods of financing

Basic concepts considers the time preference for use, opportunity costs, minimum attractive rate of return, cash flows over the planning horizon and profit measures. There are a number of techniques available for undertaking an EE; however, its practical application in built environment facilities is seemingly less than many other techniques. The selection of a

proper method depends on the context and availability of the project information. The literature reveals the techniques of simple/discounted payback, cash flow, discounted cash flows, net benefits – net savings, benefit to cost ratio/savings to investment ratio, internal rate of return, overall rate of return, net terminal value, net present value, real option analysis for evaluating economic costs and the benefits of a facility (Ruegg and Marshall 1990, Ashworth 2000, Boussabaine and Kirkham 2004, Ellingham and Fawcett 2006). Dale (1993) argues that simple payback, net present value and internal rate of return are the three most commonly exploited techniques for evaluating the economic considerations for buildings.

However, these methods have some limitations, which are discussed in the forthcoming sections of this chapter. The third consideration of the EE process identifies factors affecting cash flows, which are depreciation and tax effects, price level changes and the treatment of risk and uncertainty. Therefore, these factors need to be studied in detail for an accurate EE.

Moreover, attention needs to be paid to identifying the effects of different methods of financing, which includes types of financing and risk, public policies on regulation and subsidies, the effects of project financial planning and the interaction between operational and financial planning. These four steps explain the key considerations for undertaking a robust EE for built environment facilities. The EE process takes into account the present value of the future costs and benefits of the adaptable facility whilst exploiting the discounted techniques to evaluate these costs and benefits in monetary terms.

Developers do invest in a certain degree of adaptability; however, which means that the cost difference between what can be considered ‘best practice’ and ‘worst practice’ is somewhat less (Arge 2005). The design for adaptation (DFA) method aims to design new buildings to respond to potential future changes in built environments. The client/developer interest is in knowing that investments in these designs are cost-effective in the long term. The Whole Building Design Guide (2011) defines the characteristics of cost-effective designs as the lowest initial capital costs, lowest maintenance and operational costs, longest lifespan, most productive and the greatest return on investment. The same design guide further states that true cost-effectiveness requires a lifecycle perspective where all the costs and benefits of a given project are evaluated and compared over its economic life. In this regard, a number of alternative courses of actions (adaptable design options) could be generated and an EE would be required to identify the most economical design option. The building will be adapted if the value of adapting the building for new or future use is thought to be greater than the value of the alternatives and the cost of the adaptations (Blakstad 2001). Thus, the importance of undertaking EE for adaptable buildings is highly acknowledged in the built

environment. The WLA approach is considered a cost-centred engineering economic analysis (Kirk and Dell’Isola 1995). Thus, the previously noted EE techniques could be successfully adopted to undertake WLA in built environment facilities.