A Study of lifecycle management of housing using LCC as probability function

Liao Yu Chia Ph. D Candidate Yashiro lab, University of Tokyo Chiachia.ut@gmail.com

Summary In Japan, the value of housing on market, especially the existing one, is underestimated. In order to create a resource-circulation society and extend life-span of housing, assessment of existing housing needs to be improved for the market. How to manage our property with flexibility during the planning period is also a critical issue. This study focus on housing asset and LCC from the point of view with an approach of property values and economic life, propose a appraisal model for housing management by adopting both concept of LCC and ROA method. Differing from conven-tional testing model, this study evaluated LCC present value by using various hypothetical circum-stances rather than limited, and simplified conditions. It also attempts to clarify the cost of various projections underlying uncertain factors for decision makers. This Study re-examined the applica-bility of LCC appraisal by analyzing different households. Based on the LCC simulation result, Ring-shaped LCC model is exhibited in the end of this study.

Keywords: Decision Making, Real option, Asset management, Uncertainty, DCF method

1. Introduction This research focus on housing asset and LCC from the point of view with an approach of property values and economic life. However, the value and price of housing on Japanese market, especially the existing one, is underestimated because of lack of proper estimation tools. Since extending life-span of existing housing and creating a resource-circulation society has become the priority principles of residential policy for Japan government, Assessment of existing housing needs to be improved to smooth the circulation in property market. How to manage our property with flexibility during the planning period is also a critical issue. 1.1 Purpose of Research The main purpose of this paper is to propose a alternative model to users which can analyze the lifecycle cost of different alternatives during the planning period, and help to manage their proper-ties and make decisions at each step. According to users' different life stages and conditions, this model simulates various alternatives, and visualizes the present value of LCC and also compares the results of LCC simulation. This model also assumes the uncertain future, which puts uncer-tainty factors, (such as interest) into LCC equation and analyzes the probability distribution of each alternative. Finally, this study proposes a flow model for housing's life cycle management. It is based on a new approach to lifecycle cost, and is considered with the uncertainty of future. (fig.1)

Fig. 1 The image of applying LCC Model to each step of decision making

1.2 Scope of Research Lifecycle management of housing can be discussed by different terms such as physical life, func-tional life, economical life or social life, This research regards housing's property values from the economic point of view of economical life. This research focus on presuming the lifecycle cost of the existing housing in Japan, It simulates the LCC of alternatives during the planning period, and analyzes the effects by uncertain factors. The scope of this research is considered with several aspects, which are: a. Simulation object Existing housing, apartment building type, Built over 10years, Concrete construction. b. Different household with different financial plan Single, Young couple, Nuclear family, Elder c. Alternatives during the planning period Maintenance plan, renovation plan, rebuilding plan (based on users’ life stages) d. Uncertain Factors Various assumed volatility of interest rates is added to anticipated items of uncertainty factors in the model. 2. Literature review and research contributions This research focus on housing asset and LCC from the point of view with an approach of property values and economic life. No matter we buy a house for living or treat it as investment tools, hous-ing can be regarded as merchandise. However, the value and price of housing on Japanese mar-ket, especially the existing one, is underestimated because of lack of proper estimation tools and inspection system. This is also the reason why the life-span of housing in Japan is much shorter then the UK, US and other countries. (MLIT,2011) Regarding to understanding of how to manage our house and treat it as asset, there are some research literature we need to review. They are: 1.evaluation method for property value. 2. the application of lifecycle cost on housing research. 3. asset management study concerned with flexibility and uncertainty. 2.1 Evaluation method for property values Although housing can be regard as merchandise, real-estate market belongs to neither perfect competition market nor monopoly market. Pricing for real estate is a complicate system. In order to respond this particularity, different analytical aspects such as cost approach, sales comparison, income approach have been well applied in practice for building property. (JAREA,2011) However,

Assume the futureLCC Simulation Probability Analysis

reference

Life cycle management

Table. 1 Application of LCC (lifecycle cost) on housing research

only sales comparison is applied to housing transaction even though it is not appropriate enough. In the process of housing transaction, asking prices are the only information we can have as benchmark, but even contract prices and registry prices are more substantial. The buying behav-iour is also concerned with someone's decision-making. Therefore, the price on the market be-comes more difficult to estimated, especially for the existing housing. In Japan, some researchers attempted to explicate the pricing construction on the market by using hedonic approach. According to Shimizu's research (Shimizu et al,2011) , as constructing a housing price index, it is critically important to choice the data sources of house prices, and to proper tools among alternative methods of estimation. Although the hedonic approach can be use to compare housing price in conclusion, the difference between the distribution of house attributes and quality still remains, Hence, the hedonic approach need s to be adjusted in appropriate manner. 2.2 Application of LCC (Lifecycle cost) on housing research The general definition of LCC is: the sum costs over the full life span or a specific period of a good, service, structure, or system. Including purchase price, installation cost, operating costs, maintenance and upgrade costs and salvage value at the end of its useful life. (http://www.businessdictionary.com) In the field of construction industry, LCC method is generally applied to appraise different plans while buying equipment or choosing a method of construction. An assumption of LCC could help owners (or users) to imagine the probable revenue and expenditure in the future. Considering their particular requirements or preference , decisions can be made in a more reasonable way. In Japan, there is a lot of studies discussion about LCC of housing from different perspectives. (Table.1)

Moriya. K focus on examining the useful life of components in order to propose an appropriate maintenance cycle (Moriya. K et al,2000) . Igarashi (Igarashi et al, 2004) tries to test the feasibility of layout planning for variable living space which will meet different demands for every stage of users' lifestyle. ; Kubota. T scrutinize the economical advantage of sustainable housing which is designed in circulative and longevous resource. (Kubota. T et al, 2004) . (Table.1) Most of these research have generally concluded that LCC prediction critically are applied with limited hypo-thetical conditions. Therefore, results are applicable only under assumed situations. According to the inadequacy of previous approaches, we need more flexibility to manage housing property, while using LCC appraisal in order to avoid any unexpected situation in the future. 2.3 Asset management study concerned with flexibility and uncertainty. Most of the research in Japan applied DCF (discount cash flow) method to calculate the LCC pre-sent value. Under many circumstances, asset value is underestimated in practice by using DCF method. The reason is that the discount rate of WACC (weighted average cost of capital) is set constant. Under the long-term prediction, however, it is inconstant in reality. During the planning period, to adjust management plans and strategies or how to reallocate budgets, is not included in the concept of DCF method, (Copeland et al,2002) Differing from conventional financial options, ROA (real option analysis) provides more flexible options to undertake business initiatives and helps decision makers to be explicit about the assumptions under their projections. The option itself is the right but not the obligation. Decision making associated with uncertainty is much more reasonable resemble to real-life. Option value is explicit by using decision tree. Decision makers can modify their plan at any time of any step. (Mun,2003)Although ROA as been increasingly employed as a tool in business strategy formulation at the present, in Japan there are a few studies which applied concept of ROA in the research of housing asset management. 2.4 Research contributions

This research is to propose a appraisal model for housing management by adopting both concept of LCC and ROA method. Differing from conventional testing model, this research evaluated LCC present value by using various hypothetical circumstances rather than limited, and simplified con-ditions. This model analyzes various scenarios and projections which underlying uncertain factors in the future. It also attempts to clarify the cost of each choice for decision makers 3. LCC analytical method and theoretical model

3.1 LCC analytical method most of the LCC studies in housing management are considered with simplified situations without alternatives. Decision is also be made at only one specific point of time without flexibility.. When analysing the LCC present value through conventional way, decision makers have no other options such as "call option". This research attempts to consider more complicated situations, and put dif-ferent conditions into simulation, in order to re-examined the applicability of LCC appraisal by using DCF (discounted cash flow) method. 3.1.1 Simulation of various households and real interest rates As a parameter, composition of household has been divided into four types: a)Single (late twenties) b)Young couple (early thirties) c)Nuclear family (early forties ) d)Elder (late fifties) Except for different composition of household, other simulation conditions are under the same setting. (Table 2.)

Fig. 2 The Composition of LCC by year Fig. 3 LCC Comparison of four type households

Fig. 4 Optimization model with uncertainty (Mun.J.C,2003)

3.1.2 LCC Simulation result analysis Operating cost occupies the highest ratio in LCC. (fig.2) Depending on the setting of cycle and maintenance plan, LCC present value have obvious difference even if all the other conditions are same. The composition of LCC in housing is very relevant to different household. Not only because of different number of family member but also have relevance to how they operating it (fig.3) (Comparing with b and d type family) According to these results, it is verified that user's different life stage or way of operation have critical influence on LCC assumption.

3.2 LCC Model for decision making by using probability distribution This research proposed a hypothetic LCC Model which can be applied to decision making when user enter the next life stage or face an important change. Considering the probability of uncertain events on time series, this model analyzes various scenarios and alternatives for decision makers, and help them choosing their favorite way (route) to manage their property. 3.2.1 Optimization model with uncertainty The basic conception is analogous to optimization model with uncertainty, we can simulate every alternative and analyze the LCC result through this process (fig.4) (Mun.J.C,2003)

Subject BackgroundApartment building Concrete constructionAge of building: 30years Once renovatedData resource: リフォーム支援ネット http://www.refonet.jp/csm/case/theme/0_2_1_26.html

Hypothetical ConditionsPlanning Period 32years with maintenance planSpecification of repair work Refer to database of

"建築物のライフサイクルコスト(平成 17 年版),2005" Assumption Operating Cost(Utility expense only)

Refer to database of Statistics Bureau, Japan

Real interest rate a) 0% b) 2% c) 4%Composition of household a)Single. b)Young couple. c)Nuclear family. d)Elder

Table. 2 Simulation conditions

Thousand JPY

Time

Left scale：expenditure cost per yearright scale：Cumulative total of LCC each year

Cumulative total of LCC (32years)

Case: Single householdreal interest rate 0%

Thousand JPY

Cumulative total of LCC (20years)

Cumulative total of LCC (10years)

LCC in Detaila) Utility Expenseb) Repair, Renovation

Equipment exchangeElectronic componentConstruction work

c) Cumulation

LCC in Detaila) Utility Expenseb) Repair, Renovation

Equipment exchangeElectronic componentConstruction work

c) Cumulation

Thousand JPY

Time

Cumulative total LCC

a)Single b)Young couplec)Nuclear familyd)Elder

Cumulative total LCC

a)Single b)Young couplec)Nuclear familyd)Elder

Table. 3 Variable setting in LCC model

Fig. 5 Making probability tree

However, optimization is not the purpose in this research. Since each selection of decision maker is "right" but not "obligation", this study prefer using "choose a favorite route" rather than "optimize the LCC" as main purpose. The variable setting in this study is showed as table.3

3.2.2 Ring-shaped LCC model the flow below will explain how LCC model is established. a)step1: Making LCC probability tree (fig.5) set up first planning period named T1. Length of time depends on user's life plan. Input the volatility of real interest rates which reflects the uncertainty of future. Larger volatility means that uncertain future is hard to predict. (It's zero in DCF method ) A,B,C....D represent the probability of events and route. For example, if we presume the real interest rates be up and down with 20% every year from now on, after 9 years the rates will become A,B,...D in certain probability.

Fig. 6 Making decision tree

Fig. 7 Ring-shaped LCC model

b)step2: Making LCC decision tree (fig.6 ) Set up second planning period named T2, and complete LCC probability tree from T1 to T2. When the time comes to point T1, user has opportunity to re-examine the original plan and target then make decision: continue, adjust it, or choose a new plan. Depends on user's different de-cision making, simulation result of LCC might become X,Y...Z at T2. For example, a couple have 9 years old child at time point T1, they might consider converting their house into appropriate living space for child's growth in next 9 years. At route c , everything happened as they have expected at point T0, they can continue original plan. Then the LCC might be Z 9 years later. They can also choose a new plan, such as extending additional space or change the layout.

c)step3.Making Ring-shaped LCC model (fig.7) Triangle represents the original plan. It grows up with time which also means that the prediction of future becomes more uncertain. only decisions like repair, renovation or maintenance cycle ad-justment are allowed in original plan. Mirrored triangle with dotted line represents different alterna-tives (new plan) at different point of time (T1,T2...Tn) decisions like moving out, rebuild are defined as alternative (new plan) . A project (plan) starts from the center and spread outside with time by adding various triangles (alternatives) from time point T1 to Tn (important point of life stage) Finally, ring-shaped LCC model is established.

4. Conclusion Although DCF method is a conventional way which is generally conducted to estimate housing's LCC present value, the limitation of prediction only under single situation without alternatives, lacks of flexibility to face the uncertain future. This Study re-examined the applicability of LCC appraisal by analyzing different households with more complicated conditions. The result that operating cost occupies the highest ratio in LCC shows the same tendency with previous research. Number of family member is also very relevant factor to operating cost estimation. User's different life stage and way of operation have critical influence on LCC assumption. Even under the same conditions, simulation object's appearance on LCC changes when the setting of maintenance cycle is adjusted. Ring-shaped LCC model which exhibited in the end of this research is a hypothetical model at this stage. It is based on the LCC simulation result of various type of household. So far in this study, we can assume the LCC for different life stage from T0 to Tn by using probability function, then com-plete a triangle (original project) . However, in real life there are more alternatives such as moving to a new place or rebuilding which have not been assumed yet in this study. To complete the Ring-shaped LCC model, these alternatives should be considered and put into LCC probability function in further study. The reliability should be verified as well. 5. Reference [1] MLIT (Ministry of Land, Infrastructure, Transport and Tourism, Japan) " Current state of the

market distribution and remodeling of existing housing(住宅流通リフォーム市場の現状) ",,2011, pp3,http://www.mlit.go.jp/common/000039409.pdf

[2] JAREA (Japan Association of Real Estate Appraisars) ,“Standard for real estate appraisal(新・要説不動産鑑定評価基準-改訂版)”, pp. 29-38.

[3] Copeland.T, Antikarov.V, Tochigi.K,"Real Options (決定版リアル・オプション) " 2002,pp. 77-82.

[4] Mun.J.C., Kawaguchi Y." Real Options Analysis (リアルオプションのすべて) " 2003,pp239-260.

[5] Flanagan R., Jewell C.," Whole Life Appraisal for Construction ",2005 [6] Shimizu.C, Nishimura.K, Watanabe.T," House Prices at Different Stages in Buying ~Selling

Process ", Understanding Inflation Dynamics of the Japanese Economy Working Paper Series No.69, 2011

[7] Kubota. T, Nagao .K, Saito. H, Nakajo. Y, " A Study of Housing to Reside in an Apartment House for Generations A Study of a Planning for Variable Living Space to Match Residents' Life Stages " ,Summaries of technical papers of Annual Meeting Architectural Institute of Japan. E-2, Architectural planning and design II, Dwelling houses and housing sites, rural planning, education, 2004

[8] Igarashi. T, Kanaou .N, " Study on Life Cycle Cost of a Resource Circulation House - Study on economical assessment of housing system for sustainable society ",Journal of architecture, planning and environmental engineering. Transactions of AIJ (560), 2000,pp 253-260,

[9] Moriya K. Omi T. Ishizaka K." A Study on Material Selection Method and Repair Plan Method with Necessity Evaluation by AHP", Journal of architecture and planning (535), 215-222,2000

[10] Umeda K. Hashiguchi H. Tsuboba S. Ishi E." An Evaluation of Life Cycle Cost for a Detached House", Summaries of technical papers of Annual Meeting Architectural Institute of Japan. D-1, Environmental engineering I, 2000,pp.947-948