Understanding Condo Reserve Funds and Reserve Studies
One of the most important responsibilities of your condominium corporation's board of directors’ faces is effectively planning for major common-area repairs and replacements. Whether a costly expenditure is needed in a few years or not for 20, it’s the board’s fiduciary duty to make sure your condominium corporation has adequate funds when the time comes. That’s where your condo reserve funds come into play.
There are many misperceptions about condo reserve funds and the role a reserve study plays in planning your corporation’s future expenditures, so we’ve broken it down for you.
What is a condo reserve fund?
A condo reserve fund is an account where money is put aside to pay for large capital expenses that are expected to arise over the next 30 years. This money is exclusively allocated for common-property components that have a limited useful life. Maintaining an adequately funded reserve account ensures that your corporation will have the money available to replace expensive items (typically those that cost more than $10,000) and make major repairs to roofs, mechanical equipment, garages, amenities and other common areas when the time comes.
According to Ontario’s Condominium Act, 1998, all condominium corporations are required to maintain one or more reserve funds that are used solely for “the purpose of major repair of a unit, common element or assets, if any, of the corporation, if the corporation has the obligation to repair in that regard under the act."
How does a board allocate money to the condo reserve fund?
The amount of your annual dues that should go toward a condo reserve fund can vary significantly. Factors such as the age and type of property, the number of common structures, how recently the corporation had major work done and the size of the community will all affect the amount of money you need to set aside each month.
You may hear that corporations should allocate between 15 and 40 percent of their assessments toward their condo reserve fund, but you need to be careful about using set numbers as guidelines. You can’t simply decide to allocate a percentage of your fees toward reserves. You need to base the amount on an up-to-date condo reserve study.
How does a condo reserve study help?
A reserve study assists your condo board to predict when capital expenditures will be necessary. It identifies predictable common-area repair and replacement projects so the corporation can financially prepare to meet those costs. It usually looks at common elements that require major repairs or replacement within the next 20 to 30 years. Reserve studies must be completed by a qualified individual, such as an engineer, architect, architectural technologist, or a Certified Reserve Planner (CRP), which is designated by the Real Estate Institute of Canada.
The reserve study consists of two parts:
A physical analysis, which involves an onsite inspection of the components on your property and an estimate of their expected useful life (in general, every other study should include a site inspection).
A financial analysis looks at how much you currently have in your reserve fund and determines how much money you need to collect each year to adequately cover the cost of making repairs or replacing those components (best practice says corporations should update numbers every year as part of their annual budget process).
Upon reviewing the study, boards must understand both the capital cost and operational costs of each project. For instance, when a board needs to replace a chiller in 10 years, does the estimate include the necessary upgrades for preventative maintenance in the operating budget? Are installation costs included in the estimate as well? Boards should not be afraid to challenge the assumptions with their reserve fund professional; after all, it is the board’s responsibility to understand the plan, so ask questions!
How often should you update your reserve study?
An initial reserve fund study must take place within the first year of a condo’s incorporation. Follow up studies must be performed every three years after the initial study. In general, every other updated study should include a site inspection. Some of the factors that might alter previous recommendations include inflation, changes in the condition of individual components or how they are being used, unexpected situations such as weather and your level of compliance with the previous recommendations. An experienced property management company can help you determine when you should get an update.
In an attempt to keep monthly fees low, condominiums might sometimes short their reserve contributions. At all costs, this practice should be avoided as property values suffer if the condo reserve fund is too low. In other words, boards shouldn’t short their reserve contributions for a bit of convenience today, as this guarantees the condominium will pay more for it in the future.
What are the risks of underfunding your reserves?
Underfunded reserves can impact your community’s property values, the safety of residents and the integrity and appearance of your structures and grounds. Despite these, research conducted by Association Reserves found that more than 70 percent of the corporations they reviewed were less than 70 percent funded! As a result, these communities do not have the money to pay for all the major expenditures they are expected to face. Why is this the case?
According to the Community Association Institute, “Uninformed homeowners perceive reserves as increased financial burdens rather than financial protections.” Additionally, many homeowners and corporations still have not financially caught up from years of slow economic conditions. As a result, condo boards continue to seek ways to minimize assessments/dues, both for existing homeowners and buyers looking to purchase within their community.
Unfortunately, this only delays – and most likely increases – the financial burden on homeowners. The only options for completing projects when a corporation is underfunded are to significantly increase assessments immediately, impose a special assessment or take out a loan. What frequently happens, though, is that the work simply doesn’t get done. Of course, when that happens, the community ends up in a bigger mess that becomes much more financially difficult for the corporation to get out of. The bottom line, adequately funding your condo reserves is imperative to the long-term success of the corporation.