Reserve Fund Studies (Part 1)
There is a lot of ground to cover when it comes to reserve Fund Studies.
Condo owners do not understand their condo corporation’s Reserve Fund Studies. This is understandable because the owners don’t read the actual study. If they did read it, most likely they would not be able to understand what they are reading.
The single-sheet contributions tables that they receive, after having a couple years of higher-than-the-rate-of inflation increases, show reassuring 2% annual increases in contributions. The Board and management do not explain how the funding for the Reserves is determined.
If the Reserves are badly underfunded and very expensive major repairs can no longer be put off, then the owners may be surprised by special assessments, the corporation taking on million dollar loans and/or the condo corporation going under court-appointed administration.
The intent
“… the reserve fund study, more importantly, monitors board conduct and management of funds generate by monthly condo fees paid by the owners. … the Condo Act 1998, was criticized for leaving considerable room for boards to deviate from reserve fund study recommendations.”
—“Condo Conquest” by Randy K. Lippert, UBC Press, pages 139-140.
The Condominium Act 1998 was written to protect condo owners. The requirement that condominiums need to have updated Reserve Fund Studies (RFS) to plan for future required major repairs and replacements is an important part of the intended consumer protection.
Up until the 1998 version of the Condominium Act, condo corporations in Ontario did not need to have fully-funded Reserves. The new Act gave condos, that were registered before 2001, 15 years to build up Reserves that are “adequately” funded from the date of its first comprehensive study.
An engineering company is hired by the Board to inspect the building, list the items that require major repairs or replacements and state by what year these repairs need to be completed. The engineers then list the cost of the repairs and replacements and provide a spreadsheet listing all the repairs that are required, the cost of those repairs and they recommend the year that the repairs should be done for the next 30 years.
The Board then knows how much money they need to raise and when. The owners know how much they need to contribute to the Reserves and potential buyers will be assured that they will be buying a unit in a well maintained building and that they need not worry about future special assessments or the corporation needing to take out expensive loans.
On paper, great stuff. The Board knows how much money they need to collect and when. Every three years, or less if deemed best, the Reserve Fund Study is updated and any needed adjustments made.
New purchasers can review the Status Certificate and know the amount that is in the Reserves and if the future funding requirements match the estimated cost of living increases. (Usually 2% per year.)
The reality
Reality can be far different. Many condo Boards do an adequate job of funding the Reserves and few games are played.
In other condos, the owners are not so lucky. The Boards underfund the Reserves, repairs gets pushed out and the Reserve Fund Studies are badly compromised.
Goals
There are two parties in the making of a Reserve Fund Study and they can have different goals.
Board
The Board wants to keep the fee increases low so the owners don’t rebel. Pushing work out into the future is an easy way to accomplish this.
They also may want to postpone or ignore unpopular noisy and intrusive repairs that will upset the owners such as jackhammering on the balconies, water pipe replacements or major concrete repairs in the parking garage.
The engineering company
The engineering company wants to keep the RFS contract as the company that does the RFS is usually awarded the contracts to plan, manage and oversee the repair work. That is where the real money is.
So the engineers have a strong interest in not upsetting the Board as they do not want to be replaced by a different engineering company.
—see “Condo Conquest” by Randy K. Lippert, UBC Press, page 219.
Management
I have seen property managers tell the directors that they do not have to follow the RSF plan and that they can decide what repairs are the most important. One “senior manager” is fond of telling the directors that the RFS is just a guess as who knows when something will fail.
It is just a guess? Then why don’t Boards go to the nearby fortune teller to get their RFS? It would be a lot cheaper, far less time consuming and much more fun.
Here is a second Spiritual Clinic just a bit further down the street. The directors could get two “expert” opinions far cheaper than hiring a professional engineering company.
Board has the final say
The Act states:
94 (8) Within 120 days of receiving a reserve fund study, the board shall review it and propose a plan for the future funding of the reserve fund that the board determines will ensure that, within a prescribed period of time and in accordance with the prescribed requirements, the fund will be adequate for the purpose for which it was established.
So the Board takes the information that they received from the engineers but they can add items to the Study that they want done immediately (such as renovating the lobby or party room), change the order in which the projects will be done or have necessary work pushed out into the future.
If the Board is unhappy with the Study and/or the engineering company, they can hire a different company that they feel more comfortable with.
A senior engineer who, years ago, did a RFS for a condo I know well, told me that:
“The Board wanted to hide its problems.” For over 20 years they did that very well.
Creating the Reserve Fund spending plan
The engineers may conduct an onsite visit during which they will inspect the building structure, the machinery, the plumbing and drainage systems, electrics, the parking garage, the balconies, the elevator machinery, the HVAC system, the concrete slab expansion joints and all the other building systems.
They will ask the manager and the superintendent if there have been any problems and damages especially from water leaks. They will read the older Studies and ask to see documents. If it is an older building with signs of concrete deterioration they should do concrete core samples.
The critical work, anything to do with safety or that if left undone will cause serious failures will be listed to be done first. Other items will have to wait until there is sufficient money in the reserves to pay for the repairs.
If there are expensive repairs required, the engineers (or the directors) may suggest local repairs be done now and the major work be pushed out into the future. Money may be included for contingencies for such things as window repairs, fixing pinhole leaks or for epoxy injections to patch deteriorated concrete.
Too much work & too little money
The funding starts with the Reserves Opening Balance. Then the engineers list all the work that needs to be done and the estimated costs at current prices. The annual contributions have to be a cost that the Board is willing to accept. After the initial two or three, annual increases, the remaining annual increases should not exceed the expected rate of inflation. Those financial constraints determine what and when the expensive repairs can be scheduled.
Once that is determined, the required repairs and replacements are slotted into a year that can absorb the expense.
Kicking the can down the road
Work can always be pushed out into the future, sometimes far into the future. I have seen garage repairs pushed out 20 years. One condo in Etobicoke had a RFS that stated that the roofs had to be repaired immediately. A new Board was elected, they hired a different engineering company, and the new RFS had the roof repairs pushed out fifteen years.
Dropping an Item off the list
This is not too common but I have seen it. A condo needs $661,000 worth of repairs to the exterior walls. In the next RFS that item is dropped. It disappears for ten years and then magically it returns to the Reserve Fund Studies. (The same engineering company prepared all of these studies.) Makes you wonder doesn’t it?
Lowball costs
Another way to fit all the items into a tight budget is to lower the cost of major replacements. On two consecutive Reserve Fund Studies, a condo’s window and balcony door replacement costs were estimated to cost $1,000,000. The next RFS showed that the condo needed only $500,000 to replace the windows and balcony doors.
A new director questioned this figure, when the same engineering company used the $500,000 pricing during the next Draft RFS presentation. (See what a pest a new director can be?)
The president of the property management company attended that meeting. He too was surprised at that estimated price. He estimated that the balcony doors and window replacements would cost $1,250,000.
For the second Draft, the engineers revised the figure to $750,000. By then the Board gave up on them. A different company will do that condo’s next RFS.
The funding scenarios
When presenting the draft study, the engineers usually give the Board two funding options.
Scenario 1
The preferred plan is Scenario 1. In the first year, the present owners are hit with a large Reserve Fund increase. In the above case, it would be a 26.5% increase.
At this condo, since the Reserves accounted for about 40% of the total budget, this would work out to a 10.6% increase in the total monthly maintenance expenses. If you add a 3% increase for the Operating Fund, the owners would be hit with a one time 12.4% increase.
Scenario 2
In this case, required the initial contribution is so high, the engineers kept the annual increases above the inflation rate for three years, not one.
The 10.9%, 10% and 9.3% increases to the Reserves are then followed by increases that match the expected rate of inflation.
Read the Description in the spreadsheet above where the engineers wrote:
“This plan of increasing reserve fund contributions greater than the rate of inflation will be evident on Status Certificates and be perceived negatively.”
The 2% annual increases
The RFS may call for a one or two-year funding increase that exceeds the rate of inflation but the study then calls for funding that equals the rate of inflation for the next 28 years. This is to satisfy auditors, real estate lawyers and potential buyers that the Reserves are adequately funded and that the owners will not be hit with unexpected expenses.
This may allow for proper funding but it may also be “required” to comfort the owners and potential purchasers. One engineering company stated in their RFS:
“However, some auditors and lawyers are defining “adequate” as a plan where annual increases match inflation.”
So if 2% or less is what they want to see, then that is what they will see.
(Look at the two spreadsheets above.)
Reserve Fund Studies Part Two
In Reserve Fund Studies Part Two, I will write about why many condo owners never see the promised 2% annual increases.