RES01 - An Introduction to Reserve Funds
Purpose
Reserve Fund Reports (or Depreciation Reports if you are in BC) are an incredibly important document that charts the financial and physical well being of a condo for the next 20+ years. Many of you are planning for your own lives, saving a few bucks here and there for that new car you’ll need in a few years, the kids education, and one magical day – retirement! A condo has to do the same for itself, saving for a replacement boiler, a new roof, new elevators if you have them, and for anything else that is expected to wear out over it’s life. The plan that does all of this is called the Reserve Report. Reserve Reports seem like they are incredibly complex documents with all sorts of tables, lists of stuff, and all sorts of numbers that seemingly appear out of nowhere. However – broken down into its basics, Reserve Fund Reports are actually not that hard to understand. A condo buyer willing to put in a bit of time can read through a report and ask some intelligent questions around “What’s Missing” from the report and ensure that the condo is adequately saving in accordance with the report. How it is used by the Board / Property Manager Once a report is completed and approved by the Board, it serves as a financial roadmap as to 1) How much to save for annually for major repairs, and importantly 1) What and when can we spend money? The Board will set condo fees based partly based on amounts it is required to save yearly based on the Reserve Fund Report. More on this later. Spend the Money! An important thing to emphasize here is that Reserve Funds are meant to be spent, not guarded and hoarded to create the largest balance possible. All too often I have seen buildings defer necessary and specified spending per the reserve report in the misguided hopes of “saving for the future” and “keeping fees” low. As any owner of a detached house or even car will tell you – robbing from today will only cost you tomorrow. In one example I saw, the Board continually deferred replacement of the 47 year old elevator (poorly maintained I might add too) despite having sufficient amounts in the reserve fund and being clearly identified as an expenditure item in the report. All of this was done in the name of “saving money”, but to the residents of the 6th floor dependent on these often broken, and terrifying (since they would trap you at random) elevators – I can tell you they desperately wanted to replace this thing. Ironically, units in the building were selling for less than they should have – primarily due to the shabbiness of several items scheduled for replacement in the reserve report. Residents were losing tens of thousands due to the Board not spending as it should have. What’s the old saying: “Penny wise, pound foolish?” Spend the money folks, that’s what the Reserve Report is there for. Capital Items, Not Operating It’s important to note here that the Inventory (and the Reserve Fund Report in general) is meant to encompass capital items, not ongoing operational expenses or maintenance. Capital items are physical assets that will be used for many years into the future. Examples of this include:
Often you will see Board adopt a dollar limit to help them determine that is capital or operating. For instance, any expenditures less than a certain amount may be deemed operating and no capital, even if they meet the definition of being a capital expenditure. The exact amount used will different depending on the overall size of your budget. The benefit of this is two fold – 1) the reserve fund doesn’t become cluttered with too many small irrelevant items, and 2) the annual operating budget doesn’t fluctuate up and down every year for major *planned* operating expenses. (more on this next) Major Planned Expenses The “key” word here is PLANNED….not UNplanned…. An example of a planned expense would be the fact that the exterior sidings needs painting every 5 years….not an unexpected discovery of leaking pipes, which would most definitely be unplanned. For major planned expenses, the Board may wish to include a line item in the reserve fund report to ensure that it will be funded via that instead of having to adjust the operating budget significantly in the year the expenditure is needed. Here’s an example of this – in one of my buildings, the complete repainting of the exterior wood siding is required to be done every 5 years…paint gets pretty tattered in the Western Canadian winters. In our labor constrained market, we were looking at $15,000 to complete this. Rather than hike condo fees in year 5 to raise the $15,000 all in one year we elected to add it as an line in the Inventory of Common Property and ensure that it was continuously saved for via the monthly reserve fund contributions. Lets be clear that major UNPLANNED expenses can’t be saved up for via this way….the lack of time to collect amounts over a period of time would effectively make it a special assessment. So if the Board suddenly discovers a large mold infestation and needs $400,000 to fix it in 3 months time…..I’m afraid there isn’t time to save up for it via a series of smaller payments….time for the lump sum special assessment I’m afraid. Quality of Replacements This falls under the category of being a matter of judgement for the Board. However, in general the Reserve Fund is meant to replace current items with a like replacement in the future. It is not meant to serve as a means of “upgrading” facilities and equipment with additional capacity or functionality, or improve on the quality of materials (ie linoleum to marble flooring). However, if improvements are required to meet current code requirements, these would generally be acceptable to incorporate into the costs. The judgement I referred to comes into play when a certain amount has been provided for in the reserve report. For example, if $40,000 has been put aside for ceramic tile replacement in the main lobby, and marble is available for a similar price – the Board generally has discretion to proceed with the marble alternative. In general, as long as the dollars spent don’t deviate upwards from what has been provided for the in reserve fund report – it is not uncommon for Board to “upgrade” on the replacement. It’s a 25 year Report Reserve Fund Reports are generally for 25 years into the future, though this amount varies by province. This length of time certainly makes it difficult to “peer” into the future to project what might be required in terms of maintenance and replacement. The 25 year window always rolls forward every year, to provide a consistent 25 year window going forward. Typically this is done whenever the reserve fund report is updated, vs annually so don’t be alarmed if your report is slightly out of date. Differences by Province It’s important to note that Condo / Strata Acts across the provinces all difference in certain regulations around Reserve Fund reports. For instance, in Alberta, Reserve Fund Reports must be updated every five years, whereas in other provinces it is three. We’ll try our best to flag provincial differences here (and in our Provincial Differences table), but in the interest of accuracy, please consult your Provinical Condo Act. ~CondoSensei |
|