RES2.2 - Reserve Fund - Main elements of the Report - Part 2
(continued from Part 1: Reserve Fund - Main Elements of the Report)
3) Funding Schedule
One of the most important schedules in a Reserve Fund report is the Funding Schedule. It utilizes the results from the Inventory of Common Property and the Table of Annual Expenditures and combines them with the reserve fund contributions schedules from the owners to answer a very basic question. Is money collected from owners enough to pay for the replacement of all items on the Inventory of common property?
Again, lets look at our example from Tiny Townhouses.
There are two very important numbers right at the top of this report: the Inflation Rate, and the Interest rate. I say this because one of these two numbers has an effect on EVERY column of this very important table. Lets start from left to right:
Year – kind of exactly what it sounds like – for each of the next 25 years, there will be a separate line representing individual years for the next 25 years.
Opening Balance – this represents the amount that should have been in the Reserve Fund account on Jan 1 of the year. When the fund was started in Jan 2013, the amount in the account was $2,800 – you could have pulled a bank statement for Jan 2013 and have seen that amount. However, it’s not the opening balance you typically focus on, it’s the Closing Balance….more on that in a second.
Annual Contribution – This is the total sum of all reserve fund contributions from all units for all 12 months in a year. For instance, at Tiny Townhouses in 2013, 3 units contribute $350 a month in total towards the reserve fund ($116.7 per unit x 3 units x 12 months = $4,200).
But wait you say – I see how you get to $4,200 in 2013, but why does this amount grow to $4,284 in 2014 you say? It’s all due to that wonderful thing called inflation and the simple fact that everything usually gets more expensive in the future. As a result, the Board is expected to continuously increase fees collected from residents in the future by at least an amount to offset inflation.
Remember that inflation rate right at the start of the Funding Schedule. Well it gets used here. $4,200 x 1.02 gives us the $4,284 you see that needs to be the reserve fund contribution from all the units of Tiny Townhouses in 2014. That works out to be $116.70 per unit per monthly. Less than a bottle of soda per month. Not so bad right?
We’ll talk a little more about the important of increasing rates (and condo fees) to match inflation in our Operating Budget article.
Additional Assessments – It’s rare, but if a condo has already adopted a plan to special assess additional funds over a series of years into the future from the owners, those amounts would be reflected here in this column. Tiny Townhouses has no Special Assessments planned so this column is blank.
Interest – As the Reserve Fund balance grows it of course earns valuable interest. This is an often overlooked part of reserve fund reports as in some years at Tiny Townhouses, the interest earned is almost as much as 10% of the money set aside by residents for reserve fund contributions. As such, interest earned is a critical part of ensuring future spending needs can be met.
Often I see wildly unrealistic rates used in Reserve Fund reports, and that alone often accounts for them being “underfunded”. Since the economic crash of 2008, interest rates have been incredibly low in Canada for risk free investments. Put it this way, your typical high interest savings currently yield between 1.3% to 2%. If you see a reserve fund report with 5% as the interest rate, I’d certainly question how they intend on achieving that.
I’ll talk a little more about interest rates and investments suitable for Reserve Funds in a follow up article since I’ve seen people propose some pretty crazy “get rich quick” ideas. For now, let me just say, you want something safe, liquid, and boring – all of which translates to a pretty low rate of return. Additionally, certain provinces legislate the types of investments that are allowed.
This all important column is the total amount by year that must be spent per the Table of Annual Expenditures on replacing items from the Inventory of Common Property.
Back in the Inventory of Common Property, I mentioned that the replacement costs for every line was done in “today’s dollars” right? Looking 10+ years into the future, things will be more expensive in the future right? Given that, don’t we have to increase the cost of things in the future? We sure do. Take a look at the cost of the Deck Flooring replacement in the Inventory of Common Property – it’s scheduled to be $7,500, with the expenditure planned to be done in the year 2024.
If you look at the ‘Annual Expenditure” column in the year 2024, you can see that this has since grown to $9,325 due to the 2% inflation rate used. How does this happen? Report preparers utilize something called the ‘Future Value” of money – I’ll let Wikipedia explain that little technical gem a little better than I can. In short, the $7500 expenditure grows by 2% a year, compounded for 10 years to arrive at $9,325.
All of the previously mentioned column all combine to form this one column, arguably the most important column in the reserve report. The closing balance represents what should be in the reserve fund bank account for any given year. If there’s only one column of numbers in the whole report that you pay attention to, start here please!
Here’s a quick test you can do – arguably one of the quickest and easiest things you can do. Look at this column, and match it against the balance on the bank statement of the reserve fund for the corresponding month. (ie Dec 31, 2014) If the bank statement is significantly less than what’s indicated in this column for that year – you’re underfunded. If it’s significantly higher – you’re overfunded. Overfunding is certainly better than being underfunded, but that should trigger some questions too, notably, what have you not spent money on to create the surplus? Is it a temporary deferral of an expenditure, or a permanent one? As for underfunding, see our related article on the topic here: Link.
While it’s not uncommon for the bank balance for the reserve fund to be less than the closing balance column, you’d never want to see a report that has negative numbers on its closing balance column in any of the years. That means they’re planning to be underfunded – a situation I never like to see. That’s kind of like saying you’re planning to retire in 15 years but your retirement plan clearly says you don’t have enough money to do so in 15 years. Does it happen – yes for a variety of reasons. As a buyer, would I be worried? I’d have to understand the exact reason why there are underfunded, but in general, yes – I’d be worried.
Looking at the Tiny Townhouses Funding Schedule , you can see the impact of having too many expenditures in a single year. Take a look at the year 2028, when $20,188 of expenditures is scheduled to be completed ($15,000 to completely rebuild all decks per the Table of Annual Expenditures, future valued to $20,188). This is a massive expenditure and it drains the Reserve Fund Balance to a mere $847 dollars. It also means that the interest earned drops to $65, down sharply from $313 in the year before. With this example you can see the benefit of staggering major expenditures – it certainly helps to prevent the massive outflows of cash in the reserve fund accounts that take it into underfunded status. As mentioned previously, talk to your report preparer about any preventative maintenance that can be done to better stagger major expenditures.
Main Elements Conclusion
In a nutshell, that’s it – not so bad is it? If I had to break this down into plain English, the above three schedules would be renamed to:
1) What do I need to replace/fix?
2) What years do I have to replace/fix stuff?
3) How will I balance money collected with amounts spent to replace/fix stuff?
That ends our basic walk through as to the basic anatomy of a reserve fund report. Next up are a few questions as to specific aspects of the Reserve Fund Report.