Director of Reserve Fund Studies and Partner at Enerplan Building Consultants, Martin Bonomo, explains the ins and outs of Reserve Funds!
One Director on a condominium Board said, “I don’t even buy green bananas anymore!”
The gracefully maturing gentleman was objecting to the notion of putting money into a reserve fund, when he could put his hard earned money (or retirement fund) to better use in the short term. And, just as he had always done as non-condominium homeowner, he would cough up the money necessary for any major repair or replacement at the time of the need, even if it meant a bank loan.
Well and good for many to have this philosophy or maintenance practice… if you are a non-condominium homeowner.
Firstly, a condominium is a business owned and operated by a group of owners, and managed by an elected Board of Directors. Secondly, there are rules, regulations, responsibilities and obligations attached to the condominium Declaration and By-laws, as well as the Condominium Act, 1998 and Regulations designed to ensure the business duly serves the interests of all of the owners – present and future without bias.
One significant implication of all this is the requirement that a condominium corporation must have and maintain a Reserve Fund from day one in perpetuity. A Reserve Fund that, again, treats all owners equally, regardless of their tenure, so that time of ownership does not result in a sudden increase in a contribution to the Reserve Fund, including a loan or Special Assessment. The idea is to establish a Reserve Fund early in the life of a condominium that can be adequately maintained over time with inflation only annual increases to the ownership.
To this end, the Condominium Act, 1998 and Regulations oblige the condominium corporation to conduct a Reserve Fund Study during the first year following Registration, and as a minimum, every three years thereafter. This is the key component in the ongoing process of ensuring every effort is made toward the proper maintenance (funding) of the Reserve Fund.
The Reserve Fund Study is prepared by a qualified consultant, referred to as the Reserve Fund Planner, who estimates the remaining life of each major common element component or system/assembly before major repair or replacement and the value or cost of the remedial work. This information is then processed to identify the predicted future cost for each component and tabulated. The result is a tool for planning all current and future repairs and replacements to common elements while making the appropriate annual contributions to the Reserve Fund.
The Reserve Fund Study is a predictive tool, always subject to change due to a variety of factors. These influencing factors include inflation rates; interest rates; weather conditions; cost of products and materials; labour rates; energy costs; and, hidden factors, such as unobservable design or construction flaws. There are also more obscure factors, such as changing Boards and condominium ownership priorities.
To complicate matters further, other Acts and Regulations affect the operation of a condominium from time to time, causing, for instance, an upgrade to a common element (e.g., elevator to improve safety). These difficult to predict obligations also impact on the Reserve Fund, as unforeseen and unexpected reserve fund expenses arise.
The Reserve Fund Study is therefore, a living document, which means it is accurate for the day it was created and must evolve with predictable and changing circumstances. Hence, the obligation to each corporation to conduct a new or updated Reserve Fund Study at least every three years. This best ensures the Reserve Fund Study remains as accurate as possible and the reserve fund is maintained in a manner that protects the interests of the ownership. In the case of the unforeseen and unexpected Reserve Fund expenses mentioned above, these factors will at least be picked up when they occur and carried forward, again toward best ensuring accuracy of the Study and adequacy of the fund into the future.
Another condominium Director said, “Our twin corporation of about the same age, has a poorly funded Reserve Fund. They have less than $500K in theirs and we have over $2.5 million in ours. Aren’t they are going to be in trouble some day?”
As the old adage states – you can’t judge a book by its cover! In this case, the corporation with the lower amount in their Reserve Fund had actually been following their Reserve Fund Studies and undertaking major repairs and replacements as they became necessary. Consequently, the asset value, aesthetics and livability of the corporation with the lower fund balance were much greater than the other corporation.
The annual Reserve Fund balance in a well managed, Reserve Fund, when graphed over time, generally resembles the outline or profile of a mountain range with peaks and valleys. It is a dynamic tool designed for saving and spending. Owners of a condominium Unit/Suite deserve the opportunity to realize a return on their investment. The single best way for this to occur is for the Reserve Fund to be used for the purpose it was designed to fulfill.
Still another Director said, “We need to reduce the numbers and move some of the capital improvement work out a few years. We can just patch and hold until then. This will keep the annual contribution to the Reserve Fund lower for the next few years.”
The Reserve Fund Study, to be sure, is not a numbers game. Reserve Fund budget numbers are realistic and based on assumed, proper scopes of work not to be manipulated. A well-designed Reserve Fund Study is an unbiased accounting of the real needs of a corporation to preserve the asset value. Further, the actual amount of money required for the major repair or replacement never disappears. The work must be undertaken, in accordance with assumed scopes of work, sooner or later. In addition, the patch and hold approach always results in higher contributions to the Reserve Fund in future years as additional funds are wasted while building a higher major or replacement budget to account for factors such as inflation, labour costs, rising product or material costs and construction mobilization costs if the work is phased as well as deferred.
The bottom line – neither the need nor the obligation to pay go away. Turning the Reserve Fund Study into a numbers game causes a spiral into a situation demanding a ramped up annual contribution over two or more years (there is a limit to the number of years that can be used for this purpose, usually restricted to three years) in the best-case scenario, or a third party loan or Special Assessment, in the worst-case scenario.
A Director could say, “We respect our Reserve Fund Planner. He/she is the conductor of our symphony. We put away the amount we will need to spend and we spend it when we need to. The result is our corporation is a growing asset we are proud of.”
Being predictive trumps being reactive in any business, such as running a condominium corporation. Life throws us many curves. Good planning (Reserve Fund Studies) and timely actions (following the plan set out in the Reserve Fund Study) help to smooth the way. A healthy Reserve Fund is simply a fund that is properly planned, funded in accordance with the plan and used to make the capital improvements set out in the plan.