In an ideal world, condominium owners are satisfied with the way their corporation is run, fees are comparable to the condominium down the street, major repair and replacement projects are well-managed, and the reserve fund maintains a healthy balance. Then again, in a perfect world, condos never leak! The unfortunate reality is that many corporations have underfunded reserves, which can limit available options.

An underfunded reserve is one where the reserve fund contributions are not enough to cover the expenses expected to crop up over the span of the reserve fund study. This puts the long-term durability of the property at risk, will usually diminish property value, and may compromise safety.

Ontario’s legislation only loosely defines what constitutes an “adequate” reserve fund. The Condominium Act requires the board to review the reserve fund study and propose a plan for future contributions that ensures the fund will be adequate for the prescribed time period of the study. Most interpretations of the act suggest this means that contributions should be fair and uniform to present and future owners, over the life of the property.

To achieve this, the corporation should be setting aside enough money to cover annual expenses while limiting annual increases to contributions to the rate of inflation. This results in equitable payments for current and future owners.

The act further requires boards to declare what funding plan they’re following, and whether or not the reserve fund study consultant has endorsed it. Other provinces have no such requirement for “adequacy” in their respective legislation.

Why the reserve is underfunded

There may be many different reasons that a reserve account is underfunded. Common reasons include: The board adopts a funding plan not endorsed by the reserve fund planner; major projects must be completed sooner than anticipated in the reserve fund study (therefore there is less time to save for these expenses); and project costs run higher than was budgeted for in the reserve fund study.

Let’s look at each of these scenarios.

The board does not adopt recommended plan.

Outside of Ontario, there is no direct link between the funding plan(s) in the reserve fund study and the funding plan the board actually adopts. For example, in Alberta and British Columbia, the board is required to approve a plan, but not necessarily one of the plans provided in the reserve fund study. There is also no requirement to disclose whether the plan the board has adopted was endorsed by the reserve fund study planner. If the recommended plan will require an increase in contributions, the board may be pressured to generate an alternate plan which avoids or defers the increase.

Projects must be completed sooner than planned.

Restoration planning for a reserve fund is based on the average lifespan of systems and components. Of course, reality rarely complies. In some cases, major systems will last longer than normal. In cases where a major repair or replacement is required sooner than expected, the corporation loses time to build up the reserve, and so may fall short.

Project costs are higher than anticipated.

The reserve fund study is not intended to generate specification-level pricing. The analysis is based on a visual assessment, a review of the performance and repair history from board members, property management and service contractors, and a review of construction drawings and past reports.

With this high-level information, the reserve fund study consultant provides order-of-magnitude opinions of cost. These should be accurate within about 25 per cent.

The reserve fund study will identify what components require additional evaluation to prepare more accurate budgets, one to three years before the expenditure is planned. Without these detailed condition assessments, actual repair costs may vary considerably, but detailed reviews are not always done.

How to make up the shortfall

The good news is that if the reserve is underfunded, it’s possible to remedy the corporation’s position. First, analyze the cash-flow shortfall. Several variables influence the cash flow in this financial analysis. The most important variables are the critical year, the interest/inflation rates and the phase-in period.

The board sets a minimum balance that the reserve fund should remain above over the term of the study. This is an important contingency against unexpected repairs. The analysis will yield a “critical year” where the reserve fund reaches its lowest point (i.e. the minimum balance). The timing of the critical year has a big impact on cash flow.

If the critical year is close (within about 10 years), then the corporation has less time to save up for large repair projects and the recommended increase may be steep. The required contributions can be reduced if projects are moved past the critical year.

The analysis is an iterative process, so the critical year gets re-calculated and may actually be pushed out. But not all repair projects should be deferred.

What projects have tolerance?

Discretionary projects, such as those based primarily on aesthetics, can often be moved or scaled back, especially since renovation costs have risen dramatically in recent years. For example, rather than a full corridor renovation, consider only replacing the carpets, repainting the walls, or replacing lighting (which is also an opportunity to reap energy-efficiency incentives).

Similarly, major restoration of structural components (such as balconies and parking garages) or building envelope components (exterior walls, windows, doors and roofs) can sometimes be significantly deferred by completing targeted repairs. That’s provided that there is tolerance for more frequent repair intervals and a potentially patchwork appearance. Some mechanical equipment can also be maintained beyond a typical lifespan by replacing individual components.

Work with the condominium’s property manager and reserve fund study consultant to identify these projects, complete detailed evaluations where necessary, and discuss the advantages and disadvantages of targeted repairs and local replacements compared to general replacement.

The required contributions are also sensitive to the difference between the assumed interest and inflation rates used by the analysis. When the critical year is close, using the interest rate that the fund is currently achieving avoids overstating the projection for interest earnings. If the critical year is far off, using the current rates penalizes owners, as the long-term (30-year) average is normally much higher. Higher reserve fund balances can also command higher interest rates.

If annual contributions are too low, increases will be required. While in the long term the best way to make the required increase is right away, current owners rarely appreciate a large jump in contributions within a single year.

When a large increase to reserve fund contributions is required, it can often be phased in over several years while still meeting the intent of fair and uniform contributions. Limiting the phase-in period to about three to five years provides disclosure to existing unit owners and potential purchasers.

What other options are available

Sometimes tweaking variables in the funding analysis doesn’t produce a workable plan, or the shortfall is too great. Fortunately, other funding options can be employed. They include special assessments/levies and loans.

Since these options impose an additional burden on current owners, they are usually considered a last resort, but they do not have to be. Creative use of a low-interest loan can effectively reduce a corporation’s shortfall while maintaining manageable annual contributions. The property manager can help the corporation work with a condominium lender to prepare a funding plan that is fair for current and future owners.

If the pessimist would say the reserve is half empty, perhaps the optimist would ask “Is the reserve fund half full?” Increased contributions to the reserve fund could represent opportunities. If the corporation has been making lower than necessary contributions, age and wear may be showing, so chances are the corporation has a lower market value.

Increasing reserve fund contributions allows for major repair and replacement projects to be completed. This renewal adds value for those who continue to live and work at the condominium and for those planning to sell.

Leading up to repair/replacement projects, speak with the property manager and reserve fund study consultant; there are almost always opportunities — for energy savings, more durable systems, more efficient equipment, easier to maintain/repair equipment, and so on. Completing an energy audit in conjunction with the reserve fund study can help form a holistic and practical plan.

Knowing what goes into the reserve fund study allows the corporation to make the most of what comes out. Maintaining a financially healthy reserve fund requires not only technical knowledge but an understanding of the needs of the board and unit owners. When the board has a clear vision for the corporation, its reserve fund consultant can help act as a guide along that path.

Jeremy Taylor is a technical lead and project manager at WSP. A structural engineer by training, his experience includes reserve fund studies, performance audits, property condition assessments, and evaluation, specification, and construction review of structural and building envelope systems. He can be reached at jeremy.taylor@wspgroup.com.