When considering the impact of COVID-19 on reserve funds, we need to consider both the here-and-now and the future. In the near term, the impacts are strictly practical. In the long-term, it is more of an intellectual exercise in evaluating the likely impact on long-term inflation and interest rates.
Three Key Near-Term Impacts
Impact on Preparation of Studies
Financial updates have proceeded throughout the lock-down; however, there have been impacts on the timing of site-visit based studies. For three months, most consultants were not visiting sites at all, and many are still reluctant to enter occupied suites. The good news is that there are fewer corporations with summer year ends, so the number of corporations impacted has been modest.
Reserve fund study providers are likely to remain overloaded for the next few months as they attempt to catch up. If your corporation is struggling to finalize the study in time for budgeting for your next fiscal year, the recommendation would be to see what the overall message is in the draft study. If a significant increase is needed, the board should set a contribution level higher than existing. This can be communicated to unit owners via a Notice of Future Funding that explains that the study remains incomplete, but that the board is implementing a preliminary increase based on the knowledge that an increase is needed. When the study is finalized mid-way through the following year, it can be based on that new contribution, setting the required contribution for the following two years. This will necessitate a revised Notice of Future Funding but is a better plan than avoiding an increase until the study is finalized.
Impact on Spending
Many reserve fund projects have not been able to proceed this year. Even now as construction has “opened up,” contractors have backlogs that will allow them to complete only some of the previously planned projects. Corporations should be clear about projects that have true urgency and be willing to accept that non-urgent projects may need to be delayed. They should also consider the impact of projects on stay-at-home workers. This may not be the best year to complete disruptive projects like riser replacements.
COVID-19 Related Costs
Some corporations that have had COVID-19 positive cases in their buildings have seen significant unplanned costs this year related to cleaning. This may have put their operating fund at risk. Their instinct may be to look to reserve funds as a source of cash. Reserve funds can be used only for the major repair and replacement of the common elements and assets of the corporation, so it is not appropriate to use reserve funds to cover operating shortfalls. However, it may be possible to reduce the amount deposited to the reserve fund in the current year (on a one-time basis). This would allow more of the common expenses already being collected to be allocated to operating costs. It is important that the board work with their reserve fund study provider to model the impact and develop a new board funding plan that reflects this one-time reduction.
This must be communicated to unit-owners via a new Notice of Future Funding. It is important to make sure that this new low contribution does not become the “base” from which future contributions are calculated. Instead, the following year contribution must increase to the previously planned level, plus any additional amount required to ensure that the fund remains adequately funded despite the one-time shortfall.
Long-Term Impacts Are More Challenging To Predict
Since the financial crisis of 2008, we have been waiting for interest and inflation rates to return to historic norms. Now, with the financial hardship presented by the pandemic, it is safe to say that interest rates are likely to stay low for the foreseeable future. Low interest rates protect borrowers and penalize savers and are a painful pill to swallow for reserve funds, particularly in new buildings. It will be a long time before new buildings reach their critical years, so the interest earned on their balances becomes a significant contributor to the fund. Reduced interest rates mean that more money has to come from owners’ pockets, which will be reflected in additional increases at future updates. Older condos live more hand-to-mouth, spending most of what they collect in each year, so low interest rates have a lower impact.
It is very hard at this stage to predict where construction costs will go in the future. If supply chains and global trade break down, costs will rise. If spending drops too much, suppliers will be pressured to drop pricing. If governments spend on infrastructure, resources may be strained, and costs may rise. As such, it is difficult to evaluate where inflation rates in reserve fund studies should be set. A conservative assumption is an increase over what has been used in recent years. Each corporation should consider the impact of these assumptions on their study and proceed with caution. As with interest rates, inflation rates have a stronger impact for new buildings. However, newer condos also have many three-year study cycles before major spending occurs, allowing for course correction over time.
We are hopeful that the pain caused by COVID-19 will soon be behind us. This will be dependent on Ontarians stepping up and doing their best to minimize the second wave. Masks on, Ontario.
Sally Thompson is a managing principal at Synergy Partners and past-president of CCI Toronto.