For many condominium boards and owners, one of the most challenging issues is the need to increase reserve fund contributions each time a reserve fund study is conducted, which is mandatory every three years. This is especially confusing when the board has diligently followed the cash flow plan provided by its reserve fund study consultant.
There are many reasons why contribution levels must increase, including: unexpected issues; rising costs; underperforming building components; regulatory change; and the new expenses that come with a new reserve fund study.
Many projects are predictable and should be covered in a quality reserve fund study but invariably something unplanned will arise. Unexpected major repair or replacement projects must be funded, adding to the increase in contribution levels. While inconvenient, it’s better for this to happen than for the reserve fund study consultant to assume every disaster will befall every condo, which would drive contributions up unnecessarily for all.
Construction or equipment costs can sometimes increase at a rate greater than the inflation rate assumed in the study. This can be particularly true if there are changes in a marketplace such as the withdrawal of a large contractor, which creates reduced supply for the same demand, driving prices up.
Similarly, there are times when a major storm can raise the cost of repairs. Basically, the repair work is needed to recover from the storm, which increases demand and subsequently the cost of the repairs.
Underperforming building components
When building components perform worse than the industry standard, they have a shorter service life. This leaves less time to save and take advantage of compound interest for the replacement of these components.
New legislation or regulations can require building or equipment upgrades and retrofits such as installing elevator equipment guarding or back-flow preventers. These projects are generally paid for from the reserve fund, though there is some debate about whether or not these are eligible reserve expenditures.
New study, new expenses
The most common (yet most commonly overlooked) reason for contribution increases relates to the very nature of the reserve fund study as mandated by the Ontario Condominium Act. Each time the reserve fund study is updated, it captures three more years of expenditures. For example, if a condominium’s last study covered the period from 2012 to 2042, the condominium’s next study will capture the period from 2015 to 2045. If the projects in the 2043 to 2045 period cost more than those in the 2012 to 2014 period, then an increase in contributions over the 30-year period will be needed.
Generally speaking, it’s reasonable to assume that more projects will come into the study than will fall out of it for the first 30 years of a building’s life. This means that, by design, a condo requires an increased reserve fund contribution at every update.
At some point, though, when the large renewal projects are behind a condominium, a similar decrease with each update may occur. But as most of the local building stock is on the upswing in this process, increases at the time of update will be the norm for now.
While large renewal projects that fall into the “new last three years” of the study will be undertaken well into the future, they can have a significant influence on the current reserve fund contribution. For example, if a large project such as re-waterproofing a garage roof deck is planned for 2045 and will cost $2 million (in 2013 dollars), then, using a 30-year cash flow, the current year contribution will likely increase by approximately $50,000, just to budget for this one project.
A fairer way to share future expenses
To minimize the impact of new projects, the reserve fund study provider can consider 45 or 60 years of projects in the analysis backing the 30-year cash flow. That way, when a project falls into the “new last three years” of the study, the corporation will have 45 or 60 years to save for it rather than just 30, lessening the impact on the current year contribution.
This requires somewhat higher contribution levels from day one but it more fairly shares the costs across all owners, both current and future. It also reduces the impact of these large projects entering the timeframe of the study because the corporation has more years to save. An increase may still be needed upon update but it should be smaller and more manageable than if only 30 years had been considered.
So, it is important for condominium corporations to understand that while they receive a 30-year cash flow table with each study, only the first three years of the analysis are really relevant. When the next update is done in three years time, a change to contribution levels will always be needed.
Sally Thompson, P.Eng., is executive vice-president and national practice leader for property condition assessment services at Halsall Associates. She acts as project principal for a wide range of capital planning and restoration projects for a variety of building types. Sally can be reached at email@example.com.