The experience of condo and co-op board members and trustees can often feel like a juggling act. There are varied interests in the community that want different things. There's legal counsel, financial advisers, and managers who try to offer the best professional advice they can, and they may not always line up. It's easy to feel like the life of a board member or trustee consists of mostly just putting out fires, and never getting ahead to the important things. But some boards may not realize that many of those fires might have been preventable in the first place had board members made the smart investments, and took the time to plan.
Just as an individual or couple can have a bank account or into which they can tap into in the event of an emergency, condos and co-ops need a reserve fund for planned, as well as unplanned, expenses. Whether a major repair like a new boiler or roof, or something completely devastating like Hurricane Sandy, reserve funds can offer a great deal of relief and security.
Financial planners and accountants all agree on the importance of a reserve fund. But all reserve plans are not created equal. Careful, competent, professional management is the key. If the rainy day fund can't foot the bill for an unforeseen emergency, boards could find themselves in a tough spot.
Reserve Study Needed
Community association professionals say there is no magic formula for what makes the smartest reserve strategy for an association, although there are general guidelines.
To begin with, buildings need to have a reserve study, which is typically done by an engineer, architect, or reserve specialist. According to Michelle Baldry, PE, RS, PRA, the director of client services in the Northeast region for Milwaukee-based Reserve Advisors, the study is usually done in two parts. A physical study identifies all common area components, assesses the conditions of the components and equipment, estimates the remaining life of these components and estimates their replacement cost. The financial analysis examines the status of current reserves, maps out a funding plan and identifies funding goals. A study will generally take a 30-year outlook, since components like roofs may have life spans in that range.
“Roofs, decks, balconies, interior finishes, pools, pavement, playgrounds—those are all standard items,” she says. “But no two properties are the same, so it’s really important to get out to the site and see what the association maintains. The way we determine if it’s a reserve component is generally based on cost; a rule of thumb is 1% of the operating budget—so with a million-dollar budget, anything over $10,000 should probably be considered a reserve expense. But,” she cautions, “it really depends on the property.”
In addition to studying the components and figuring replacement costs, she notes, Reserve Advisors also makes recommendations for cost savings. “We go into the details about how the association should maintain these components, and look at options for replacement.”
Stephen Beer, CPA and a partner at the Manhattan accounting firm of Czarnowski & Beer, LLP, breaks the reserve fund amount down by unit. For buildings his firm advises, he recommends a minimum of $2,000 per unit. Buildings with a reserve fund that translates to $4,000 to $6,000 per unit are healthy and robust, he says. On the other hand, Baldry feels it’s hard to set a rule of thumb, because so much depends on the current state of the property.
“The reserve study is really a snapshot in time,” she says. “The goal is to establish a ‘safe’ level of reserves. So we look at how much money do you have today, what expenditures do you have planned, and then how much money do you need to maintain that safe level of reserves?”
One note of caution: Some buildings have very old reserve studies. Costs of labor, building materials, and utilities change over the years, and new technology comes along. That’s why it’s important to get your reserve study updated from time to time. Most reserve specialists recommend re-visiting the reserve study every three to five years, and any time that an association adds components like a pool or other amenity. “And there are also external elements to consider: large market changes, inflation, new technologies, new codes—like the Virginia Graeme Baker Act a few years ago, that was a large cost to associations,” Baldry explains.
The Virginia Graeme Baker Pool and Spa Safety Act, which became effective in 2008, requires that all public pools and spas, including those in condos, install anti-entrapment-compliant drain covers to prevent the accident that took the life of seven-year-old Graeme Baker in 2002. Baker, the granddaughter of former Secretary of State James A. Baker, drowned when powerful suction from a spa drain pulled her underwater.
Some boards—especially at smaller condos—try to save money by doing their own reserve studies, contracting directly with engineers, paving experts and other professionals. One board, recalls Mark Love, CPA, of the accounting firm of M Love & Associates, LLC, in Worcester, Massachusetts, spent six months working seriously on their in-house reserve study, “and the study they did held up to professional scrutiny.” But it’s a time-consuming project, especially when undertaken by volunteer committee members, and not recommended for all associations. “That board was certainly the exception, but they took it to heart and took it seriously.”
On the other hand, “It’s good to have an independent opinion,” Baldry says. “Often, if you do an internal study, you’re relying on vendors who have a vested interest.” And, she notes, there are a number of “hidden” components that non-professionals might not think of, such as common pipes and electrical systems.
One thing that almost all professionals agree on is that you shouldn’t use your reserve fund as a vehicle for aggressive investment. During the economic boom of the 1990s, and the real estate boom of the early 2000s, some co-op and condo buildings invested their reserve funds aggressively, only to be left out in the cold when the market collapsed. Boards should remember that reserve funds are, in essence, made up of other people’s money and should be treated as such.
In general, conservative investments like CDs, government bonds and so forth seem to be the rule. “Conservatism is still the order of the day, even though CD rates are at the lowest level they’ve been at in 25 years,” Love says. “Boards by and large are very, very conservative. They want to have the principal protected, rather than roll the dice.” The roller-coaster ride of the stock market in late August, he notes, is a good example of why associations should shy away from aggressive investment.
“Condo owners tend to be older, savvy, seasoned and conservative. They know that it’s somebody else’s money they’re dealing with. We speak to this point a lot at seminars,” Love says. “I’d say maybe one percent of the time, or less, someone will start talking about being more aggressive. But conservatism wins out at the end of the day.” While a 1% gain on a CD may not seem like much, it’s better than a 20% loss if the market tumbles, he notes.
Gary Adler, CPA and a partner with the accounting firm of Bass & Lerner in West Hempstead, New York, points out that “If you’re looking for yields, it’s hard to get yields unless you go long-term (investments).” But co-op and condo boards are reluctant to go long-term, because they’re not sure what their needs will be. Many New England associations, for example, found themselves digging unexpectedly into their reserves after ice dams caused extensive damage to roofs and other building components last winter.
One strategy Love sees is associations using short-term CDs, “seeing what’s happening six months from now,” rather than investing in long-term certificates. “The big advantage of the fluidity of a CD if it’s short term is that even if you had to break the contract because you need the money quickly, the penalty is minimal.” A good practice is to “ladder” CDs with different maturity dates.
“Not only are trustees and finance committee people more sophisticated these days, the owners are also more sophisticated” about association finances, Love says. “There’s been a shift in the last 10 years; residential communities are becoming more like small businesses. Almost all of our condo clients are running them like a small business.” Still, he says, in doing financial statements for 2014-15, he has seen associations citing reserve studies that were done in 2006.
On the subject of who oversees and/or has access to the reserve funds, the consensus is that it should be under the control of the board itself. Ideally, there should be two or more individuals who have access to the reserve account, to serve as a form of checks and balances.
“The manager and the board have to be in lockstep,” Love says. “The very best-run associations we deal with have a very good board and a very good property management company and a fully-engaged property manager.”
In addition to the reasons previously mentioned, there are other reasons for buildings and developments to keep a healthy and adequate reserve fund—including rules from Fannie Mae, Freddie Mac, and the Federal Housing Administration, put into place after the real estate collapse, specifying that to receive FHA-backed loans, condo associations set must aside 10 percent of their operating budget for reserves, or “have a reserve fund that shows you have the funds necessary to do the replacements” spelled out in the reserve study. An association may think it’s in good shape if it has a half-million dollars in reserves, “but that could be reduced considerably by a single project. Decks, roofs, paving—these are expensive projects. And if they’re left in disrepair, it will affect future mortgages and future resale values.”
A look at the Internet shows that in 2010 and 2011, there were quite a few cases of bank loans being held up because the condo association didn’t have 10 percent of its funds in a reserve account, since it was dealing with foreclosures and other immediate, pressing problems.
Another reason to keep a healthy reserve fund is that, in today’s real estate market, it’s a plus to attract potential buyers of units. If a buyer is looking at a condo community with healthy reserves and one with a minimal reserve fund, professionals say, the healthy one will win out every time. So how much is enough? “You can never be too thin and never have too much money in your reserve fund,” Love quips. “You need a reserve fund to separate the money, and then you need to feed it annually.”
Where to Learn?
Where can condo board members and administrators learn more about how to manage their reserve funds?
There are quite a few resources. For one, board members should consult their management firm and their CPA. Associations should also seek to get members onto the board who have a finance background. Also, the national Community Associations Institute (CAI), of which there are several chapters in New England, has on its website several materials about reserve funds, reserve studies and reserve specialists. Visit CAI-New England (www.cai-ne.org) or CAI-CT (www.caict.org) for more information.
And, of course, keep reading New England Condominium, and plan to attend the 2016 New England Condo Expo, which will take place at the Seaport World Trade Center in Boston on May 24th next year.
Raanan Geberer is a freelance writer and a frequent contributor to New England Condominium. Associate Editor Pat Gale contributed to this article.