Should associations fully fund reserve accounts today for anticipated future capital expenditures?

Like all things in life, condominium operations encompass many shades of grey. The questions that readers send to New England Condominium often fall into that range, where a simple answer is not always a complete one. From time to time, this column will ask members of our Editorial Advisory Board to put forth the arguments on both, or multiple, sides of these issues.

This month, we asked two of our board members, who have decades of condominium experience, to explain why associations should fully fund reserve accounts for every anticipated capital expenditure, and why many associations take a less-aggressive funding approach to reserves — potentially leading to a “surprise” assessment down the road.

Ralph Noblin, PE

Noblin & Associates, LC, Consulting Engineers, Bridgewater, MA & Dover, NH

Yes, full funding is the way to go

Why would a condominium association plan to fail? The finances associated with condominium living are complex and extensive. Anyone who has owned a home for an extended period knows that certain areas require “upkeep.” For example, most townhouse condominium associations built in the 1980s have already undergone major replacement projects involving, to name a few, roofing, siding, decks, pavement, fencing, and retaining walls. Although the useful lives of these items are not entirely predictable, enough real world data exists that allows predictions to “begin the discussion.”

Roofing is probably the easiest to predict. Depending on the exact methods and materials used, useful lives of roofs on condominium buildings usually range between 20 and 35 years. In the ideal situation, one twentieth to one thirty-fifth of the estimated reroofing cost is collected and set aside every year for the inevitable day when replacement is required. As condominium associations often consist of tens, if not hundreds of homes, the total cost of reroofing can easily run into six or seven figures, and that’s just for roofing.

It is the rare condominium where the wood or synthetic siding continues to successfully (both functionally and aesthetically) perform after 25 years. Siding in obviously poor condition absolutely affects property values. With condominiums, however, it gets more complicated. Windows and doors, most often owned by the individual unit owners, usually have a useful life similar to the siding. The best time to replace these windows and doors is during siding replacement so that all the building envelope components (siding, windows, doors, underlayment, flashings, etc.) can be properly integrated to combat severe New England weather. Most homeowners will be financially stretched to pay for new windows and doors; more so if the association did not adequately prepare for the siding cost and bank loans or special assessments result.

Another deck collapse was in the news recently, this time during a picture-taking of a multi-generational extended family. Local building inspectors have been known to condemn wood decks that have extensively deteriorated and the effect on property values is obvious. It is much easier to pay for a replacement deck at the rate of one twentieth per year than to scramble to assemble the funds in the last few years.

All condominiums have an operating account and a reserve account. For the most part, operating expenses tend to rise continually with inflation, not to mention severe winters like we have just experienced in 2013-2014. It is wishful thinking at best to hope that condo fees will not rise in time to address all the issues that condominiums face.

For most condominium budget meetings, the elephant in the room is what does it really cost, on a per-unit, per-month basis, to properly run a condominium? Let’s face it, a condominium must be run like a business to succeed long-term. One only has to look at the federal government to see what a disaster deficit spending is.

David J. Levy, PCAM

Sterling Services Inc., Holliston, MA

Circumstances determine whether or not to fully fund

To spur a more informed discussion on core issues facing board members and property managers, I have been asked to present a strong case against fully funding the reserves.

For full disclosure, I am typically the person strongly recommending to clients to fully fund the reserve contribution. However, I have been asked to put forth the best arguments that I’ve heard in the past 25-plus years against fully funding.

Like many issues, we should start with the requirement of state law. In MGL 183a, Section 10, the wording includes the following:

“ … (i) All condominiums shall be required to maintain an adequate replacement reserve fund, collected as part of the common expenses and deposited in an account or accounts separate and segregated from operating funds. …”.

As noted above, the requirement is “adequate,” not “fully funded.” So the real question is, how and when should reserves be funded to comply with the definition of “adequate?”

Let’s assume that a roof installed by the developer and reviewed by reserves consulting firm is said to likely last 20 years, and that the cost for a new roof is $6,000/family.

Best practices would say that $25/month of the current condo fee, from day one, should be placed into the capital reserve fund so that in 20 years, there is enough to pay for a new roof.

Yet did not the first owner already pay for a new roof when purchasing the first one? Should not that original person get some value out of his/her purchase prior to start paying for the second roof?

If the condo fees are raised to fully fund the replacement of this roof, and by extension, all other common elements, then the condo fees could be $50-$100 (or more) higher than at its peer properties. Is not the board’s primary obligation to create a budget that facilitates curb appeal and property values? Does not a higher condo fee reduce the value of the homes, if that condo fee is higher than other nearby, similar, competing properties?

Still another argument, especially in upscale properties, is that owners would rather hold on to their own money, likely getting a higher rate of return on their assets, than pre-pay for a future new roof, with the common trust getting very meager interest on the accumulating funds.

What are the options to cover the difference between the “fully” funded model, having the entire $6,000/family in reserves for the roofs (and thus likely $20K per family for all of the common assets that typically need attention in many condo complexes when the property reaches 20-25 years), and having less money in reserves?

Options include, but are not limited to, a loan or a special assessment.

What most experienced managers recommend that the board discuss the funding options with its law firm, with input from its independent accounting firm. During that discussion the economics of the property and the owners of that property are discussed honestly.

In an affluent property, with no existing collection issues, the board may wish to have a special assessment. These owners can just write a check. There is little, if any risk, of default. And for those with technical backgrounds, home owners may be able to change the cost basis of their homes due to the special assessment, which could be helpful at the time of sale, reducing capital gains taxes.

Yet with a special assessment not covered by the State’s superlien, the Trust’s management, law, and CPA firms will all recommend that if there are any significant risk of non-payment by some owners, then a loan, paid off by higher condo fees, is the prudent way to finance the needed common area capital project.

In summary, the state law, MGL 183a, requires that reserve funding shall be “adequate,” without defining “adequate.” Each board should speak with their advisors and membership to determine what funding method is best for that community. Then that decision should be disclosed with the membership, at every annual meeting, such that all owners are aware of how the current and likely future boards are going to fund the replacement of major building components.

The more research, planning and transparency the board puts into that capital reserve replacement plan the more stable, financially, physically, and politically the property will be, now and for decades in the future.