Saving for a rainy day is a lesson we all learn as children.  As individuals, we put away a little something for that ‘just-in-case’ moment; similarly, co-op corporations and condominium associations must keep reserve accounts, not just for unexpected replacements and repairs, but for expected ones as well.  

The question is, how much money your board of trustees should keep on hand?  The answer may depend to a great extent on what the ‘portrait’ of your community looks like.

Why are Adequate Reserves Important?

“When people seeking to buy a condo or co-op see an anemic reserve fund, it can have an impact on their decision,” says Jason Prisand, a partner with Prisand Melina Unterlack & Co, an accounting firm located in Plainview, New York.  “If they see that necessary improvements are being made, and that there is money to pay for them, they’re more comfortable.  If the money isn’t there, potential buyers know there may be an assessment – and that’s a red flag.  Many people won’t buy into a situation like that.” (For more on the importance of your community’s financial profile, see also our article on raising monthly fees, elsewhere in this edition of New England Condo. -Ed.)

Another major reason to keep capital reserve levels healthy is the ever-present possibility of the unexpected.  Greg Cohen is the president of Impact Management, a co-op and condo management firm with offices in Manhattan, Westchester and Long Island, New York.  “In a condo or co-op,” he says, “there are unexpected situations. There are new city and state regulations, and items that require upkeep, and these can be costly.  If a corporation or association is underfunded, the building has no cushion from these new requirements, and these are potentially expensive. You must also be able to maintain your physical infrastructure and do other repairs at the same time.”

What Are the Alternatives?

When considering how much your community should hold in its reserves, and how to raise and maintain those funds, the financial profile of the individual shareholders or unit owners is a primary consideration. This is because basically, there are three approaches to funding or replenishing reserves:  The board of trustees can levy an assessment, build a monthly line item into the common charges or maintenance fees, or – in the case of a co-op – borrow money, offering the building itself as collateral. (It should be noted that condo associations can borrow money too, but under different collateral arrangements, which we will return to later.)

The vast majority of co-op and condo communities are home to residents who would probably find a large assessment difficult to manage on short notice. That said, there are certainly properties whose residents have sizable assets, and prefer to keep their money working for themselves, rather than for the corporation or association.  According to the pros, it’s not unheard-of for a building or association with very high net-worth residents to simply levy a very large assessment to fund its reserves. These tend to be small buildings with very wealthy owners who can afford to write a large check if they have to. 

That’s definitely not the norm, however. The second, far more common method of up-funding reserves is to build a line item into the monthly maintenance or common charges, sparing residents the pain of having to come up with a lump sum all at once.  Each month this money is collected and placed in the association’s or corporation’s reserve accounts.  In many buildings this is a common practice already in place – not only in consideration of residents’ financial realities, but because many end-loan lenders, which are the source of mortgages for co-op and condo acquisitions, require that a building have not only a minimum capital reserve but that monthly charges include a line item for replenishment as a condition of the loan purchase.

The third alternative is to replenish reserves through financing.  This method is more applicable to co-ops than to condos and associations, as co-op properties carry underlying permanent mortgages against their entire property.  By contrast, in a condo or HOA, each unit is held in fee simple as an individual unit of real estate, so an association can’t place a lien against the entire property.  For co-ops, reserve accounts can be replenished by borrowing and depositing the proceeds into the reserves, or by taking a line of credit, along with an underlying mortgage, to be tapped when major work is required as an alternative to assessing residents.  However, says Prisand, “Inadequate reserves can also lead to higher interest rates, escrows or reserve requirements.”

Options for Condo Associations

In the past few years, some banks and other lending institutions have begun to look at financing of condominium associations from a different point of view.  Financing for capital improvements is now available.  “Condos don’t borrow as often as co-ops,” says one attorney.  “But there is financing available now secured by the condominium’s receivables.”  The monthly common charges and reserve accounts are pledged as collateral against the loan, making the reserves even more important.  “Lenders want to see that they have adequate reserves.”

As mentioned above, low reserves can also affect buyers’ and unit owners’ ability to finance as well. According to Ellen Shapiro, a partner with the law firm of Goodman Shapiro and Lombardi, located in both Massachusetts and Rhode Island, if a community’s reserves are scanty, “Owners may not be able to qualify for FNMA approval on the secondary market. Low reserves affect the ability of unit owners to obtain mortgages.  If I am representing a purchaser, I will apprise them of the risk.  One never knows what might come up.  If I am representing an association, I advise them to build up the reserves if they are not sufficient.  There is never a reason for inadequate reserves.”

What if Everything Has Been Done?

Say you live in a successful, mature, well-functioning co-op in Boston. Over the past few years, the building has managed to check off every last item on its ‘replacement and refurbishment’ list; the boiler has been overhauled, and converted from oil to gas; the roof and sidewalks have been replaced, the elevators upgraded and the lobby and hallways redecorated. The building’s reserves have been substantially depleted.  Do you need to replenish your reserve accounts to previous levels?

“If it’s a timing issue, and the building has done all necessary work, it’s an individual decision,” says Prisand, cautioning that there are still potential ramifications of not replenishing.  Buyers’ attorneys may be uncomfortable with the low reserves, regardless of all the work that has already been done.  Potential lenders will have minimum reserve requirements that must be met, no matter how new the boiler may be.  The best path to replenishment, according to all of our experts, is a steady, incremental one – through small monthly increases included in common charges or maintenance, so the financial pain is minimized. All also suggest that reserve funds should never be used to subsidize monthly charges to residents, and that maintenance or common charges should be increased by two or three percent each year on a regular basis to keep residents used to the idea of regular increases, just in case.

Potential Effects on Unit Sales

Bobby Woofter is a broker with the website MyBostonCondo.com.  He says that the deleterious effect of low reserve funds on sales “Often depends on the professional guiding the buyer. It’s something that someone who isn’t a real estate professional might too easily overlook.  In reality, it’s a really good peek behind the curtain to see how a building is managed – an important indicator, not so much about the dollars as about the planning.  If there are low reserves, you need a good explanation for the purchaser.  If the low reserves are from work already completed that’s one thing, but if it’s from bad management, that’s something else altogether.” 

Saving for a ‘rainy day’ is not just a cute saying; it’s also good policy.  Co-op and condominium buildings, like individuals, need savings.  We call those savings reserves.  We never know when an emergency will occur, that’s why it’s called an emergency.  Keeping those reserves at an acceptable level protects the association or corporation and the residents against the unknown and helps them plan for regular maintenance.  Like an insurance policy, reserves guard us against the unexpected, both physically and financially.

A J Sidransky is a staff writer/reporter with New England Condominium, and a published novelist.