Underfunded Reserves The Dangers of Running Short

The importance of saving for a rainy day is a lesson we all learn as children. Just like we as individuals should put away a little something for that ‘just-in-case’ moment, co-op corporations and condominium associations must also keep reserve accounts for unexpected as well as planned replacements and repairs. The question is how much money they should keep on hand. The answer to that depends to a great extent on what the portrait of the community looks like.

Why Reserves Really Matter

“When people seeking to buy a condo or co-op see an anemic reserve fund, it can have an impact on their decision to purchase [in that building or association],” says Jayson Prisand, a partner with Prisand Mellina Unterlack & Co., LLP,  an accounting firm in Plainview, New York. “If they see that the necessary improvements are being made, that there is money to pay for them, they are comfortable. If the money isn’t there, potential buyers know there may be an assessment. It’s a red flag. Many people won’t buy into a situation like that.” 

Another major reason to keep capital reserves at adequate levels is the possibility of the unexpected. “In a condo or co-op,” says Greg Cohen of Impact Real Estate Management, a New York-area property management firm, “there are unexpected situations. New York City is always changing laws and regulations. There are new regulations, and items that require upkeep, and these can be costly. For example, Local Law 11 – or the new requirement for elevators to have automatic door monitoring systems, which have to be installed by the beginning of 2020. 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.”

A third reason to keep reserves at adequate levels, particularly in co-ops, is their necessity when seeking financing. Stuart Bruck, a commercial mortgage broker with Time Equities Inc., a real estate firm in New York City, points out that adequate reserves are required by banks and other lenders when refinancing underlying permanent mortgages and/or lines of credit. “Banks require replenishment of reserves if they are too low when refinancing an underlying permanent mortgage or other financing vehicles,” he says. Skimpy or depleted reserves can not only cost you when it’s time to fix the boiler; they can be a roadblock to a lot of other financial necessities. 

What Are the Alternatives?

When considering how to maintain and how much to keep in reserve, one of the biggest factors to take into account is the financial profile of the community’s individual shareholders or unit owners. Basically, there are three approaches to funding reserve increases or replenishments: the board can levy an assessment; build a monthly line item into its common charges or maintenance fees; or – in the case of a co-op – borrow money, offering the building as collateral. (Condo associations can also borrow money, but under different collateral arrangements, which we will return to later.)

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Comments

  • Robert Nordlund, PE, RS on Saturday, January 18, 2020 3:10 PM
    Cooper - thank you for bringing this important topic to the forefront. The problems caused by underfunded Reserves are due to poor choices, not misfortune. Fortunately, national standards for Reserve Studies exist, so associations can obtain wise guidance to know how much to set aside, learn how much is "enough" in their Reserve fund, and so prospective buyers can quickly evaluate the size/strength of the Reserve fund (just look at the association's Percent Funded!).