Reserve Funds

An Indication of Financial Well-Being

By Abe Kleiman

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The primary function of a board of a co-op or condo is to operate, maintain, repair and preserve the common property. The board also has a responsibility to maintain the value of the property.

Most boards develop an annual operating budget in which they project operating expenses for the upcoming year to determine the level of maintenance or common charges required from unit owners. In addition to an operating budget, the board should also establish a capital budget to plan for current and future repairs, replacement, and improvement of major components of the property, such as roofs, balconies, the exterior fa├žade, elevators, boilers, and so forth. The capital budget should project expenditures for major repairs and replacement of property components for a longer period, such as five years.

Developing a Capital Budget

In developing a capital budget, boards must decide how to fund the projected cost of repairs and replacements of the property's major components. Boards have several options: accumulating funds over a period of time, special assessments when the funds are needed, borrowing, or a combination of the above. Funds set aside for this purpose are usually referred to as "reserve funds." A properly funded reserve assures that money will be available for any major anticipated repairs and replacements.

There is no simple formula for determining the proper level of reserves. Many co-ops and condos maintain a reserve fund by falsely using informal rules of thumb (i.e., three or six months of maintenance), which may not be sufficient.

In order to determine the proper level of reserves, a detailed study should be performed. A reserve study can be done by the board, the property manager, or building maintenance staff, but is generally best carried out by a professional engineer or architect. The reserve study requires a physical analysis of the components of the common property, as well as a financial analysis. The physical analysis includes identification of the major components of the property, an inspection and assessment of the age and condition of the components, and an estimate of their remaining useful life.

A Detailed Financial Analysis

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The financial analysis requires an estimate of the cost of the major repair or replacement of the components and the establishment of a funding plan. Like operating budgets, capital budgets must be updated annually, taking into consideration repairs made since the last capital budget, any changes in the condition of major components since then, as well as cost, reserve balances, and so forth.

Because co-ops or condos with adequate reserves have the funds available to make needed major repairs and improvements, they are usually better maintained, which enhances the value of the property. Inadequate reserves may restrict a board's ability to properly maintain the property, and thus adversely affect the value of the property and the ability of owners to sell their unit.

In addition to the board's responsibility to maintain and preserve the property, as well as the value of the property, it also has the responsibility to protect, maintain and enhance the assets of the co-op or condo. Boards should develop an investment strategy for reserve funds. The board should consider only investments that are safe, liquid and maximize yield. They should not speculate with co-op or condo funds in an effort to beat the market. Most boards follow the above philosophy by investing their reserve funds in U.S. obligations, bank Certificates of Deposits (CDs), municipal obligations and money market accounts.

Once the board of a co-op or condo is convinced of the need and desirability of maintaining a properly funded reserve, they face the challenge of educating their unit owners of the need to set aside funds for future major repairs and replacement. It is not unusual for unit owners to resist funding for future repairs and replacement. They are reluctant to contribute to a reserve fund they believe will benefit future owners. Owners must be convinced that accumulation of reserves assures that funds will be available when needed to maintain or improve their property, and to minimize the need for large special assessments. A healthy reserve fund is an equitable means of spreading the cost of building maintenance and repair to all users, and is an indication of the well being of the building, which enhances the value of the property and unit owners' investment.

Abe Kleiman is a certified public accountant and partner in the Manhattan-based firm of Kleiman & Weinshank LLP.

Comments

Robert GABORIAULT

I agree with the fact that contribution to any reserves will benefit future owners. Reserves will always be nonsufficient, so why making contribution to any reserve fund. Co-op and Condo are like micro-communities where owners have to share the utilisation common assets. So each occupant is owner of his unit and tenant of common asset. It is Public Finance Principles that have to be applied to co-op & condo as well. Simple : 1st) set the common asset to value ratio ( ex 20%) ; 2nd)mortgage the common asset (ex 5%-25years) ; 3rd) refinance every 8-12 years and get monney to do any major repears or improvements. In my model, current expenditure are shared between owners at the pro rata of the unit superficy but the common capital expenditure have to be shared to the pro rata of each single units market value. That way will cost less to each owners and will assure the maintenance and the improvement of the value for the benefit of all. In my point of view, it is the only way to be fair with actual and future owners RG

GERALD WATKINS

IF CONDOS OR TOWNHOUSES ARE LESS THAN 5 YEARS, HOW HEAVILY DOES THE MORTAGE COMPANY WEIGH APPOVAL OF A MORTAGE BASSED UPON THE AMOUNT OF THE RESERVE FUND AS OPPOSED TO UNITS 20 YEARS OLD.

Lila Starman

I would like more information on developing a reserve fund an I have to agree that projecting future expenses is not a science but an estimate . how does a person find out the costs involved with setting up a reserve fund study and how does one go a bout doing one

Jerry

Interesting question, to have a reserve fund or not. Personally, in looking to buy into a condo or townhouse developement, I prefer to not have the risk of future assesments. Presuming others may have the same bias, I would think property value might be better preserved in a development with a healthy reserve. Also, a reserve to cover future repairs and replacement seems more fair in that these costs are spread over all occupants whether they own when the units are new or old. With no reserves, those that own later in the life of the development would pay more to live there than those who bought in early. Also, with no reserve there would be finance charges, which would make repairs more expensive. You would also be at a disadvantage if interest rates were high. In conclusion, I think I would prefer an adequate reserve.

an unknown user

Is it permissible for a co-op to use its Reserve Fund to cover month-to-month operating expenses? In other words, is it appropriate for a co-op to use the Reserve Fund to cover on a regular basis, say, for years, expenses that are part of its Annual Operating Budget?

rita

own a condo, started the reserve fund put it into a money market----the problem is we needed 2 signatures on the account and the treasurer put her name and her boy friends name who owns the condo with her. We are not happy about that and she would like to know why.

Melvin Barrett

I am the president of our condo assn and I am in favor of creating reserves. Over the last 40 some years our resident have voted down the establishment of a reserve. I would like to recommend to the owners a general pool of reserves. QUESTION? Do I first hold a vote on if the owners want a reserve, or must I first conduct a study to establish an estimated cost?

James

i am on the board of my condo association and we place as close to 10 percent of our annual operating budget aside for reserves. no, you cannot use reserve money for operating expenses unless the item in question is in the reserve study, which should be done (by law in certain states) every 10 years. you do not want an underlying mortgage on the property, some mortgage lenders will not give a mortgage with an underlying mortgage. what happens if people do not pay their maint. fees and you have that mortgage obligation? too much of a risk to take in this economy.

gittel

i am the president of an 8 unit townhouse assoiation. We have no pool or orther amenities.Our condo dues are $140 per month and so far this seems to be sufficient. We have not had a special assisment in 3 years and we don't have much of a reserve. The thinking is divided between having a special assesment for work to be done in the next month, or use the money we have and if any major expense comes up , then to have a special assesment. What do y ou think?

Lee

Does anyone have a reserve specifically for earthquakes/disasters?

Phil Bishop

Reserve funds for condo associations and for HOA's can vary widely depending upon the amount of common assets there have, the values of them and their estimated useful life. If nothing else, condo associations should maintain a reserve fund (only usable for capital repairs, by the way) in an amount sufficient to cover any insurance deductable from a major loss such as roof damage from a major storm. Doing so will eliminate the need for special assessmants down the road which are never popular and can be very large with a major project. Even paitnting or re-siding an entire complex can be a major expense. I manage 2 condo associations with 45 units each in Texas

J. Bart Foster, Realtor KW Boston

A sure fire way to undermine the saleability of a property by means of a mortgage is to live paycheck to paycheck... ie, not having a reasonable contingency for over spending the budget (an Operations Reserve Funding). The property becomes unwarrantable and a buyer would be forced to seek a portfolio lender (at a cost) or worst a cash buyer from the Gods of Sellers. I am dealing with just these problems on three properties, no reserve funding, no reserves what so ever, and late payment of monthly operating fees. Low condo fees at the expense of a reserve fund? You might as well take a 5-10% hit on market value for this alone. On the upside the budget can be readjusted each year to for over & under budgeting which would in effect keep the reserves in account steady.

Gerald Watkins

Can the reserve funds be used for every day repair as opposed to long term projects like roofs, siding,, etc .We need to repair some steps, power wash siding and add fencing. Should it come from the reserve or the operating funds?

wskinner@cogeco.ca

I am on the Board of a co op and the president states I cannot have the financial statements for the full financial year (I came on the Board part way thru the financial year). I am also not allowed to view the reserve fund. I was president of a Condo Board for 15 years and cannot understand why the President has such power. I as a member of a co op should be allowed to see and copy the minutes and financial statements

an unknown user

wskinner, the president's contention is preposterous...read your bylaws and call him on it. A coop must share its financial documents with shareholders, (there is even a specific time of year that it has to be presented and discussed with the board- then offered to residents) never mind that you are a board member- you are legally permitted to view these documents- usually with an appointment with your managing agent! Have the bylaws in your hand with the specific wording which by all means should permit you to see the financial statements. How are residents supposed to sell their apartments without knowing the financial health of their building? It is required information on loans!


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