finance

 

Capital Reserve Studies
Planning & Funding For Your Condo’s Future
By Bob Grant, CPA
As any homeowner knows, at some point in a home’s useful life, the structure will need certain components replaced or renovated, such as the roof, siding, driveways and other permanent structural items. The question is how to pay for it.

While a homeowner has the option of saving for the future costs or bearing the burden when the need arises, since the financial burden is his and his alone to bear, in the case of a condominium association, there are many owners often coming and going as units are bought and sold.

The condo association’s board of directors has a fiduciary responsibility to both the current and future owners to make sure adequate funds are set aside or “reserved” in order to provide for the repair or replacement of the various components of the condominium complex. Additionally, there are state laws that either allow reserve funding or require it of the board, depending on the particular state in which the complex is built.

In this article, we’ll try to outline some practical guidelines for both determining what components should be included in the reserve plan and some methods for raising the funds necessary to adequately fund needs.

A reserve study is defined as a plan for setting aside funds for the future major repair or replacement of the association’s common property. There are two main steps in accomplishing this study: (1) an analysis of common property components and (2) the financial analysis. Click here for an illustration of a capital reserve study.

A 4-STEP ANALYSIS OF COMMON PROPERTY COMPONENTS
The following is a four-step process for determining what comprises common property and its condition.

1. The board should take an inventory of the common components of the condominium. This should begin with a review of the condominium documents that often define those common elements along with a physical inventory, through observation of the grounds, etc., to determine what should be included in the reserve study. Many of the more common components are the elevators, roof, pools, parking lots, waterproofing, railings, windows, doors, plumbing and electrical systems. Remember that every complex is unique and has its own particular items to deal with that others may not, such as piers, boathouses, conference areas, etc.

2. The board should then make an assessment of the current condition of each component by utilizing the expertise of the maintenance staff, contractors or consultants.

3. The board should then estimate the remaining useful lives of the items to determine how long the association has before the repairs or replacement becomes necessary.

4. The final task for the board is to estimate the future repair or replacement costs of the components. The best sources of estimated repair or replacement costs include but are not limited to prior costs paid by the association, existing bids, engineering estimates and the informed judgment of association personnel.

In the performance of the above steps, it is logical and prudent for the board to enlist the assistance of an engineer, architect or contractor experienced in condominium construction to assist the board in the compilation of the information needed for the physical analysis portion of the study. If the association is fortunate to have such a person as a unit owner, that individual could be extremely helpful as a liaison between the board and the consultant, as well as lending expertise to the study and the process.

Having performed the physical analysis, the board now can go to the membership with a reasoned, well-thought-out determination of the future financial needs necessary to effect the repairs and replacement of the common elements. How that is accomplished is the focus of our next discussion.

THE FINANCIAL ANALYSIS
The association has three options when it comes to being able to pay for the repair or replacement of major association common elements. The association can save for the expenditures over time, it can levy a special assessment to the unit owners when needed (not always a popular decision), or it can borrow the funds needed and repay the loan through increased operating assessments.

The latter two methods may indicate that the board has not gone through the needs analysis and is adopting a “pay-as-you-go” approach to solving the problems as they arise.

The prudent thing for the board to do, of course, is to adopt a long-range funding plan, incorporate that into the annual member assessments and set the funds aside to be able to pay for the repairs and replacements as they come due according to the needs analysis. It should be noted that all owners over the life of the condominium building are consuming the common elements each day they own their respective units. Therefore, not funding reserves on a periodic and systematic basis allows these owners to avoid their responsibility to pay for their fair share of the costs. There are five components to the financial analysis needed to accomplish this goal:

1. Determine the amount of funds currently set aside in the reserve fund (if any).

2. Prepare a cash flow projection that will anticipate future expenditures based on the study and the contributions required over time for the funds to be available when needed (generally at least for 15-20 years).

3. Determine the funding level at which the association intends to fund the reserves, or the funding plan.

4. Determine current and projected fund investment earning rates.

5. Determine current and anticipated cost inflation rates.

By completing these steps, the board will have, over time, a well-thought-out and well-funded plan for making sure the complex is in the best physical condition and well maintained for both the enjoyment of the unit owners and for the protection of the investment all the owners have made in the property. As potential buyers become more knowledgeable in the financial condition and operation of condominium associations, the study and funding of future major repairs and replacement show prospective buyers that the association is fulfilling its fiduciary responsibilities in planning for the future needs of the association.

Bob Grant, CPA, is president of Grant, Sanders & Taylor, P.C. in Gulf Shores, Ala. The firm has provided auditing, tax and consulting services to the condominium community on the Alabama Gulf Coast and the Florida Panhandle for more than 25 years. Contact Grant at (251) 968-2727 or bob@grantsanderstaylor.com.