Finances

September 7, 2022 Published by London and Area Chapter - By Lyndsey McNally

Inflation is Coming for You

From the CCI Review 2022/2023-1 September 2022 issue of the CCI London Chapter

The table above has condos sounding the alarm bells! It reflects the StatsCan Residential Construction Price Index from 2020 to the end of first-quarter 2022, and indicates that in just over two years, the average construction inflation rate for the eleven census metropolitan areas was a staggering 36%.

Our current economic environment is difficult as we come towards the end of the COVID19 pandemic, throughout which we’ve seen real estate bidding wars, long periods of low interest rates, and a suffering supply chain. In the news, we hear a lot about the Consumer Price Index increasing the cost of living. We are all feeling this in the price of gas, groceries, and daily cost of living. The Consumer Price Index for same period shown above was 22.4%. This general cost of living increase will surely impact condo fees, but the Construction Price Index long-term will have a greater impact as this affects the capital repair plans for condominium corporations, particularly the need to increase contributions to the Reserve Fund to support projects now that they are becoming more and more expensive. Keep in mind that it’s not just our projects today that are impacted, but also cost uncertainty for future projects must be accounted for.

How does this affect our projects today?

Reserve Fund Planners in Ontario typically assume a long-term inflation rate of 2-3%. If your condominium corporation is executing a major repair project this year, it has inflated faster than your Reserve Fund contributions have increased to support the costs.

When the current rate of inflation is applied to your capital projects, you will very likely experience a shortfall in the Reserve Fund. Even if you do have the cash today to support the current project, you may be borrowing from funds earmarked for other projects to cover the increased cost

Add the greatly increased cost of completing major repairs and replacement, to the current state of Reserve Funds in the Province of Ontario; a market is already in financial crisis. In 2020, Ontario's Auditor General suggested that 69% of condo built between 1980 and 2000 do not have enough funds in the Reserve Fund. The tables above show that the condos they surveyed need to increase condo fees by an average of 50% to meet their long-term capital repair obligations. Because the majority of condos do not have enough money in the Reserve Fund, we’re playing catch-up in the maintenance and repair of our property. This was already the case even BEFORE inflation came for us.

The reality is that the projects you're doing this year, after experiencing just two years of inflation, can be almost 40% more than you had anticipated and saved for. When we're dealing with projects in the millions of dollars the impact is substantial.

To put this into simple terms. A project that cost $1,000,000 at the end of 2019 now costs $1,400,000. As a lender for condominium corporations, I see the impact of this everyday. If your corporation is struggling, you’re not alone.

Condos have very few options to recover from these shortfalls, as the owners are the only major source of revenue. The following three items are the only ways for a condo to generate income to make up for the shortfall:

Special Assessment –

• Special Assessment – can be a good option, but only if your owners can afford it. Owners have to pay a special assessment either using personal revenue or to leverage the equity in their homes.
• Condo Fee Increases – may not be able to raise funds fast enough for projects that need to be completed now and could bring condo fees to a level that isn't attractive to potential buyers, therefore impacting property values.
• Loan – there are a number of ways that loans can be structured to minimize the financial burden on the owners today. Loans allow fees to increase more gradually, and less than would be required to accelerate contributions related to a specific project. There are other benefits, such as eliminating the need to phase projects due to cash flow – eliminating mobilization costs associated with phasing, as well as inflationary pressures on future phases of the project. In order to borrow funds, strategic planning is necessary as well as robust communication to the owners in the condominium corporation (majority approval is required to pass a borrowing bylaw).

How does this affect us into the future?

The market hasn’t yet seen the full impact of the recent construction inflation. Condominium corporations executing major projects in 2021 & 2022 have seen a preview, but many condos are still working on reserve fund studies that were completed in 2019 & 2020, before the inflationary pressures really kicked off. Reserve Fund Studies (RFS) need to be completed once every 3 years, so as we approach the end of 2022 and get through 2023, cost adjustments will be applied to these “older” studies.

Let’s look at a condominium corporation that is “adequately funded”. The example we’ll use is a pretty standard high rise; 40 years old with 174 units. Their RFS was completed in 2019.

Their current RFS has a positive outlook, and the corporation is currently using inflation matched increases. They have some big projects coming up: $1,000,000 in 2025/2026 for mechanical equipment, $2,500,000 in 2027/2028/2029 for windows and patio doors, and $2,000,000 in 2031 for underground garage repairs.

If we adjust their RFS to reflect a 10% increase in 2020, and 35% in 2021 (with the inflated pricing retained on projects thereafter) but make no other adjustments, the corporation suddenly has a large shortfall for these projects of $2,700,000 or ~$15,500 per unit.

This gets worse over time. If the corporation doesn’t make adjustments to its funding model, the shortfall over time becomes $7,400,000 or $42,529 per unit.

This isn’t a stand-alone horror story. This is a condominium corporation that had every reason to believe that they were fully funded. They weren’t behind, they didn’t defer, inflation came for them.

What do we do?

The first important point that needs to be made: Don’t defer because your corporation can’t afford a project. Deferring only costs the owners of the corporation more in the long run (because of inflation and ongoing costs to maintain failing components) and can harm your property values if your building deteriorates. Instead, look thoughtfully at all the available funding options. Model what will happen to the condo fees in each scenario. I can assure you – the outlook for condo fees will not be better if you defer/delay. Many corporations will decide to defer projects without taking this important due diligence step.

Condominium corporations also need to start preparing to top-up their Reserve Funds. You can start today does the corporation have excess operating surplus to make a special contribution to Reserve? It could even be prudent to have a financial update of your RFS completed so you can start increasing regular contributions sooner (if you know you’ll have a shortfall, it’s never too early to start addressing it).

Boards and Managers will also need to prepare to educate Owners about the long-term financial plan for the corporation and the need to increase condo fees. This is never a popular conversation, but one we will be having often in the next few years. Perhaps the measures the Bank of Canada is implementing with rate increases to slow inflation will have an impact, but it is unlikely to correct to the point where we were in 2019.

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Lyndsey McNally is Director, Originations at CWB Maxium Financial.. She joined the CWB team in 2020 with an extensive background in the condominium sector, having worked with condominium corporations in the GTA since 2022. Lyndsey is a licensed condominium manager and in 2017 was selected as property manager of the year by the Association of Condominium Managers of Ontario (ACMO).

Lyndsey works exclusively with condominium corporations, property managers and other condominium stakeholders to develop and implement customized financial solutions.