Reserve Funds

November 3, 2023 Published by Toronto and Area Chapter - By Sophia Rojenko,

Reserve Fund Study Report Card - Study Term and Phase-in Periods Really Matter

From the Fall 2023 issue of CCI Toronto Condovoice Magazine.

Tackling Underfunded Reserve Funds

Site Description
The corporation consists of a fifteen-storey high-rise condominium with a three-level underground parking garage, constructed in the early 2000s. The corporation was due for their reserve fund study update and opted to change providers.

Reserve Fund Assumptions
The previous reserve fund study (and prior updates) used a 30-year analysis period when calculating reserve fund contributions. In addition, the annual increase in contributions was higher than cost inflation for the entire thirty years. The previous study was also prepared prior to the recent inflationary pressures. The new provider prepared the study using a longer analysis term, and recommended phasing the required increase in over no more than four years.

The Reality
Many 10 to 20-year-old buildings are severely underfunded, despite following the recommendations of professionals, which makes them question how they ended up in this position. There are several key reasons why condos in this age group end up underfunded.

All new condos start out underfunded
The Condo Act currently allows the initial reserve fund contribution to be 10% of the operating budget. As an industry, we know this is not sufficient and that the Condo Act needs fixing. Each corporation has their first reserve fund study done and discover that they need a significant contribution increase.

Looking out 30 years is not enough
The Condo Act requires a minimum of thirty years of cash flow data. Some providers use this minimum and only consider 30 years of data looking forward. The problem is that the first twenty years of a building’s life typically have light spending relative to all following years. For a new condo this skews the apparent funding needs down. Each reserve fund study update will drop off three years of light expenditures and pick up three more years of high expenditures, triggering a significant increase in contribution at each update during the first twenty years.

Long phase-in periods = more deferral onto future owners
Phasing in an increase helps reduce contributions in the short term by deferring some contributions onto future owners. The longer the phase-in, the more financial burden is passed onto future owners. The Condo Act requires the reserve fund to be “adequately funded” but does not provide a definition for what “adequate” means. In the absence of a definition, there is no legislation preventing providers from preparing plans that allow increases above inflation for the entire analysis period resulting in ridiculously high contributions for future owners.

Lessons Learned for Reserve Fund Planners
You should limit phase-in periods to no more than three years.
In June 2021, Professional Engineers Ontario (PEO) released a “Guideline for Engineers Conducting Performance Audits and Reserve Fund Studies”. In this guideline, the PEO states that “…it is reasonable to inflate contributions at a greater rate than the rate of inflation for the period of time until the next study will be completed (three years), after which time the contribution rate should match the rate of inflation”. Phasing in a large increase is acceptable but becomes an issue when the phase in period is too long. In this study, the provider permitted four years because the increases were huge, but this is not ideal as the corporation will go into the next update already behind.

You should use at minimum a 45-year analysis period in your studies, especially for buildings under 20 years of age. The length of the analysis period should be equivalent to the component with the longest service life in the study.

Takeaways for Board of Directors and Property Managers
As a Board, you may be tempted to phase in increases over a long period to keep fees low for current owners. This may even be presented as an option without any discussion about the impact on future owners. Know that in doing so, you are deferring significant financial burden onto future owners and are setting your condominium down a path of financial hardship.

Sophia Rojenko, P.Eng
Synergy Partners