Reserve Funds

April 15, 2024 Published by Golden Horseshoe Chapter - By Dave Williams

Outside the Box Thinking... Reserve Funds [Opinion]

From the Volume 19, Spring 2024 issue of the CCI GHC Condo News Magazine

Something has gotta give!

If you had the opportunity to read the Globe and Mail “Report on Business Magazine” (October 2023), there was a interview with Isadore Sharp on his long, founding, association with “Four Seasons” Hotels. There may be some similarities between the hotel business and the condo business.

During the interview, Mr. Sharp observed that “hotel ownership is a volatile business, and you have to have deep pockets. Because it deteriorates (buildings), it is constantly needing more refreshing and more investments.”

Wow! Does that ring any bells?

The “it” he refers to is the “hard” asset………the building.

Mr. Sharp arrived at a conclusion very early in the history of “Four Seasons.” Let someone else own the bricks and mortar and offer “management services” only. If you are old enough, you will remember the vaunted “Four Seasons Inn on the Park” in Don Mills. I don’t know what it is called today, but it is probably under some other flag……. not that there is anything wrong with it……..but it probably doesn’t stand up to “Four Season” standards.

January 8th 2024; Morguard Financial, announced the sale of 14 hotels under different flags in Canada to another party. It may be that they want to get out of the hotel business, but there will be a reason for the sale. If an asset is making money, you usually don’t sell it. So, could it be yet another example of bricks and mortar aging and costing more dollars?

Where are we going with this?

It is suspected that as a general statement “reserve funds” are under-funded. I have heard many excuses for this including the recent spiral of inflation. Even more than 5 years ago, people in my community didn’t want to hear about higher “condo fees.” Reasons ranged from, don’t want to fund repairs for future residents. One former director and community president even pointed to a row of units and said: if we increase fees all those units will be up for sale. Really?

This implies that the reserve fund is a magical pot of money that will fund all capital expenditures without cost to the resident. Not!

It also speaks to the fact that residents are sold (by the developer) on the “relax and don’t worry,” theory of condo life. Yes, there are some savings to be garnered: grass cutting, snow ploughing, maybe re-roofing and window replacement to a point. Anything you would normally do to maintain a free-standing home still applies at your cost. Maybe at a slight discount because of volume but at the end of the day……..resident beware………you still have to pay. There is no magic pot of gold.

To the hotel Business

So, here is where the hoteliers have a formula. When the building passes beyond our standards……..sell it! In the condo business that formula doesn’t work.

Three Choices

The solutions are to properly fund the reserve from the get-go, prepare your residents for some steep assessments or plan on borrowing money at some point to keep the lights on.

Here is the problem with the second and third choice. The existence of assessments can cause properties to be sold at reduced prices. The same can also be said for debt financing. Why would anyone buy a condo unit that is somewhat supported by a bank loan?

The Simplest and Best Solution

Anyone buying a condo deserves to know the financial condition of the condo corporation and to be briefed on the workings of the condo corporation. This should be the law. Many folks who are buying can be pre-occupied with getting a mortgage, maybe retiring, maybe downsizing……..the list goes on. Quite often, over-zealous real estate salespeople don’t pass on the nitty gritty. In fact, they may not know the details. Does a prospective buyer have any responsibility to ask the appropriate questions? Of course, but they may not know what to ask.

In the absence of proper briefing at the point of sale, it is incumbent upon the condo board of the day to follow the best transparency protocols. Have regular town hall meetings for residents. Give them the up-to-date financial standing of the corporation and as importantly let them know if there are any projects pending with high costs. In other words………..make them a part of all decision making.

This can often mean bringing in expert speakers, even financial experts, to explain why monthly fees need to be increased commensurate with building age and condition.

Every building/community has residents that are experts in business, construction, accounting, communication, whatever. These folks often don’t come forward to stand for board positions. That said, in my experience they would if invited or asked.

Interesting Example over time

I have been following a condo property for several years now. When I first noticed it, the units were selling for $900,000, with monthly fees of $1100. The building was 20 years old and housed most of the original resident owners. Three years later, the asking price is still the same and the monthly fees are $1400. There is now some turnover. The point? When fees get too high, turnover will occur and that is alright.

Is it a governance problem?

If your condo’s Reserve Fund is where it should be, then chances are good that you have a great board of directors. If on the other hand, your condo Reserve Fund is lacking then the opposite is true. The board may be loving their power positions and not understanding the overall need for transparency that leads to increasingly harder decisions. Mind you, they are probably enjoying the level of fees that are lacking.

Condo Communities offer a great deal to many people. Folks, with similar standings in life, people requiring a safe place to live in retirement, young folks getting started. The fact is; the social benefits can be very important. That said, proper, responsible and yes even professional management is important………even critical.

So, what is the solution?

Condo governance may be entering a new era. By and large, the CAO has failed to provide leadership in this new time. Some parts of Condo governance need to step forward with a much more thoughtful approach to operating affairs.

It may appear complex, but it really isn’t. It starts with an annual plan that looks at least 5 years ahead. Yes, I realize there is already an engineering study in place. But this, at best estimates approximately when certain capital expenditures will require attention.

The five-year plan needs to be more specific. Where will the money for these projects come from? Is the reserve fund ready to cover not only the first project in line but also whatever projects are to follow. If there appears to be a shortfall, how will that be satisfied.

The five-year plan needs to be rolling in the sense that when year one expires, year six needs to be added on. The big question to be answered here is whether the property management company has the expertise to assist the board in constructing such a plan? Secondly, is the board willing to build the plan? If not, is the property management company or the community’s/building’s auditor willing to risk losing a client by pushing the plan? What about the legal advisor getting involved?

Communication is vital!

Residents need not only to be kept aware of these issues, but educated on these same issues.. When increased funding (to the reserve) becomes necessary, they will most certainly complain unless they have been kept advised of the real process issues. If they have been consulted (town hall meeting briefings), I am willing to bet they will be onside. If on the other hand, a five year plan with unexpected increased funding is kind of “sprung” on them………..well yes, they are going to “b----” and so they should.

Bottom Line

The CAO has already or is already demonstrating that they “don’t get it”, so if condo communities are waiting for the government to legislate, it could be another lifetime. This implies that the leadership for proper condo governance which would include long term planning and funding for capital expenditures, will fall to the property management companies, the condo legal community and the auditor.

Time to start thinking about how this could work folks!

A point of History I got curious about what happened to the Inn on The Park. Apparently during the early 1980’s, Four Seasons management realized that the hotel guests were no longer interested in their standards. So, the building became a Holiday Inn. There can be many reasons for this including proximity to where business is conducted etc. However, it kind of reinforces our argument about building deterioration and the need to invest to properly maintain the standard.

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Dave Williams is a retired corporate executive and graduate of York University. I am always interested in feedback, good or bad, and new ideas on the subject. You can reach me at williamsdavem7@gmail.com.