Reserve Funds

April 26, 2024 Published by Eastern Ontario Chapter - By Luka Milidragovic

Navigating Reserve Fund Shortfalls: A Response to Inflationary Pressures

From the Volume 37 issue of the CCI Eastern Ontario Condo Contact Magazine

“We just got our reserve fund study back – turns out we need money”

Working for a lender that provides financing to condominium corporations, this has been, by a wide margin, the most frequent phone call I have received from prospective clients considering a loan. This is not coincidental. In fact, it can be attributed as a direct result of what we have experienced in the current economic climate, especially as it relates to inflation. This article will aim to dissect the impact of the financial pressures felt by condominium corporations as a result of the recent extreme levels of inflation, the options available to the boards faced with the resulting challenges, and the necessity of adopting a longer-term approach to reserve funds rather than one that is shortsighted.

Reserve Fund Shortfalls – A Common Theme Lately

As stated above, when I receive a loan inquiry from a prospective condominium corporation client, it is often at the time when they receive their updated reserve fund study.

So why exactly is that the case? Well, it would make sense to first take a step back and look at one of the key assumptions of a reserve fund study – the assumed inflation rate. The average reserve fund study in Canada will account for an inflation rate of about 3% year-over-year. Over the course of three years, which is the same timespan to the next required reserve fund study renewal, this amounts to a total increase in inflation of about 9.3%. In stark contrast, however, Statistics Canada has published a 51% increase to construction inflation in the Greater Ottawa Area from Q1 2020 to Q1 2023.

What exactly does this mean? It means that if you live at a condominium corporation in the Greater Ottawa Area, and your corporation completed a reserve fund study in 2020, and subsequently received an updated version three years later in 2023 (as required by the Ontario Condo Act), then presumably the estimated increase in expenditure costs was short by an average amount of about 41%. This is according to the estimates of Statistics Canada – the figure was derived by simply taking the difference between the 51% Statistics Canada estimate and the assumed 9.3% inflation increase within an average reserve fund study.

And what is the result of this large gap? Unfortunately, the answer to this question is quite unpopular: a reserve fund shortfall to the condominium corporation as a direct result of underestimated reserve fund expenditure costs. Before moving onto the next section though, as an epilogue of sorts, it is important to understand that the inflation estimates used within a reserve fund study – of about 3% year-over-year – are entirely reasonable. The worldwide pandemic, as well as the supply chain issues that followed, amongst other factors, were virtually impossible to predict. Rather, we are dealing with a historic event in modern history and navigating the consequential aftermath (being extreme inflation) as best we can. This leads me to the next section.

Exploring Funding Options Amid Inflation

Confronted with the harsh reality of a reserve fund shortfall, it is imperative that Boards have a complete understanding of all options available to them. Each option presents its unique set of considerations, especially in an economic landscape characterized by high inflation:

1. Deferring: Deferring necessary capital projects can allow the corporation to accumulate and save up the required funds over time to undertake the works involved. However, this can lead to a degradation in the quality of life and property values, while also accumulating higher project costs due to the natural effects of inflation. Obviously, in this time of extreme inflation, this is especially apparent. Assuming the 51% figure stated above, this would mean that if a corporation in the Greater Ottawa Area deferred a $1 million project, during the period from Q1 2020 to Q1 2023, then this would have resulted in a final increased project cost of $1.51 million over that time span, presumably. That is staggering.

2. Special Assessments: This method, though quick and direct, can be financially jarring for unit owners, especially when large sums are involved. It is not uncommon for our office to come across clients faced with special assessments in excess of $50 thousand dollars per unit. In fact, as I often say, this no longer even raises an eyebrow at our firm.

3. Loans: In the face of these challenges, loans emerge as a potentially more flexible solution. By opting to finance a necessary capital project through a loan, condominium corporations can distribute the financial impact over a more extended period, helping in alleviating the immediate financial pressures felt by unit owners faced with special assessments. Loans also offer the upfront availability of cashflow, eliminating the need to defer and/or phase construction works. The obvious drawback, however, is the additional costs due to the interest paid on the loan, which would be paid back through higher monthly condo fees for the duration of the amortization period.

Looking Ahead: Strategic Financial Planning for 2024 and Beyond

As the condominium industry – and to be honest, the modern world at large – steers through the turbulent times of an inflationstricken economy, boards must engage in candid and realistic discussions about their financial strategies. Again, nobody could have seen the previously mentioned figure of a 51% inflationary increase coming, and if they did, they would probably be on a beach somewhere. Navigating these times becomes crucial. As stakeholders in the industry, we must continue to encourage boards to ask necessary questions: What significant major repair and replacement projects are upcoming in the near future?

How might the final cost be affected by the inflation we are experiencing? What are our funding options? Should we consider a loan?

It may be worthwhile for boards to consider creative strategies that may not have been as popular in more normal economic circumstances. Some strategies to consider include a renewal of the reserve fund study prior to the required three-year timespan or a meeting with the corporation’s reserve fund study engineers to discuss their professional recommendations. Staying ahead of any necessary major repair & replacement projects, communicating these necessary changes with the owners of the corporation, and being well prepared is imperative. Consulting with experienced lenders could provide the Board with comprehensive insights into the corporation’s funding options, the advantages of each, and the feasibility of a loan in their unique situation.

As we look toward the remainder of 2024, the path forward for condominium corporations is undeniable: Adopting a forwardlooking financial strategy that accounts for the realities of an inflationary economy is not just advisable, it is essential. By prioritizing the establishment of a robust reserve fund, exploring flexible funding options as well as creative strategies relating to the reserve fund study, and preparing for the financial implications of reserve fund study renewals, condominium boards can safeguard the financial health and stability of their communities. There is no doubt that there will be surprises, or namely reserve fund shortfalls. The best we can do is continue to educate the industry and the boards alike of the above-discussed dilemma in an ongoing effort to push back on the frequency of such surprises altogether.

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By Luka Milidragovic, Morrison Financial

Luka is an Associate at Morrison Financial, responsible for the origination and management of condominium corporation term loans. He supports condo boards faced with reserve fund shortfalls and special assessments by customizing and arranging a financing solution that suits their needs. Morrison Financial is a Toronto-based private lender formed in 1987 and has become one of Canada’s longest-standing private finance firms.