What Is a Reserve Fund Study?
When I tell people what I do for a living, I explain first that I love my job. It incorporates so many different aspects of being outside, doing tons of math, talking to people and educating them. What do I do? I prepare building component and financial audits for condominium corporations. In short, I do Reserve Fund Studies. I get questions that are both simple and complex and will attempt to address some of the main ones.
What is a Reserve Fund Study?
A Reserve Fund Study is a document that assesses all of the common property and the current funding of a condominium corporation. The study should make recommendations for future funding. When assessing common property, quantities and condition should be determined.
Reserve Fund Studies are required by section 38 of the Alberta Condominium Property Act (the Act), which states:
A corporation shall, subject to the regulations, establish and maintain a capital replacement reserve fund to be used to provide sufficient funds that can reasonably be expected to provide for major repairs and replacement of
a) any real and personal property owned by the Corporation, and
b) the common property
where the repair or replacement is of a nature that does not normally occur annually.
In layman’s terms the Act requires that an account be created to provide funding for the replacement or major repairs to all common property for which the corporation is responsible. In order to create this account, money must be deposited on a regular basis to ensure that funds are available when required. This protects the investment of every owner in his or her property. When replacement of common property components is deferred for financial reasons, the individual units will suffer devaluation of the property.
Why do we need a Reserve Fund and a Study?
Some reasons for including section 38 in the Act are:
- The conversion of some older rental projects into condominiums completed only aesthetic repairs. Units were sold with insufficient reserve funds and a significant amount of deferred maintenance.
- Annual contributions were set extremely low by developers to increase buyer appeal.
- Annual contributions were set too low by directors pressured by owners to keep them low. The directors also failed to think about the corporation as a whole.
How is a Reserve Fund Study done?
When a condominium corporation contracts to have a Reserve Fund Study done, the steps below should be followed:
- All common property components should be measured, counted and their condition assessed. In order to determine what is common property, condominium plans, bylaws and as-built-drawings are reviewed. Discussion with the Property Manager, Board Members, on-site personnel and any existing contractors is advisable.
- Replacement costs of each common property component are determined, and should include the cost of full replacement. Phasing repair or replacement of components over time for financial reasons is not recommended due to the difficulties this will cause future Boards and owners.
- The current funding is reviewed and compared to expected expenses.
- Required funding scenarios are provided.
- The study provider must submit a written reserve fund report to the Board for review.
Most providers will not only attend a meeting to discuss the report with the Board and to answer any questions, but also will attend the Annual General Meeting (AGM) to discuss the report with the unit owners as well.
What information is included?
Information that should always be in a Reserve Fund Study includes, but is not limited to, the following:
- The qualifications of the person(s) and/or corporation who completed the study.
- Recommendations for reserve fund contributions.
- A common property inventory and condition assessment for all components that may require replacement or major repair over the next 25 years.
Additional information that the Study may include is:
- Spreadsheets showing funding scenarios.
- Pictures showing the condition of common property.
- Recommendations for investing.
Who should do this Study?
In order to get a useful Reserve Fund Study, it is important for the Board to understand what they want out of it. Boards should use the study as a planning guide. This means choosing the right provider. Studies vary from provider to provider. Providers have different funding philosophies as well as financial planning ideas. Questions the Board should ask providers when getting a proposal are:
- Do you incorporate construction inflation? Some providers do not use construction inflation. The result is that the price of the roof stays the same now as when it requires replacement in 10 years.
- Do you incorporate a contingency and a safety margin? Contingencies allow for small errors in expected costs. Safety margin amounts are useful as a buffer for the replacement of components that are not visible for inspection such as underground services.
- What are the qualifications of the main person doing the study? When hiring a corporation – who is participating in the study?
- What level of customization are you willing to provide?
- Will they phase components at the Board’s request?
- How many funding options will be provided?
- What funding philosophy will be used?
- How long will the study take once awarded?
- Will a sample study be provided for the Board to review to ensure that the document is usable for their purposes?
- What will the study cost?
The answers to these questions will assist a Board in determining which provider will best fit their needs. Cost should not always be the deciding factor when choosing a provider.
The Alberta Condominium Property Act states that a qualified person must do the study. A qualified person is someone who has knowledge and experience in assessing depreciating property, the operation and maintenance of the property, and cost associated with replacement of the common property. The Act does not say that you must have an engineering company perform the study. Property Managers, accountants, real estate agents, and adjusters bring their own unique experience to the development of a Reserve Fund Study.
When should a Study be done?
Generally, a Reserve Fund Study should be completed every 5 years. However, since the Board should use the study as a planning tool for operating the corporation, it can be done more often than every 5 years.
New corporations must complete a study within 2 years of its initial development. If the corporation is a conversion of previous rental units, then the study must be completed prior to any units being sold.
There are no condo police to fine a Board when they do not complete a study every 5 years. However, neglecting to have a study updated could cause the following:
- Insufficient funding of the reserve fund account.
- Unexpected costs associated with failure of components, which usually results in special assessments.
- Legal implications for Board Members.
- Lower value of properties due to components not being replaced in a timely manner.
A Reserve Fund Study is a tool that the Board uses to help manage a corporation and its assets. Therefore, it is important to find a provider who will produce a document that the Board can use.