Reserve Funds 101

by: Audrey Loeb

Reserve funds exist to ensure that money is available to pay for the cost of major repair and replacement of major capital items in the property.

Major capital items include roads, walkways, lighting, lobby’s, hallways, underground garages, landscaping, mechanical and electrical components, elevators, recreational facilities and building exteriors including windows, roofs and walls. In some condominiums it can include sewage lines and septic tanks.

Ontario has among the best legislation anywhere for dealing with the establishment and funding for reserves. The law is simple: the board is obligated to carry out a Reserve Fund study within the first year after a condominium corporation is created and set  up a separate Reserve Fund  account into which funds must be transferred, usually monthly, and the monies can only be used as prescribed in the Condominium Act. Reserve monies cannot be used or borrowed from the Reserve Fund for operating expenses. Only the replacement and major repair of capital items are permitted Reserve Fund expenses.

The reason the government gave this authority to the boards of directors is so that we won’t have situations like the Florida Surfside disaster, where the owners won’t vote to make the necessary contributions to do repairs, and the building becomes dangerous or even collapses. Florida, for example only requires a building engineering review 40 years after construction.  

Those of us involved with the legislative amendments knew that securing owner approval would be impossible when we amended the Condominium Act in 1978. We knew that the boards needed to be charged with the responsibility and given the rights to ensure that necessary repairs were done.

Let’s talk now about Reserve Funds themselves. The Act requires that condominiums carry out Reserve Fund studies. Typically, they are done by engineers.

There are three types of studies provided for in the regulations and studies must be done every three years.

The first is an on-site assessment and analysis of all the components of the common elements of the condominium, with a value in excess of $500. An estimate is made of all the projected costs for repair and replacement over the next 30 years, accounting for interest earned on the monies and inflation.

The second study 3 years later is again on site but without the physical analysis of all the components.

The third study 3 years later is an off-site study and essentially a review of the numbers in studies 1 and 2.

Reserve fund studies are not an exact science; the estimate for lifespan and replacement costs is no more than an educated guess.  Each listed item in the Reserve Fund study will have a date when it is expected that major maintenance, repair and/or replacement will be required and a guesstimate as to the cost at that time.

The study is not a bible; it is a guide. Some things may fail sooner, others later. Decisions may be made to move work forward or back depending on the condition of the items. 

Just because the study says the roof is projected to cost $500,000 it doesn’t mean that if the cost ends up being $750,000 the corporation cannot use funds from the reserve to complete the work. The monies in the fund are not earmarked just to be used for specific purposes, they are fungible. If, a condominium has a large unanticipated expense that requires the use of significant amounts from the reserve that were not allocated for a particular repair and more monies are used than contemplated in the study, the corporation should carry out a new Reserve Fund study and disclose in its status certificates that an interim update is being carried out.

In addition to the inability to contemplate all the things that might affect lifespan and costs going forward,  the engineers have to consider other matters.

When preparing the Reserve Fund study and plan for contributions the engineers have to think about repair and replacement projects for things we have not seen before like tall glass walled buildings. When that glass needs replacement and/or repair in addition to the cost of the materials required, they need to consider the equipment and labour costs that will be needed to carry out that work. They can only imagine what these repairs will cost. 

Once a Reserve Fund study is completed, the engineer will present a draft plan of projected repair and replacement timelines and the costs for same. The engineer will also deliver the contribution table to set out the payments needed to fund the reserve account.

If the condominium’s Reserve Fund is in good shape and the funding is not going to have a serious impact on cash flow for owners, a Reserve Fund plan is prepared, which must be sent to all owners, showing  their contributions. These are the easy ones.

However, where the Reserve Funds are in poor condition, non-existent or in some cases in a deficit and  there is a lot of work to be done, the financial shock can be overwhelming. The board is faced with telling the owners that there are huge increases needed. The board members who also have to pay these amounts (either by way of special assessment, increased common expenses or both) will often be faced with a rebellion.

Some corporations borrow and these costs are added to the common expenses.

Reserve fund information is included in the status certificate. The form requires this information and also information as to whether the corporation anticipates any increases in common expenses. This is where we mention the updated Reserve Fund study being done or that an engineering study is being done which might result in increased costs. The problem is we do not always know what those costs will be and in those instances the parties who want to close the transaction will need to determine a holdback or reduced purchase price.

Condominiums created after 2001 are typically in better shape than many of the older ones when it comes to Reserve Funds because that is when Reserve Fund studies became mandatory. Prior to that it was just taken that contributing 10% of the budgeted common expenses was adequate, although that is not what the Act said. Many buildings have never caught up to where they should be and now have no funds to carry out repairs.

If the information in  the status certificate shows that no Reserve Fund study has been done in the last three years or there is a note in the financial statements that the corporation  is not compliant with the Reserve Fund study, these are red flags and purchasers will be alerted to them.

If there is a very large Reserve Fund, that may be a good sign but only if the condominium has been maintaining and repairing the building and there are no major projects on the horizon. $5 million in reserve can disappear in a flash on one or two projects.

Funding and managing the Reserve Fund are among the most important responsibilities a board of directors has.