Condominium Reserves - Fair and Fully Funding

By Bob Burns, P.E., R.S. Invariably the question will come up during one of our on-line seminars. “How much should we carry in our condominium capital reserve fund?” I usually answer by saying that the better question to ask is at what rate should you contribute to your reserve account. The time remaining until you need to replace things is going to have a significant effect on how you assemble the needed funds. A baseball analogy may help. If you’re six runs behind in the sixth inning that calls for a whole different strategy than if you’re faced with the same deficit in the second. A capital reserve account is there to accumulate funds to be able to replace each common area component at the end of its anticipated service life. One approach known as “fully funding”, says that you should level fund the reserve account over the service life of a component. If roofs cost $100,000 to replace, last 20 years, then you should be setting aside $5,000 a year. But that, in my opinion, is really an over-simplification. It can ignore the varying rates at which all your combined expenses accumulate. And fully funding can easily, in many cases, result in over funding the reserve account at a time when there is no need for cash. Over funding penalizes current homeowners. They have better places to put their money than adding value to value already in place. If a roof was just re-shingled, its value is in place. Under funding, on the other hand, penalizes future homeowners who can be faced with a special assessment at replacement time. We tell clients that the principal aim of our capital reserve fund study is to establish for them reasonable reserve contributions that treat current and future homeowners as evenly as possible. The way we recommend doing that is by using what we call the “value replacement” method. This approach recognizes the principle of declining value with advancing depreciation. As roofing shingles age, the depreciation of their initial value increases. So, we reason, the rate of contribution to reserve should increase to match that depreciation. Homeowners, (and astute buyers) seeing an aging roof matched to accelerating contribution will sense that the inherent value of the property is in balance. By contributing to reserves at the rate at which components depreciate, homeowners are maintaining the value of their investment. How do you know what the comprehensive rate of accumulated expenses will be for these components of different service lives? You start by having a capital reserve fund study done. The study determines the remaining service lives of components and what their costs of replacement will be. It sets up a cash flow projection that matches monthly contributions to depreciating value. Using that you can set the monthly assessment to homeowners. The bottom line is that reserve accounts are not static line items in a budget. Your level of contributions to reserve needs to anticipate the accumulative rate of depreciation of the capital items that make up the value of your investment. You don’t want to get in the position of needing six runs in the sixth inning. Article Source: http://EzineArticles.com/?expert=Bob_Burns,_P.E.,_R.S._ http://EzineArticles.com/?Condominium-Reserves---Fair-and-Fully-Funding&id=478723