Recognizing a Failed Reserve Funding Plan

By: Gary Porter, RS, PRA

We recently performed a reserve study for a 40-year old condominium association and discovered an all-too-familiar scenario we’ve seen in older projects.  The situation? Huge deferred maintenance obligations that should have been resolved long ago, and an assessment structure that is higher than comparable projects.

How did this association get to this place?  Forty years ago, reserve studies as we know them today were rare.  This association never prepared a complete reserve study.  Instead, they prepared an annual budget that included reserve calculations for the major reserve categories; roofing, painting, and paving.  The association then created a fixed amount reserve funding plan that fit the “political” assessment climate within the association.  This was done in the very early years of the association’s existence, but that was not based on any comprehensive analysis of the actual major repair and replacement needs of the association.  There was considerable reluctance to raise the assessment because this “senior” community consisted primarily of fixed income retirees.

Over time, the association was not able to afford all of the reserve maintenance projects that needed attention, because of their “fixed income” reserve funding policy. While they knew that special assessments or borrowing funds from a commercial lender were options, the board felt that these options were politically impractical based on their member demographics. What each board decided to do was to simply fund all of the maintenance projects that they could each year until they ran out of money.  This literally became the association’s policy.  This caused them to defer any uncompleted projects to the following year, thus passing the buck to the succeeding board.  Unfortunately, the uncompleted projects continued to accumulate, so that this “uncompleted projects” list grew to include a several year accumulation of maintenance projects.

When we came on the scene, this problem had reached critical mass and could not be ignored.  We were engaged to perform the first comprehensive reserve study for the association, and had a number of meetings with the board to help them understand how they had reached this position.  The association’s failure to perform timely maintenance caused further damage by the complete failure of certain components that would not have required replacement had the scheduled maintenance been performed.  An example of this was the failure to correct numerous water intrusion issues from poor roofing, poorly designed gutter and downspout systems, misdirected irrigation sprinklers, landscaping issues such as earth/wood contact on wood siding, etc.  These issues ultimately required the complete replacement of siding on many buildings; a cost that could have been avoided.  This is just one example of issues that caused future repair costs to escalate even further.

In the more recent years before we were engaged, the association had begun to recognize that it had a problem and had more aggressively raised reserve assessments to the point that they were higher than those of comparable projects.  But, it still was not enough to overcome decades of underfunding.  Further, our reserve study and analysis of the association’s reserve expenditures over the last few years resulted in almost doubling the reserve requirements.   This was because the association paid for numerous “small” repair projects from reserve that were clearly appropriate reserve expenditures, but for which the association had never established a reserve budget.  They were spending money on projects for which no assessments ever existed.

We have observed several associations over last 25 years attempting to fund their deferred maintenance projects in this manner. All suffered a very predictable ending. The fact is if you just spend the amount of money you’ve got available and not the amount of money it takes to actually complete a project, the projects never get completed as planned, and your deferred maintenance projects snowball into an insurmountable problem. This is not a plan, this is a reaction.

A responsible board must make tough decisions rather than passing the buck to the successor board. That often means that a current board has to resolve problems created by a prior board. The fact is that you don’t get to play the cards that you want, you get to play the cards that you’re dealt. When the board is faced with a situation of not enough money coming in and too much money going out, there are only two possible solutions. One, increase revenues, or two decrease expenses.

An association may attempt to decrease expenses by making temporary repairs that extend the life of a component or by substituting lower-cost products in making repairs or replacements. Since most associations have already done this analysis and still are coming up short, the only remaining answer is to increase revenues. This generally means that the association must make a special assessment or borrow funds, or a combination of both.

In this particular association, we also recommended that several substitute products that didn’t exist forty years ago be used in repair and replacement work.  While these resulted in higher immediate costs, it considerably reduced the long term maintenance costs to the association.

How expensive was this for the association?  They ended up borrowing $30,000,000 (about $10,000 per member) to fund major reserve repair and replacement projects. Unfortunately, they will still need more, as that does not address all the association’s needs.  Had that amount instead been assessed ratably over time to the members from inception, it would only have amounted to about $20 per month per member.  Effectively, given the age of the association and member demographics, this resulted in a shift of the entire cost from one generation to the next.

Gary Porter, RS, PRA

Facilities Advisors, Inc.