Should fees remain constant?
August 2014

August 2014 - Summer is almost over, and that means budgeting season is just around the corner. This month we discuss another reason that contributions to the reserve fund should be increased every year.

Welcome to this month’s newsletter. As always, we look forward to your thoughts and comments.

Regards,
Ernie Paustian
Ernie Paustian


Should fees remain constant?

In a previous newsletter we discussed how having a fully funded reserve fund typically contains a higher level of funding than is necessary. We have also discussed how for most condominium properties, and particularly residential condominiums, Reserve Fund Studies that include planned special assessments or loans 10, 15 or even 20 years in the future shouldn’t be considered to be fair or equitable; they are simply a way of minimizing fees for current owners while shifting the burden to future owners.  

What about a scenario where reserve fund contributions stay at the same level throughout the study period? Say for example that reserve fund contributions of $100 per month are recommended each month throughout the 25 or 30 year period. Sounds pretty fair – everyone pays the same right?

Well, not really. What it actually means is that the current owners are paying more than their fair share for the benefit of future owners. If we lived in a perfect world where there were no annual increases in the cost of repairs and replacement, the stable contributions make sense. However, major repair and replacement costs generally increase annually, with substantial increases having occurred over the past 25 and 30 years, thus making it necessary to account for inflation.

Making an assumption of 3% average annual inflation- let’s see what the purchasing ability of those $100 contributions are over time.

3% average annual inflation 0 5 10 15 20 25 30
Monthly contribution 100.00 100.00 100.00 100.00 100.00 100.00 100.00
Loss due to inflation 0.00 (13.74) (25.59) 35.82) (44.63) (52.54) (58.80)
Actual purchasing ability 100.00 86.26 74.41 64.18 55.37 47.46 41.20

Using a little more conservative number of 2% average annual inflation

2% average annual inflation 0 5 10 15 20 25 30
Monthly contribution 100.00 100.00 100.00 100.00 100.00 100.00 100.00
Loss due to inflation 0.00 (9.43) (17.97) (25.97) (32.71) (39.05) (44.79)
Actual purchasing ability 100.00 90.57 82.03 74.03 67.29 60.95 55.21

The above two tables demonstrate that although the contribution level remains constant throughout – by year 30, depending on the inflation rate used, that $100.00 contribution only buys somewhere between $41.20 and $55.21 worth of goods and services as the purchasing ability has decreased substantially. Because of this, it would also mean that the current owners are receiving less value for their contributions in comparison to future owners.

Therefore, the most fair and equitable way for most situations is to establish contribution levels that meet the funding levels required and include annual increases to account for inflation. Of course there are also the rare situations when fees need to be decreased, however that’s for another newsletter.

The topic for this newsletter was prompted by a call from a colleague who has a bay in a newer commercial condominium complex. He had just received a copy of a study that the Board had commissioned from another provider that recommended a substantial increase in reserve fund contributions. He was somewhat dumbfounded for the huge increase because the complex is only a few years old, has no known problems and is well-built. The only planned expenditures indicated in the study for the first 15 years or so were some relatively minor asphalt repairs and of course 3 more reserve fund studies. After the large, initial increase, the reserve fund contributions remained at a consistent level for 25 years.

While I was asking him why he didn’t call me when it was time to quote on the project, he forwarded a copy of the report. After reviewing the report, it’s my opinion that there was no reason for the fees to go up as much as recommended or to remain constant for the 25-year study period. Although an increase in fees is warranted, it’s my belief only a gradual increase in fees is necessary and that his reserve fund study report recommended starting fees that were 45% to 50% too high. Hopefully he calls Delta for the quote next time...

Thank you for taking the time to read our newsletter. At Delta Appraisal, we work with Property Managers and Board Members to set realistic budgets and to prioritize maintenance and repair projects. Our functional Reserve Fund Studies are unbiased. We are not competitors in property management or maintenance.

For more information about Delta Appraisal and our easy to read Reserve Fund Studies or to request a no-cost, no-obligation proposal, please contact us.

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