Loans to Condominium Corporations
March 2014

March 2014 – The calendar is telling us that Spring is here and I am definitely hopeful. In this month’s newsletter we demonstrate how easy it is to move from the potential pitfalls of a Baseline Funding model to a sustainable, Adequately Funded model. Apologies in advance for the math…

As always, we look forward to your thoughts and comments.

Regards,
Ernie Paustian
Ernie Paustian


Adequate Funding

In January’s newsletter the reasons for completing a reserve fund study were discussed along with some pitfalls relating to the Baseline and Threshold Funding Models. Baseline Funding (never below zero) and Threshold Funding Models (based on an operating budget) are essentially the same; with a negligible difference in minimum reserve balance.
Consider an example of a reserve fund study on a property that we recently completed. The complex is about 8 years old, comprised of 125 residential units. Well built and maintained complex with underground parking, elevators, smaller amenity centre, balconies and central air conditioning.

In 2014 the complex had an opening reserve fund balance of $440,000 and budgeted contributions of $125,000, amounts that we consider to be adequately funded for 2014. The average reserve fund contribution was budgeted to be $83.33 per unit/month.

With the Baseline Funding model, using an estimate of 3% inflation and a 3% return on investment, annual increases of 3% are required to remain above zero, with an estimated opening balance in 2043 of just under $8,800.

Let’s assume that the inflation rate indicated above were to be just slightly higher - at an average of 3.5% while the annual return were slightly lower at 2.5%, while assuming no change in reserve fund contributions? Due to a relatively small 1% change in rates, the $8,800 surplus turns into a deficit of just under ($1,185,000) in 2043.

 

Baseline funding - assumptions
  3% inflation, 3% rate of return, 3% annual reserve increase 3.5% inflation, 2.5% rate of return, 3% annual reserve increase
Opening balance - Year $440,000 2014 $440,00 2014
Maximum balance - Year $2,682,911 2031 $2,464, 849 2031
Minimum balance - Year $8,788 2043 ($1,184,907) 2043


Now let’s consider something closer to an Adequately Funded model, using the above scenarios but instead of a 3% annual increase in reserve fund contributions, it is going to be 4.5%. In 2043 the opening balance is now almost $1,965,000.

When the inflation rate is raised to 3.5% and the annual return is reduced to 2.5%, the $1,965,000 surplus is reduced significantly, but still a positive amount at almost $690,000. This demonstrates one benefit of being adequately funded, no surprises, no anticipated special assessments for the 30 year period.

Adequate funding - assumptions
  3% inflation, 3% rate of return, 4.5% annual reserve increase 3.5% inflation, 2.5% rate of return, 4.5% annual reserve increase
Opening balance - Year $440,000 2014 $440,00 2014
Maximum balance - Year $3,440,371 2031 $2,886,087 2031
Minimum balance - Year $440,000 2043 $440,000 2043

What is the cost to unit owners?
Year 0 1 2 3 4 5
3% increase
average fee per unit/month

83.33

85.83 88.40 91.05 93.78 96.59
4.5% increase
average fee per unit/month

83.33

87.08 91.00 95.09 99.37 103.84
Difference 0.00 1.25 2.60 4.04 5.59 7.25

After 5 years the difference in reserve fund contributions is relatively small at $7.25 per unit/month. More importantly, the fees are going up at a consistent rate that is fair and equitable to current and future owners, while minimizing the risk of special assessment.

Although I am the first to admit that there are fundamental flaws in the assumptions, the first being a lack of review for the reserve amounts over 30 years. But it’s important to demonstrate that relatively minor changes in the assumptions of today can have a significant effect many years in the future.

More important is the demonstration of how little it can cost to reduce the potential for a special assessment, along with the added selling feature of a healthy reserve fund.

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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