Q: I’ve been reading
your column about condominium reserves, and it’s made me
think that most condominium associations should have higher
reserves.
One reason to have higher reserves is that it’s more
equitable for current and future owners. Let’s assume that a
condo building has an expense of $10 million every 10 years.
If the reserves are low, the condo association will need a
special assessment to fund the expense.
|
For every $200,000 of purchase price condominium, the association should have between $10,000 to $20,000 in reserves per unit. Newer buildings may require a lower number, while older ones would have a higher number. |
Irregular costs could include
painting, tuckpointing, building chimney repair, boiler
replacement or elevator repair or replacement. If windows
are a common element, cleaning them annually might be an
expected cost, but every 30 years you might need to replace
them. And then you might have roof replacements and building
facade repairs.
When it comes to deciding how much cash a building will need
over a 10-year period, we can imagine vastly different
numbers coming from the homeowner association and property
management company. The former keeps in mind that homeowners
are usually reluctant to see their assessments go up and pay
more for living in a condominium building, while the latter
knows if property is mismanaged, small issues can quickly
become expensive fixes that are annoying to residents.
In general, we agree that many associations should have
higher reserves. There are times Sam sees clients buy into a
condo property that has cash reserves that seem way too low,
especially if the building has up to only six units. These
smaller condo associations pay for their repairs and
improvements as they go along. When something goes wrong,
current owners are asked to pitch in at that time to cover
the repair.
If you’re buying into a smaller condo property, you have to
plan for these expenses as if you were buying a
single-family house. When something goes wrong, expect to
write a check. Sam advises his clients to set some cash
aside for emergencies and other unforeseen property
expenses.
Back to your suggestions on how condo associations should
structure reserves: While we don’t know what formula each
building uses when they look at the cost for the upkeep and
maintenance of the building over a 10-year period, it’s
possible to evaluate ongoing costs and estimate what it
might cost for an extraordinary expense. If you ask for
copies of the past two years of building budgets, along with
the current budget and future projections, you can begin to
imagine what kind of extra costs you might face while you
live in the unit. And you can factor that assessment into
your offer to purchase.
What we do know is higher assessments can work to depress
property price appreciation because it lowers overall
interest in that property. When condominium assessments are
higher than comparable properties, buyers tend to go to
lower-priced buildings. If you don’t attract enough buyers,
sellers may not get top dollar for their condominium unit.
Condo properties need to look good enough to attract buyers
and keep owners happy, so the board of directors of a
condominium needs to balance the money they need to manage
the building’s ongoing and extraordinary expenses over time
with the ability to sell units at competitive prices in the
marketplace.
With all the money in the world, a condominium association
could spend willy-nilly improving the building, making the
common areas look great and never passing a special
assessment. But we don’t live in that world. (Even
billionaires can’t always agree on how much to spend to fix
building problems.) Newer buildings typically need less cash
for extraordinary expenses but might need more on an ongoing
basis to cover maintenance issues for a more robust set of
amenities. Older buildings could need more, and be
unpredictable in those needs, which might turn out to
include several once-in-a-generation expenses within a
10-year period.
The whole situation becomes even more complicated when you
go beyond the dollars and start dealing with the owners
themselves. Owners of any tenure may not wish to spend extra
cash each month beefing up the reserves and may also not
agree with the management as to how and when that cash
should be spent.
In buildings where you have proactive boards and unit owners
looking to keep their buildings in good condition, you’re
likely to find higher reserves and a better maintained
property. On the other hand, in buildings where homeowners
are constantly fighting about what to do and who is paying
for what, you might find lower reserves and money spent on
aesthetics while longer-term problems are ignored, typically
becoming more complicated and expensive.
There are companies that consult with and advise condominium
boards about a property’s physical issues. They will provide
an assessment of how much useful life each mechanical or
structural component of the building has left and, if
requested, an estimate to repair or replace various
mechanical or structural components.
But even armed with that information, boards often have a
hard time convincing homeowners to pay more in assessments.
Some homeowners can’t afford it. Others want to sell and
have the new owner pick up the cost.
We’re often asked if there is a rule of thumb condo buyers
should consider when it comes to assessing the relative
strength of condo reserves. Sam has played around with this
calculation and come up with one that seems to work well for
his clients: For every $200,000 of purchase price
condominium, the association should have between $10,000 to
$20,000 in reserves per unit. Newer buildings may require a
lower number, while older ones would have a higher number.
It’s not a hard and fast rule but it might help a
prospective buyer evaluate whether the reserves on hand are
low, adequate or well-funded.
When a home buyer reviews an association’s financials, they
may see a number that looks pretty good: $1 million. But if
there are 1,000 units, those reserves represent only $1,000
per unit. That may be too low for a development of that
size.
One final thought: In some parts of the country, condo
reserves get prorated at closing. This means that a seller
who owns a 10 percent ownership in a 10-unit building with
$100,000 in reserves will expect the buyer to pay $10,000 to
the seller for the seller’s share of reserves. In this
situation, a large cash reserve could cause concern for
buyers who are pinching pennies to make a transaction work
and quite likely send them looking elsewhere.
At the end of the day, we agree with your thinking: More
buildings should have more in reserves than they may have
now. Thanks for your question.