October 2022
Until recently, many condominium communities were operating under the assumption that the rate of inflation was two percent. While this has not been true for many years, recent peaks of eight percent or higher are serving as a shock to many communities.
Actual Inflation
The “official” rate of inflation is not indicative of rising costs for high-rise condominium communities. Condominium corporations have a great many expenses not reflected in the consumer rate of inflation; such as building equipment purchases, repairs and maintenance, management and employee salaries, security and cleaning services. Replacement and major repair costs from reserve accounts have been rising at a rate of 35 percent between Q1 2020 and Q4 2021 according to the Residential Building Construction Index.
Benefits of Inflation
Condominium corporations have large amounts of money in reserve fund accounts. Much of this is invested in guaranteed investment certificates (GICs) or stored in bank accounts. Interest income on these funds will be greater as rates increase in response to Bank of Canada efforts to lower inflation by increasing the benchmark interest rate.
Most condominium corporations invest in GICs with their banking institution. It is possible to obtain a higher rate of return on invested funds by investing with a more specialized organization such as Desjardins Financial which has advisers able to provide superior rates for GICs available to condominium corporations and consistent with the Condo Act.
Inflationary Problems
Condominium corporations are dependent on monthly condo fee payments. They operate with relatively low cash balances and establish fees at the lowest practical level. This reduces the benefit from higher interest income as compared to higher costs for daily operations and the reserve fund.
It is unlikely reserve funds have been adjusted to reflect the increase in costs over the past two years. Expenses are unlikely to drop to their prior level so an adjustment is necessary to avoid a financial shortfall. Newer buildings are more likely to have a smaller reserve fund balance and fewer major expenses in the next few years. This gives them more time to adjust condo fees to necessary levels. Older buildings with an inadequate reserve fund balance are at greater risk of requiring more funds on short notice. All communities must contend with higher operational costs on an equal level.
Communities with an underfunded reserve fund and needing to borrow funds will have to pay more. This increases the cost of everything borrowed funds will be used for.
Underfunded Reserve Fund
Few quantify what constitutes an underfunded reserve fund because of the many variables to consider. It is easier to claim that a reserve fund is in good condition because it has a large balance.
“When a new building first opens, the reserve fund is at zero dollars,” explains Jon Juffs, Director of the Condominium/Strata Group at McIntosh Perry. “By the time that building is 25 or 30 years old, and assuming a height of about 24 floors, the amount needed to pay for necessary work could be $7 million or more. While this may be a lot of money, replacing building windows, elevators and roof could use up most of it.” This amount can fluctuate for many reasons including building size and how well it has been maintained. Further complicating any estimate is that the reserve fund balance is not linear. Each year money is spent to address the building’s major repair and replacement needs while money is also added to the fund. Some years the fund may incur a net loss meaning that even more will be needed in future years.
Assuming a fund balance target of $7 million after 30 years, nearly $250,000 will have to be added annually plus an amount equivalent to what is spent each year. An average annual contribution of $500,000 may not be unreasonable considering all expenses and inflation.
Obligations of the Board of Directors
Boards of directors are responsible for the financial oversight of the condominium corporation. Some view this as minimizing condo fees that owners must pay and choose to ignore the need to protect assets of the corporation.
Protecting assets of the corporation serves to maintain owners’ homes or investments while maximizing their value. When a reserve fund is not adequately funded and the building is not properly maintained, assets of the corporation are not being protected. Furthermore, new owners of condo units are saddled with the undisclosed financial obligations of sellers. Disclosing an inadequate reserve fund or financial deficit in a status certificate leads to lower or cancelled offers to purchase. Nobody wants to live in a building in disrepair or likely subject to large increases in fees.
Balancing these interests requires an honest and realistic annual budget for operations, a realistic reserve fund study and a proper level of condo fees to support both. While many owners will be unhappy when condo fees increase, this is preferable to the level of dissatisfaction a few years later by failing to set fees at a proper level.
