February 2017
Sounds like a university math problem, but it isn’t. Those have answers.
Reserve fund studies are subject to numerous assumptions beyond anyone’s reasonable control. One such assumption is that the cost of work and expenses from reserve should change at a percentage rate equal to the rate at which annual contributions change. Available evidence shows there is little correlation between how costs and annual contributions change over the 30+ year reserve fund study plan.
In Ontario, the Condominium Act and Regulations require condominium boards to develop a plan for future funding sufficient for the anticipated major repair and replacement costs over a period of at least 30 years on a positive cash flow basis. Remember that even though 30 years may sound like a long time, for buildings it is really just a fraction of its likely, and expected, service life.
In 1991, the Canadian Government and Bank of Canada established an objective to deliberately control inflation to about 2% annually and near the centre of a 1% to 3% target range. Many, perhaps most, condo boards now seek to limit condo fee increases to the widely reported rate of the consumer price index (CPI). The CPI is a measure used to broadly track the retail price changes of a basket of goods of approximately 600 items related to food, housing, transportation, furniture, clothing, and recreation.
Reserve funds are meant to be used for the sole purposes of paying for the anticipated major repair and replacement costs of common elements and assets of the corporation. Estimating the cost of performing construction work in an occupied building bears little correlation to the changing costs of broccoli, mortgages, fuel, sofas, t-shirts, and concert tickets. Perhaps not surprisingly, construction work at occupied properties changes with the cost of building construction, which we have been tracking as the expenditure price index (EPI).
Herein lies the rub of reserve fund planning: in the past 25 years the future value of money going out of reserve has changed at rates greater than inflation 18 times out of 25, over 70% of the time. It has only been less than CPI annually seven times. Put differently, condo fee increases determined by the CPI do a poor job of reflecting changes to keep a reserve fund fully funded. This approach virtually assures that reserve funds will remain inadequate to pay for the items that appear in a reserve fund study. Condo fees will need to increase more dramatically or special assessments be implemented to compensate for the shortfall.
Our research suggests that the EPI may be a more reliable indicator of how reserve fund costs do change over time.
Jon Juffs is the Director, Condominium/Strata Group, at Egis Canada Ltd. Jon co-authored the book “Reserve Fund Essentials” a tell-it-like-it-is resource for condo owners, managers, and professionals involved with capital repair planning in co-owned property environments. He can be reached at Jon.juffs@egis-group.com.
