A Tale of Two Reserve Studies: Part II

In our first installment of this series we introduced a story-line that began in July 2015 when CIDA’s predecessor Capital Reserve Consultants (CRC) examined a local condominium association for the first time (Association A) and a second similar condominium (Association B) in June of 2016. Both condominiums contained a similar number of dwelling units and a small commercial/retail component, and both were housed in buildings that were five stories tall. The primary difference in the two Associations was that there was a ten year difference in the age of the buildings. Whereas Association A was barely eight years old in 2015 Association B was eighteen years old at the time of the initial examination in 2016.

Both Associations had engaged the same consultant to conduct a reserve study and the results of both studies suggested that each community was a relatively well-funded HOA with what appeared, on the surface at least, to be a reasonably clear grasp of the reserve spending and the reserve funding obligations of each Association would be over the next thirty years.

Part II of the story began in May 2018 when we received orders for CIDA Reports from two buyers, one of whom had made an offer to purchase a condominium in Association A, the other having made an offer on a unit in Association B. So, by early May of 2018 CIDA was hard at work examining both of these Associations for a second time and that’s where the story gets interesting.

In both instances the Association had updated their reserve study since our first examination took place although neither study had been updated for the current budget year and hence neither reserve study was current , meaning the reserve spending and funding projections did not project thirty years into the future as required by state law in Oregon. Both studies had been updated for 2017 so the projections covered a period of twenty-nine years, not thirty.

The problem for both of these Associations was that the fiscal picture that had been presented in the earlier study was one of a reasonably sound, financially responsible organization. Whereas the more recent studies in both cases painted a very different picture.

Association A, whose previous study had also been outdated when CIDA examined the Association in 2015, had gone from funding the reserves with an annual contribution of $126,000 back in 2015 to a contribution of $83,000 per year in 2018 for reasons that were not disclosed. Of equal concern was the fact that the 2018 beginning reserve fund balance that had been projected in the earlier study had dropped from $421,000 to $177,000. Again, there was no explanation offered by the Association as to why or how things had gone from being a relatively robust example of reserve funding to a pathetically weak reserve funding strategy, all in a span of less than three years.

As a result, the year-end minimum reserve fund balance as well as the percent funded levels in the years ahead had dropped like a rock! In fact the minimum fund balance had dropped so much that within 15 years the Association’s reserve account was protected to have less than $8,000 in it, resulting in a percent funded level that was less than 1%.

For those of you who are not conversant in the ways and words of the reserve planning discipline, the percent funded level is a useful metric that allows any one who is interested to see what the ratio of accumulated reserve funds is when compared to the accumulated depreciation of the commonly owned assets that will be replaced with those funds. Simply put, when the percent funded level is anything less than 100% it means that the accumulated reserve funds are less than the value of the assets that has been lost due to depreciation up to the point in time when the percent funded calculation is performed.

The percent funded metric is extremely important for a prospective buyer because it tells them whether the Association is one that has been perennially kicking the can down the road, leaving future generations of owners to shoulder the bulk of the financial burden for funding the reserves, or whether it is an organization that takes a responsible approach to reserve funding by requiring all owners who receive the use and benefit of the assets that will be replaced with the reserves, to contribute to the funding of those reserves at a rate that is commensurate with the benefits they receive from those assets as members of the Association.

Meanwhile, Association B and it’s reserve funding program had suffered a similar fate in a span of less than two years, with the 2018 reserve fund contribution having been reduced from $101,000 to $71,000 as a result of the most recent update, while the 2018 beginning fund balance also experienced tenuous decline of more than 50%. Whereas, the 2016 reserve study had projected that the reserve fund balance at the beginning of 2018 would be $150,639, the more recent study that had been updated in 2017 indicated that the fund balance as of the start of 2018 would be only $86,648.

As you might expect the percent funded levels and year-end minimum fund balance projections for Association B also suffered dramatic declines that were similar if not worse than those of Association A. Not the type of thing that a knowledgeable buyer is going to want to see if they are considering the purchase of a condominium in either of the Associations.

Most unfortunate in the case of Association B was that the seller in this transaction had actually purchased a CIDA Report back in 2016 when she herself had purchased the condo that she was now selling. Our advice to this poor woman back in 2016 was that the Association was “fairly typical” in terms of its reserve funding status, which was reflected in the fact that the CIDA SCORE the Association received in 2016 was within 1 point of the median score at that time.

We had also warned this buyer that in our opinion the Association’s reserves were underfunded and that she should expect the monthly assessments to be increased if or when there was a decision made by the Board of Directors to begin funding the reserves at a more responsible level.

Lastly, we offered the same advice that we give all purchasers of the CIDA Report, which is that it is in their best interest to become involved in the governance of the community by serving on the Board of Directors in an effort to help improve the governance and fiscal management of the organization.

Unfortunately, the buyer who purchased in Association B back in 2016 did not become involved in the governance of the Association and less than two years later she is now a seller who must attempt to sell a condominium in an Association whose reserve funding strategy is weak and clearly not in the best interest of future generations of owners, one of whom will be the buyer that she is now trying to attract.

When we came up with the tag-line, “Because You Are Buying More than a Home” for CIDA’s marketing campaign, it was not just some catchy phrase that we thought might help to get people’s attention. When you purchase any home that is located in any type of HOA, you really are purchasing more than a home. You are making an investment in a non-profit corporation and when you do make an investment in this non-profit corporation you become obligated to pay for an allocated share of the corporation’s expenses and liabilities. If you choose to be a passive owner, rather than a proactive leader of the community, then be prepared to live with the consequences.

 

 

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