A Healthy Reserve Fund, a Healthy Building

A Healthy Reserve Fund, a Healthy Building

A Healthy Reserve Fund, a Healthy Building 2112 1228 Matthew Adam Properties

By Ira Meister
President and CEO – Matthew Adam Properties, Inc.

Here is a tale of two buildings when the boiler breaks down.

Building one has a low reserve fund that is tied up in non-liquid assets such as mid and long-term CDs.  Building two has a solid reserve fund with the some of the assets in liquid investments.

Building One will have to scrounge around to get funds to pay for the new boiler, such as a special assessment on the apartment owners or using funds from operations until the money can be recouped from a special assessment or some non-liquid assets are available.

Building Two has sufficient funds that are available immediately for the repairs without the need for a special assessment or loan.

What is the reserve fund?

It is money set aside for repairs and improvements to the building, often referred to as capital projects. It should be kept separate from the annual operating funds which provide for the daily operations of the building and determine the amount of the monthly charges to residents.  Buildings that lack a sufficient reserve fund or misuse it to pay for operating expenses can find themselves in a bind when a major repair or improvement project is needed.

It is important to have a sufficient reserve fund as some lenders look at that when considering a mortgage for buyers. Purchasers with solid financials have been refused a mortgage because the building lacked adequate reserves. This was particularly true after the Great Recession of 2008.  A solid reserve fund also broadcasts that the building is well run which helps increase the value of the units. It also permits the board to make improvements to enhance the quality of life for residents.

The amount of the reserve fund depends on several factors including the age and condition of the building.  Newer buildings would most likely need less investment for repairs than older ones.  The recognized way to determine the size of the reserve fund is to prepare a capital budget plan.  This plan usually covers five years.  It is recommended that a professional engineer or architect inspect the building and determine the life span of the various systems and the cost to repair them. Included should be the roof, exterior, elevators, boilers and balconies.  The engineer can then determine the expected cost for the repairs as a guide to funding the reserve fund.  The capital plan should be updated annually to consider any work that has been done and changes in the condition of the buildings systems as well as costs and the balance in the reserve funds.

The next issue is funding the reserve fund.

Various options exist including a special assessment. Another possibility for co-ops, which was used by many buildings as interest rates plummeted to historic lows in recent years, is to refinance the underlying mortgage and direct the freed-up money to the reserve fund.  Some buildings that impose a transfer fee or fee for sublets direct these funds for capital and improvement projects.  Other buildings use a small percentage of the monthly charges to replenish the reserve fund. Whichever method or combination a building chooses, it must stick to its plan and not follow the temptation to use these funds for operating expenses as a way to keep a lid on monthly charges.

The second key component for the reserve fund is investing the money. Many properties work with a financial adviser, but they should follow some basic principles in their investment philosophy.  Most important is being conservative and while it would be wonderful to have significant asset appreciation that approach can often lead to significant losses. The money should be kept in conservative investments even in this period of low interest rates. Boards could look to U.S. or municipal bonds, CDs, or money market funds.  Equally important is having some of the funds in liquid investments so the board can access them quickly when needed.  One approach is to have ladder of investments so funds mature on a regular basis.

With prudent planning and wise investment decisions, co-ops and condos can have the funds available when needed without putting the squeeze on residents.