Published in MANN REPORT
President and CEO,
Matthew Adam Properties, Inc.
The collapse of Champlain Towers in Surfside, Florida, has given rise to an increased focus on how buildings handle finances. For a long-time, management professionals such as myself as well as attorneys, accountants and others have been preaching the importance of sound fiscal practices. Unfortunately, these practices apparently were not followed at Champlain Towers.
These include proper budgeting, sound preventive maintenance procedures, building a solid reserve fund and having a capital improvement plan.
Behind the collapse is a scenario we often encounter in New York: the tension between long-time shareholders/unit-owners and more recent buyers. Often, long-time residents are older with some on fixed incomes. Recent buyers tend to be younger at the prime of their earning lives or wealthier. A board is challenged to determine strategies that satisfy the parties while keeping the building in good shape and moderating monthly charges and avoiding special assessments.
Not all buildings face this issue, but from media reports it was an issue in Florida.
Good fiscal planning starts with the annual budget. The goal is to realistically determine the services the building can afford and then determine a financial plan to cover these expenses, including the level of staffing, amenities or upgrading of certain areas. There must be integrity in the analysis of expenses and income. Underestimating expenses or creating phantom income can throw a budget out of whack. Above all is consideration of the monthly charge and if an increase is required. Poorly planned budgets can force the property to dig into its reserve fund to pay operating expenses, a path to significant problems.
Within this budget framework is the need to properly maintain all systems and equipment. Properties looking to limit the size of a monthly increase will often defer maintenance or look to save by using unqualified vendors or patchwork repairs. This short-term approach can lead to significant expenses down the road, a problem allegedly faced by Champlain Towers.
A key area for vigilance is the reserve fund, money that is kept for capital projects or major repairs. In the past decade or so, with low interest rates, many co-ops refinanced their mortgages releasing additional cash. The smart boards placed a portion of these funds into the reserve fund and paying for required system overhauls or renovations. Having a sufficient reserve fund limits the need for boards to impose heavy special assessments to fund capital projects. According to media reports, the board at Champlain Towers would have required a special assessment of upwards of $80,000 per unit to make all repairs, a figure that would have imposed financial hardship on many unit-owners or forced them to sell.
Some lenders look at the reserve when considering a mortgage for buyers. In fact, purchasers with solid financials have been turned down 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.
One way to determine the size of the reserve fund is to prepare a capital budget plan usually covering five years. It is recommended that a professional engineer or architect inspect the building and determine the life span of the various systems and condition of the structure, the cost and a timeline. Included should be the roof, exterior, elevators, boilers and balconies. 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 changing costs and the balance in the reserve funds.
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 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 preserving capital.
With prudent planning and wise investment decisions, co-ops and condos can have the funds available when needed without putting the squeeze on residents.
While other mitigating factors may have contributed to the tragedy, what happened at Champlain Towers is a warning to all boards and residents of co-ops and condos of the importance of sound financial planning and execution. It’s the backbone of a well-run property.