When a buyer is searching for a condo, they pretty quickly develop a list of what is important to them. Location is obviously key, as the majority of condos are located in dense, city cores. After location, the features and layout and feel of a specific condo unit is where most buyers focus.
A smaller but still significant portion of condo buyers are concerned with the amenities within the condo building. Whether it is a concierge to accept packages, a well equipped gym or visitor parking, some buyers strongly value building amenities.
One area that it rarely focused upon by buyers and their agents is the condo corporation reserve fund.
A reserve fund, as the name implies, is a pool of money set aside (in reserve) for future expenses.
The Condominium Act in Ontario requires that every condominium corporation establishes a Reserve Fund Study (Capital Replacement Plan) within the year following the registration. The Act also requires periodic updates to determine whether the amount of the reserve fund and the amount of contributions collected from the owners are adequate to meet the expected costs of major repair and replacement of the common elements of the corporation.
If you’re interested in a great summary of how reserve fund studies work, Ben Engineering has written one here.
In a very broad sense, the purpose of a reserve fund is to pay for forecasted future major repairs or replacement of common elements in order to reduce the risk of unexpected repairs. A reserve fund is how a condo corporation ensures that funds will be available for repairs when the time comes.
The importance of a condo corporation’s reserve fund is often misunderstood and is rarely reviewed to the extent it should be when a purchaser and their lawyer review a status certificate package, a very common condition of purchase for most condo unit sales.
While your lawyer will review the status certificate and the reserve fund to a certain extent, let’s go over three red flags that you can look for when you’re looking at the package.
Red Flag – Out of Date
The Condominium Act in Ontario requires periodic updates to determine whether the amount of the reserve fund and the amount of contributions collected from the owners are adequate to meet the expected costs of major repair and replacement of the common elements of the corporation.
These updates take one of two forms.
- Class 2 – Reserve Fund Study with a Site Visit to update an existing study, and should be done alternately every three years with Class 3 (Reserve Fund Study without site visit).
- Class 3 – Reserve Fund Study without a Site Visit for updating an existing study, and should be done alternately every three years with Class 2 (Reserve Fund Study with site visit).
Despite the fact that the Condominium Act requires these reserve fund studies, not all Condo Corporations do them on time. If a reserve fund study is late when you review the status certificate package, tread very carefully.
You may be buying into a mismanaged building and you are most certainly walking in blind, without a current, accurate understanding of the state of the building. This means that a special assessment for unidentified upcoming repairs could be a possibility, or that your maintenance fees will increase due to a greater contribution required for the reserve fund.
Red Flag – Past Problems
The majority of status certificate packages include audited financial statements for the condo corporation. These financial statements have been prepared and audited by an accounting firm to verify accuracy.
Financial statements are a way to look into the past recent history of a condo corporation. You can see budgeted and actual amounts for each expense and revenue line and by reviewing the statements you can see where the building has encountered problems.
Overages on certain expenses are not necessarily a red flag, but it does require further investigation to discover if there was a specific issue that caused the overage or if the costs are now higher on an ongoing basis. As an example, higher utilities costs along with an unexpected overage on plumbing could indicate the building had encountered some significant plumbing problems. A buyer should know if it was a one-time issue or if the building is expecting further costs that weren’t budgeting in the reserve fund.
Red Flag – Future Costs
The purpose of a reserve fund is to be prepared for future costs so that when they are incurred, it isn’t solely current unit owners who have to pay for the cost. Imagine a multi-million dollar roof replacement project that wasn’t planned for properly with funds accrued over a number of years in advance. If current unit owners were on the hook for that cost, previous unit owners would have paid significantly lower maintenance fees and enjoyed the benefit of the roof while not contributing towards the eventual replacement.
There is therefore, tremendous benefit in having a current reserve fund study that accurately reflects upcoming costs. It means that the condo corporation and unit owners are less likely to be surprised by an unexpected cost.
If you are buying a unit in a building, you are able to look at the reserve fund study and see what the forecast is for costs. Every status certificate package includes a Notice of Future Funding, where expected increases to the maintenance fees and contribution to the reserve fund are laid out in exact detail.
A review of this document can identify a huge red flag in the form of significant increases over the next three to six years that will have to be paid for by the unit owners. When you combine the current maintenance fees for the unit and calculate the increased amount based on the Notice of Future Funding, you can determine the upcoming price per sf for maintenance fees.
This ratio plays a huge role in the appreciation of condo units as the higher the price per sf for maintenance fees, the less affordable the unit is for owners regardless of the purchase price. When maintenance fees reach $1 per sf or higher, you see a direct correlation with reduced property appreciation. Fewer buyers make offers due to the higher carrying costs, which means lower sale prices and over time, a stagnating building.
If you look at condo units that have seen strong appreciation, they are almost always located in buildings where the condo corporation has worked hard to keep the price per sf for maintenance fees low. Conversely, if the price for a condo unit seems very low, it often corresponds to unusually high maintenance fees for the unit based on a per square foot basis.
While there are many factors that go into deciding to buy a condo unit, one of the most overlooked aspects is the reserve fund and the financial footing of the condo corporation.
Whether it is out of date reserve fund studies, evidence of past problems or troubling future financial costs for unit owners, a buyer of a condo should make sure to look for red flags in the status certificate package.
If you’re keen on avoiding buying into a building with poor financial footing, work with agents who understand how to help protect you.