CHOA Journal Article on “Planning for Renewals”
This is the article I sent the Condominium Home Owners’ Association (CHOA) for publication in their Summer 2016 edition of their “CHOA Journal”.
It answers the following questions: What are reserve fund renewals? Hows does reserve fund planning affect strata finances? How are strata finances organised for investing? What are the effects of investment vehicles redemption dates on renewals?
Please feel free to download and share the following link to the article: Planning for Renewals
Goodbye Special Levies – Timing Reserve Fund Monies for Scheduled Renewal Expenditures
Knowing your Renewals
A renewal plan leads to on-going remediation projects, major repairs and replacements – and differs from a rehabilitation or renovation – as the latter are associated with premature failure due to lack of maintenance, or other preventable causes.
Strata corporations need a long-term working plan for the sustainment of the development’s common asset component inventory. This is at the core of a strata council’s responsibility.
The process of undertaking systemic reconstruction and/or replacement work for aging components that have reached the end of their service life is rife with risk – risk that can be managed.
Perspectives on Common Asset Management:
Conventional wisdom has strata corporations focus on the accumulation and verification of source documents – with infrequent on-site monitoring.
This traditional approach provides robustness, but it does not factor-in issues of incomplete data and actual on-site component performance. There is thus a systematic delay-and-lag with this approach.
A strata corporation without active reserve fund planning reacts to emergencies, and relies on trades and engineers for its decision-making. Reactive decisions are based on a short horizon and the prescriptions of workers, rather than on the performance of components.
The Good, the Bad and the Ugly:
Until the introduction of depreciation reports (DRs), strata councils coped with risk by focusing on three fiscal-years – the past, the current, and the next fiscal-year. This led directly to bloated yet inadequate operating funds, and repeatedly to lacking reserve fund monies – thus the history of reliance on ¾ special levies.
This common approach has ‘you cannot plan ahead’ written all over it. The variability of future fiscal-year operating budgets – especially if reserve fund component expenditures are hiding in them – means that short-term planning’s usefulness is limited.
Renewals have little to do with operating budgets, routine maintenance, and the short-term.
The Case of Two Strata Corporations:
Hiding reserve fund expenditure monies in the ‘Repair & Maintenance’ line item to take advantage of 50 percent votes has many limitations.
The fear of dealing with reserve fund restricted monies breeds inertia. A strata corporation without a DR – and an actively managed component inventory –must have a ¾ vote resolution for all major expenditures, whether unexpected or planned, typically in the fiscal-year before the project.
For this type of council, a reserve fund is believed to be a contingency fund, with little planning whatsoever required – with this approach renewals are typically afterthoughts or emergencies.
Fractured or Astute Teamwork?:
An unorganised strata corporation will mostly rely on one strata council member or a property manager for its decision-making.
For an organised strata council, member turnover doesn’t matter much, since the strata corporation has documents, renewal plans, models, and timelines in place – that any member can get a handle-on quickly.
Financials, Inspections and Quotes:
The astute strata corporation treasurer reviews the on-going statements of operations – income statements, and the statements of financial position – balance sheets, each month.
The astute strata council reviews the fiscal-year statements at least at the annual strata council budget meeting, to get the AGM package ready for the owners to vote on. This is when the operating and reserve fund needs are refined for the next fiscal-years, and investments reviewed.
If the operating has been cleaned-up and limited to daily, weekly, monthly expenses, then the strata council can focus its work on the reserve fund.
Expenditures that occur less than once a fiscal-year migrate to their rightful place in the reserve fund. The immediate result is less strata monies going to the operating fund and more contributions to the reserve fund – assuming that a sound long-term plan becomes part of strata councils’ risk-management.
Council thus reviews and updates the DR’s component inventory and the benchmark to make sound fiscal-year based decisions.
All facets of reserve fund planning – physical and financial analyses – are reviewed to make sure that the regular contributions from owners are at the right level, and that liquidity will be available for future planned scheduled renewals, above-and-beyond the mandated fiscal-year closing balance guideline.
When a DR is in Play:
If the strata corporation procures a DR, then all strata finances are on the same footing. Operating expenses and reserve fund expenditures require 50 percent votes as part of the annual budget – as long as a component is in the inventory.
Reserve fund planning allows us to take stock of components, which in turn allows us to take control of the flow of monies.
Renewing Your Financial Planning
Let’s Get Financial:
Once your ducks are in a row – document and component maintenance, major repair and replacement knowledge – it is time to review the strata corporation’s financial position and standings.
With a DR that respects the Real Estate Institute of Canada (REIC)’s Reserve Fund Planner (CRP) method, the reserve fund’s fiscal-year-end closing balance, divided by your benchmarked current requirements, provides a reserve fund’s financial position.
Once adjusted each fiscal-year for inflation, interest, transfers, expenditures, this analytical tool provided the adjusted cumulative reserve fund standings for the following fiscal-years.
The combination of all variables and their analysis in terms of the reserve fund’s position and standings allows the strata council – and all stakeholders – to determine how much monies are to be liquid for scheduled major repairs and replacement expenditures in the long-term.
What does a Strata Council Control?:
Construction Cost Inflation (CCI) is active at all times and strata councils don’t control it. Strata councils do control their reserve fund investments.
Suppose – everything else being equal – that a strata corporation has a historical Investment Income Rate (IIR) of return of 0.50 percent on all of its investments and that at this rate, using a DR’s recommended scenario, it is expected to reach a reserve fund standing of 61 percent at the end of a projection’s thirty (30) fiscal-years – meaning that in thirty fiscal-years’ time the reserve fund will have the equivalent of 61 percent of that fiscal-year’s adjusted benchmark current requirements.
With better managed investments that increase the IIR to 1.80 percent within a few fiscal-years, the strata council is geared to have the reserve fund at a standing of 100 percent at the end of thirty (30) fiscal years. This amounts to a sizable reduction in the number and magnitude of regular and special contributions imposed on the owners over the life of the development.
What’s Special about Contributions?:
While the Strata Property Act (SPA) ignores the term assessment, it mentions Special Levies over forty (40) times. Yet it actually misleads the public by calling monies in a special levy fund the same as special monies in a reserve fund.
Most special levies are to be spent within one (1) or two (2) fiscal-years after their draw on the owners. Remembering that special levies for current and next fiscal-year projects require a 75 percent vote, that they are to have their separate strata corporation fund, and that the monies in a special levy fund are restricted, means that they have little impact on a reserve fund.
The actual investment vehicles in a reserve fund can be for annual fiscal-year based regular contributions – that are escalated predictably and smoothly over time – as well as for planned special contributions that occur irregularly, and typically in future fiscal-years with large expenditures.
Since reserve fund monies can be in a reserve fund for up to the duration of the economic-life of a development – over 100 years is not uncommon – having investment vehicles that mature in five (5) year increments makes sense for a variety of reasons, most of all, to ensure a reasonable grasp on risk-management.
When it comes to managing reserve fund monies, five (5) years happens to coincide with the SPA’s maximum mandated time-horizon for the redemption of permitted reserve fund investment vehicles.
For the well managed strata corporation having its first DR acquired five (5) years ago – and renewed three (3) years since – its strata council is looking five (5) years back and five (5) years forward, for a moving total of ten (10) fiscal-years of investment vehicles that are to be managed each fiscal-year.
Managing Your Financial Risk
Who and What Affects a Strata Corporation:
Owners comings-and-goings, strata council member turnovers, fluctuation construction and interest rates, shifting real-estate markets, trades and engineers, reserve fund planners – all affect a reserve fund’s management and performance.
Strata corporations may be non-profit entities with the downside of often being a playground for speculators. The upside is that for owners who consider strata lots their home, investment income is tax-free.
New-construction and disasters have no place in the business of running a strata corporation – insurance takes care of the later – and BC Assessment or appraised-value have little to do with renewals. With reserve fund planning, contingencies no longer have a place – no more special levies, and the actual costs of remediation projects are at the centre of renewals.
From a strata finances perspective, a fiscal-year focus on having owners pay their fair-share of their use of a development’s assets makes sense.
Yet there is no turnstile to measure usage. Are users to abuse developments for their own benefit simply because there are no means in place? With active reserve fund planning all of this changes.
Renewed Return on Your Renewals
Parts to the Process:
Static, moving and iterative repeated tasks are all part of the process of best-practice management and planning for a strata corporation’s renewals.
Reviewing past plans, inspections, quotes and statements has to be done repeatedly. Having in place a sound documented process to measure changes allows any strata council member – and for that matter any stakeholder – to quickly ascertain common asset needs and financial preparedness.
Determining the consequences of these needs on strata finances, and establishing the demand for monies on the owners is possible, with DRs. Having a system in place means that all parts of the process can proceed smoothly towards sustaining renewals, and the value of strata lots and developments.
A timely fiscal-year based financial management strategy has two parts. Since a strata corporation is defined by its operating and reserve funds, a strata council is to fine-tune its operating budget requirements, and its demand for contributions to the reserve fund, on a fiscal-year basis.
For a strata council that is just getting into a renewal program after acquiring a DR, maintaining the equivalent of 25 percent of the prior fiscal-year’s operating budget in cash, and laddering reserve fund monies investments still makes sense.
As the process of planning for renewals proceeds from fiscal-year to fiscal-year, this threshold can make way to have liquidity needs match well managed scheduled renewal expenditures.
We are all for mitigating risk. Basing decisions on the performance of assets and finances – rather than only on council members, specialists, or owners – facilitates that process.