Budgeting and Reserves for Condominiums
Most covenants for condominiums require that the association include as part of the annual budget, an allocation for reserves. Reserves should be set aside for roof replacement, pavement resurfacing, building painting, and any other item of association responsibility with a replacement cost or deferred maintenance expense of $10,000.00 or more.
Traditionally, the reserve schedule accompanying the proposed budget has used the “straight line” method of calculating required reserves. For example, assume that the roof on a condominium building has a twenty year useful life, is ten years old, and will cost $100,000.00 to replace. Further assume that the current amount of money in the roof reserve is $50,000.00. The association will need to collect $5,000.00 per year, over the next ten years, to accumulate another $50,000.00 so as to “fully fund” the roof reserve. This is traditional, “straight line” funding of reserves.
Similar calculations are then made for all other required reserve items (building repainting, pavement resurfacing, and other items with a replacement cost or deferred maintenance expense in excess of $10,000.00), and the annual contribution required to “fully fund” the reserve account is thus arrived at.
When reserves are funded on the straight line method, whether fully funded or partially funded, they should only be used for their intended purposes. For example, money should not be taken out of the roof reserve account to pay for painting the building. However, the association can use reserve funds for non-scheduled purposes if approved in advance by a majority vote of the unit owners.
The concept of “cash flow” or “pooled” reserve funding differs from “straight line” reserve funding. Under pooled reserves, it is still necessary for the reserve schedule which accompanies the annual budget to set forth required reserve items (roofs, painting, paving, and other items with the replacement cost/deferred maintenance expense of more than $10,000.00). Further, the “cash flow” reserve schedule must still disclose estimated remaining useful life and replacement costs for each reserve component. The main difference in the cash flow presentation of reserves is that instead of each reserve line item having its own fund balance, there is a “pool” of money in the reserve fund, which is available for costs affiliated with any item in the reserve pool. For example, the painting and roof reserve monies are “pooled” into one fund, so a vote of unit owners is not required for expenditures from the fund, as would be the case in a straight-line reserve scenario where monies from one reserve account would be used for another reserve purpose. As with “straight line” reserve funding, with pooled reserves, a vote of the unit owners is should be required to use reserve funds for operating purposes, or for any expenditure involving items that are not part of the “pool”.
The pooling method of reserve funding attempts to predict when a particular item will require replacement or deferred maintenance, and reserves are scheduled and funded so as to insure that a necessary amount of funds are on hand when the work needs to be done. Theoretically, monthly or quarterly reserve contributions can be lowered, while still avoiding special assessments.
Of course, what works in theory does not always work when placed in human hands. In addition to needing a crystal ball to predict exactly when a reserve expenditure will need to be made, reserve contributions may be substantially higher in certain years, such as when the fund is depleted for the replacement of a required item, and there is a short useful life for the next asset that needs to be replaced.
A condominium reserve fund helps associations pay for maintenance and upgrade costs as they become due. As a property owner, you will be well aware of the benefits which accrue from setting aside sufficient reserve funds. The association will better maintained over time and you will lessen the need for special assessments to make up future budget deficits.