Publications

Reserves and Reserve Studies

Published October 7, 2000 as
Condo board needs to have maintenance plan in place

FACT – over time, the common elements of a condominium will deteriorate and will require major repair.

This may not sound like a proposition extracted from quantum physics, but such basic information seems to be ignored by many boards of directors of condominiums and homeowners’ associations. Without proper planning, the owners of a 20-year old unit may be faced with a financial disaster.

The typical board program for long term capital repair programs falls into three categories:

Ignore it and maybe it will go away. There is no up front cost involved in this program, but as the man says, “pay me now, or pay me later.” If board members have an attitude that they should not have to contribute to funding a reserve account because they will not be there in 20 years, this is a prescription for a fiasco. That is why it is critical to elect directors who have vision and who care about the property. A basic savings program right from the beginning, coupled with an ongoing preventive maintenance program, will avoid higher maintenance and replacement costs in the future.
If it ain’t broke, don’t fix it and if it is, put a band-aid on it. Many associations look at a roof problem and then direct the maintenance company to patch it. This may often work for the short term, but it may be masking a problem of far greater magnitude. It certainly is inexpensive on a day-to-day basis, but if a major repair or renovation is needed in the future, all the patches and interim repairs are wasted money and the replacement cost may have escalated over the passage of time.
Planned maintenance. The appropriate way for an association to prepare for future repairs, replacement and restoration is to have a plan. Even if an association is not recently turned over (a mature association), it is never too late to create a strategic plan for capital repairs. New roofs, parking lots, windows, etc. are extremely costly. Just as an individual would not consider retiring without sufficient savings for contingencies, so too an association must plan for the future.

First, the association needs to engage the services of a consultant who is a specialist in preparing reserve studies and analyzing the useful life of the major amenities.

Second, once the board has obtained the consultant’s findings, it should convene a meeting with the association’s accountant, the treasurer and the finance committee and utilizing the reserve study as a tool, establish a ten-year plan for funding a capital reserve account.

Despite the obvious benefits of pre-planning long term maintenance, associations, by and large, continue to ignore or downplay future needs and fail to set aside the necessary funds to replace major components or systems.

For condominiums, the Illinois Condominium Property Act [765 ILCS 605/9(c)(2)] requires all budgets to provide for reasonable reserves for capital expenditures and deferred maintenance of the common elements. Most declarations and bylaws written in the last ten years for condominiums and homeowners’ associations have mandatory language inserted by the developer.

This begs the question as to whether failure to provide for reasonable reserves constitutes a breach of fiduciary duty. At this juncture, there is no Illinois case law on the subject and Section 9(c)(2) allows associations to opt out under certain circumstances (a referendum, ability to obtain financing, adverse effect on property values), however, I believe a board that neglects or refuses to make an effort to set aside some reasonable amount each year may become the test case for breach of fiduciary duty.

There is no absolute standard, no mandatory percentage of revenues and old rules of thumb are outmoded (10% of revenues, equivalent of one month’s collections). The board is held to a standard of using sound business judgment and any reasonable business person would collect data sufficient to make an informed decision about how much to set aside each year.

The next issue is whether a reserve study must be strictly adhered to, particularly when it drastically increases assessments or requires a special assessment. The board must always keep in mind that a reserve study is a tool; a frame of reference for making an informed decision and a board, in using its discretion, must decide whether 50, 75 or 100% of the recommended forced savings can be accomplished. The objective is to have funds set aside to address the unknown. A reasonable person would set aside as much as possible without imposing a hardship on the unit owners year in and year out. Ultimately, a special assessment or bank loan to fund the replacement of roofs will be considerably smaller because an earlier board was judicious about setting money aside.

Lastly, adequate reserves may impact the ability of individual owners to sell their units to purchasers who choose mortgage companies that look carefully as association financial pictures before approving mortgages. Also, if an association chooses to borrow money for a major capital improvement, the lender is going to require an association to have some funds in reserve as part of the collateral requirements.

In conclusion, an association can ignore the future and wait for a crisis to occur before it takes action, but the repercussions, as well as homeowner backlash, are not worth the risk. The obvious and most prudent course is to establish a “replacement plan” and update it every year so when the roof caves in, the association will be fully prepared to deal with it.