At Czarnowski & Beer LLP we support the concept that reserves accumulated are reserves to be spent. Another adaption of that philosophy is during times of historically low-interest rates, if it is available to be borrowed to get the project done the best thing to do is simply refinance.
Despite our agreement that this is the best approach to take, a few factors require consideration before choosing to use your reserve fund or impose an assessment for your capital project.
Consideration #1 – Does a reserve fund study exist, is the considered project listed as expected soon? How well has the funding plan of the study been followed?
Many properties have a loose collection of facts regarding what the property will need over the next certain number of years, while some follow a specific study of work the property will require and aforethought funding plan. The property that utilizes a constant reserve funding mechanism, like a transfer fee or allocation of monthly charges to reserves, is generally well ahead of those who benchmark the amount in the reserve fund to some formula such as several months’ monthly charges.
Where your property fits on these scales can be the true driver of any decision regarding how to fund. At what level will the reserve fund balance be after the present project needs to be part of the evaluation process. Further, you must ask yourself how the annual funding level will mesh with the needs of the future after the project is complete. Prospective buyers are looking for minimum reserve fund levels and once those amounts are approached the reserve fund is no longer available to spend. Thus when a project is considered, regardless of the level of existing reserve funds, the decision to utilize what is there should never be taken lightly.
Consideration #2 – What will the reserve fund look like after this project?
Before utilizing your reserve fund for a capital project ask yourself if the fund might take a hit and decrease substantially but be able to be put back on track with an increase in monthly maintenance payments so that more money goes back into the reserve fund. We call this approach borrowing from future reserves and it should be kept in mind as a viable option to cover the cost of a capital improvement project. While this method is less popular than an outside loan or increased debt, it can provide the funding you need for an upcoming project and satisfy your fiduciary responsibility.
Consideration #3 – We really cannot afford this project, what are our other funding options?
In an environment of low-interest rates loans are being used much more prevalently than in previous years. For condominiums, while it is true that you can accomplish more sooner with a loan, the total cost is raised by the interest to be paid on the debt. In some cases, this is the best alternative, but biting the bullet can make sense in others. There is much less interest rate risk for condominiums as not being secured by real estate these loans are paid back over five to ten years.
Cooperatives on the other hand have mortgages as part of their capital structure so any additional debt tends to be added to what is existing. Over the last few decades, declining interest rates and rising property values made these decisions easy. In many cases, the same monthly mortgage payment could cover more debt and any increases in the monthly mortgage payment could be incorporated into maintenance increases. We forewarn you to consider what happens when interest rates rise and that debt needs to be refinanced. Low current rates are in cases less than half and if we go back to the early days of cooperative popularity, even a third of the rates these entities paid in annual interest. We are concerned that the shock of refinancing to more historical interest rates will cause monthly maintenance to increase higher double digits than used before.
That leaves us with the special assessment. Challenges will exist for many owners being asked to pay more, but for a board to maintain fiduciary responsibility and unit values in a potentially difficult real estate market it may be necessary. The benefit is that once the assessment has run its course the property is left with no debt to repay. Exceptional communication of the benefit from the work and offering an upfront discounted option work in your favor.
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