Is your Reserve Fund Study aligned with your year end?

The Condominium Act in Ontario requires a condominium corporation to complete a reserve fund study every three years and requires that every other study be based on a site visit.  Many Ontario condominium corporations are following this three/six-year schedule, but their reserve fund study is out of sync with their fiscal year end. For example, they may have a fiscal year end of May 31, but find that their last study was finalized in October.  Ideally the study would be in draft while you are developing your budget, so that the combined increase related to both reserve and operating costs could be considered together. For a May 31 year end, that would mean starting a study in about January, so the draft is ready in March. In March and April, the budget can be set. Then the Notice of Future Funding can go out, providing the required 30-day notice of the increase which would start June 1.

So, what is a condo to do if there study is out of sync? It may be tempting to delay the reserve fund study, finalizing the next update three and a half years after the last one. However, this puts the corporation off the requirements of the Act. Therefore, it is better to advance the study by half a year. So, in the example above, the corporation with a study that last finalized in October 2019 but has a May 31 fiscal year end would be wise to start their next update six months early - in January 2022, planning to finalize it in April/May 2022 rather than October 2022.

The good news is that if you fix the timing once, future studies tend to fall into line, because the property manager will see the date on the study and plan to have another one completed three years later. So you won't just be helping your own board be organized, you will be helping all future boards that oversee the condominium corporation.

2021 and Still Waiting

It has been a long time since I last posted. 

Looking back, I see an optomistic post I wrote in 2012 that talked about the problems with condo Reserve Funds and how I hoped that the Condo Act amendments that were starting to be discussed at that time might solve the problems. Yet here we are, in 2021 and the same problems still exist. Ontario Condos still start off underfunded in EVERY case. 10% of the operating budget IS NOT ENOUGH!!. The 30 year analysis period is still NOT long enough for new condos, given that there are very few expenditures in the first twenty years. And nothing has been done to prohibit long phase-in periods that allow condos to defer the bulk of the reserve fund contributions to future owners.

The oldest condos is our industry are now over 50 years old and many of them are struggling. They provide us with a very clear education about what happens when a reserve fund is not adequately funded. The financial difficulties simply build with time until they become almost insurmountable. The buildings degrade physically. People who move in are unlikely to have the resources available to afford a special assessment, if one is needed.

The Auditor General completed a review of the condominium industry in 2020 which contains many recommendations to rectify these same concerns.  The Ministry did a new consultation in 2020 are received much of the same feedback. We, as an industry, have done everything we can do to help move things in the right direction. Now we wait, again!

I joke that I won't retire until some of these key financial issues are addressed. I'm starting to fret that the government might make a liar of me.

Tarion Common Element Construction Performance Guideline

If you are a builder, property manager or condominium corporation dealing with warranty resolution related to a first or second year warranty in Ontario you need to get familiar with the new Common Element Construction Performance Guidelines released by Tarion last fall!

There has been a CPG for many years, but it only covered the kinds of concerns typically found in a single-family house. The new guideline finally covers the issues we encounter day in and day out in high rise buildings and parking garages.

The Performance Guideline provides clarity about warranty coverage and performance expectations for over a hundred typical claim items. These include things like:

• leakage through garage roofs and suspended slabs (no longer is injection sufficient in some circumstances!)
• ponding on slabs and site finishes (OK to have some limited ponding but not where people can't avoid walking)
• corrosion of painted metal elements (not within one year)
• water shedding at exterior walls (concentrated run-off to be rectified)
• excessive finish variation on balcony undersides (a uniform appearance from grade is expected)
• site plantings that die within the first year warranty (the previous CPG indicates dead plantings were to be reported in the PDI inspection, which doesn't apply to condominium common elements)
• excessive flow velocity in domestic water piping (the guideline recognizes that flow higher than anticipated in the design contribute to premature pinhole leakage)

A very exciting clarification is that if a bylaw or other legislated requirement comes into force during construction, the builder is responsible for complying with the requirement if it came into force prior to the date of registration of the corporation. This explicitly applies to things like painting of garages, guards on elevator cabs and backflow preventers but also sets a reasonable example to follow for future legislated changes. The corollary is that if the requirement comes into force after the registration date, the cost will be borne by the corporation. This is an improvement over prior interpretations which suggested that the builder might only be responsible for legislated requirements that were in force prior to the date the building permit was obtained.

Another clarification that deserves attention is that light levels must meet the code minimum requirements for the full warranty period. Previously builders would argue that light levels drop over time and that if the light levels were not sufficient at the end of the first year, then it was a maintenance issue to change bulbs. The new guideline clarifies that the design must accommodate reasonable bulb light-level degradation (which is expected) such that light levels remain adequate for the full warranty period. This provides more reasonable protection for the corporations, because, in many municipalities the corporations have an ongoing obligation to meet light levels similar to those required by code (and changing all bulbs every year is not a reasonable expectation!).

The best thing about the new guideline is that it removes some ambiguity helping create not only clearer expectations but also less friction during the resolution process. Combined with Tarion's new resolution tracking portal and the new 18 month builder repair period, the CPG should help make the resolution process much better for all involved.

What needs fixed in the Ontario Condo Act?

The Ontario Condominium Act is currently under review so I have been involved recently in many discussions about what needs fixed. Over the next few weeks I will participate in stakeholder panel meetings to make sure that the key issues that require change get on the table for consideration.

I thought I would summarize my recommendations here so people can give me feedback before those meetings.

My overview.
When the work to be done matches the money in the reserve fund, life is easy for a board of directors. Sure they have to implement the projects, but the funds are there. Promptly completing required repairs minimizes the work to be done and keeps residents happy and confident that their investment is being well managed.

When the cost of the work to be done is significantly more than the amount in the reserve fund, lots of things go wrong. Just like any other level of government, the board has to decide how to handle the situation: defer the work (allowing the building to degrade), borrow money, increase fees, or special assess.

 

None of these outcomes makes anyone happy. While they decide what to do, there is a risk of a negative vortex being created: 

• There is a governance spiral – a group of people join the board. They find out that they don’t have enough money. They go to the residents asking for money. Someone in the building takes exception, stirs the pot and before you know it there are requisition meetings to kick out the current board members. The new members, like all politicians, promise to do more with less. Then they too realize they face a challenge that requires funding. This cycle can continue for many years, without a board ever being in place long enough to implement the required repairs.
• There is a physical spiral - as time passes, the small repair projects spread. Instead of replacing a few bricks, you are now replacing hundreds. And the inside of the wall got so wet that there was leakage into the building. And it was wet so long that the wall is now mouldy. Small problems rapidly progress into big problems when they are not addressed.
• There is an affordability spiral – as the building degrades physically, buyers are willing to pay less for the units. This attracts buyers who can afford less. So the very people who can least afford to pay for major repairs end up being the people “holding the bag”.

So, making sure that Condominiums have adequately funded reserve funds is critical to the long term success of these communities.

How can we change the Act to support this cause?

 Define Adequate

The Act says that the board must select a plan for funding the reserve fund that ensures that the fund will be adequate for the purpose for which it was established.

In the next version of the act, let's get clear about what adequate means. If the intention is for the cost of projects to be fairly shared by all unit owners in a building so that anyone enjoying a year of benefit of a component pays for a years worth of that components renewal (which is surely the intent of the Act), the let's say that.

That being said, I think that the funding level should not jerk up every three years when a study is completed.

So, the recommendation put forward in the CCI legislative brief is: "adequate means that the year-over-year percent change in the contribution for each year of the term of the study is no greater than the assumed inflation rate used in the study, except in the first three years where an increase greater than inflation is permitted, and that the closing balance in any year of the term of the study shall not be less than zero"

Legislated Changes

The Act should clearly state whether or not legislated changes (think sheave jammers, elevator cab guard rails, elevator equipment guarding, back flow preventers, human-rights related modifications) can be paid from reserve. These are alterations or improvements (and therefore seemingly excluded) but are mandated and should clearly be a cost shared by the owners who will benefit from the changes over time, so they should be allowed to be paid from reserve.

Energy-saving or other green initiatives.

The new Act should have clear boundaries defining when it is acceptable for a corporation to pay for an energy-saving or other green initiative from reserve. The Act should not prevent Corporations from making smart decisions, but should also not allow pet projects with no appreciable benefit to the owners. This will require some fine-tuning of the language that I won't pretend to be able to come up with on my own.

Sort out First Year Contributions

Currently first year contributions are set at 10% of the operating budget. This is a bit like suggesting that the amount you need to save for your retirement is a function of your shoe size. The operating budget is a function of so many variables unrelated to the future repair needs of a building, that it should not be used as a criteria. Invariably, the 10% is wildly insufficient, so the new owners of the Condominium have to absorb a significant increase to their fees in the second year.

We need to get first year contributions to better reflect reality. Perhaps this will be handled via a uniform contribution per square foot of area of the common elements, or perhaps this will be handled via a reserve fund study based on the drawings. But it needs to be handled.

Leases

Many corporations have significant lease payments or mortgage payments to make. These can relate to guest suites, management offices, recreations facilities, or even HVAC equipment. These leases are always disclosed, but every board I meet with says that the owners didn't realize what they were signing up for. Often first year payments are waived, so these payments start in the second year, compounding the required increase to the fees between the first and second years.

To my mind, this is like buying a car and then finding our that you are leasing the engine, with the payments starting when the car is a year old.It is simply not intuitive or something you would expect to have to hunt through disclosure statements to find.

Condo owners should know that the price they are paying for a unit covers the cost of all the facilities and equipment, with no surprises.

The only exception I would want to concede to would be a LOAN for an upgrade to the systems to improve the energy performance with the loan payments starting in the FIRST year. These "green improvements "represent an increased cost to the developer that the developer does not fully benefit from because the benefit accrues to the unit owners in the form of lower operating costs. The challenge is that the wording of the Act will need to limit the loan to the incremental cost of the improvement, not the total cost of the equipment being installed.

Conclusion

Lots of other folks are dealing with other issues (like dispute resolution, sorting out proxies, licencing of management etc). These are all important too, but not my focus so I have not discussed them here.

I do believe that sorting out the funding side of things will help prevent a lot of the problems which result in disputes, poor governance etc so it needs to remain a high priorty for the upcoming Condo Act revisions.