Here is a tale of two co-ops when the boiler breaks down. Building One has a low reserve fund tied up in non-liquid assets such as mid and long-term Cds. Building Two has a solid reserve fund with some of the assets in liquid investments.
Building One will have to scrounge for funds to pay for the new boiler, perhaps via a special assessment on shareholders or using funds from operations until the money can be recouped from a special assessment or when non-liquid assets are available.
Building Two has sufficient funds available immediately without the need for a special assessment or loan.
What is a reserve fund? It is money set aside for repairs and improvements to the building, often referred to as capital projects. It should be kept separate from the annual operating funds, which provide for daily operations and determine the amount of the monthly maintenance charges. Buildings that lack a sufficient reserve fund or misuse it to pay for operating expenses can find themselves in a bind when a major repair or improvement project is needed.
A sufficient reserve fund is also important, as some lenders include that when considering a mortgage for buyers; purchasers with solid financials have been refused a mortgage because the building lacked adequate reserves. A solid reserve fund also broadcasts that the building is well-run, jacking up the value of the units. It also gives the board leeway to make quality of life improvements.
The amount of the reserve fund depends on several factors, including the age and condition of the building. Newer buildings would most likely need less investment for replacements/repairs than older ones. The recognized way to determine the size of the reserve fund is to prepare a capital budget plan, which normally covers five years. Usually, a professional engineer or architect inspects the building and determines the life span of the various systems and the cost to repair or replace them. Included in the survey should be the roof, exterior, elevators, boilers and balconies. The engineer can then determine the expected cost as a guide to funding the reserve fund. The capital plan should be updated annually to consider any work that has been done and changes in the condition of the building’s systems, as well as costs and the balance in the reserve funds.
The next issue is funding. Various options exist, including a special assessment. Another possibility for co-ops, which has been used by many buildings as interest rates plummeted to historic lows in recent years, is to refinance the underlying mortgage and direct the freed-up money to the reserve fund. Some buildings impose a transfer fee or fee for sublets and direct these funds for capital and improvement projects. Other buildings use a small percentage of the monthly charges to replenish the reserve fund. Whichever method or combination a building chooses, it must stick to its plan and not follow the temptation to use these funds for operating expenses as a way to keep a lid on monthly charges.
The second key component for the reserve fund is investing the money. Many properties work with a financial adviser, but they should follow some basic principles in their investment philosophy. Most important is being conservative; while it would be wonderful to have significant asset appreciation, that approach can often lead to significant losses. The money should be kept in conservative investments, even in this period of low interest rates. Boards could look to U.S. or municipal bonds, Cds or money market funds. It is equally important to keep some funds in liquid investments so the board can access them quickly when needed. One approach is to have a ladder of investments so funds mature on a regular basis.
With prudent planning and wise investment decisions, co-ops can have the funds available when needed without putting the squeeze on residents.
Ira Meister
Matthew Adam Properties
375 Pearl Street, 14th floor
New York, NY 10038
imeister@matthewadam.com
212-699-8900
