If you are buying a condominium, chances are that you will receive a copy of the condo reserve study. (Most condos in the State of Washington are required to have one.) To someone who isn’t currently living in the building or familiar with the condo, such a report can be confusing. Let’s take a look at what a condo buyer should look for in a reserve study.
What is a condo reserve study?
A condo reserve study is a document that is prepared by a reserve study professional that estimates the useful life, replacement schedule and replacement cost of building components that comprise the condo. The study attempts to cover every conceivable item that makes up the condo complex, such as:
- Common area doors, carpet, paint, lights
For example, a reserve study will say “the roof has 5 years of useful life left, will cost $300,000 to replace and should last 25 years once replaced.
Once each individual component is identified like this, a forecast for the next 10, 20 or 30 years is created. The costs are added up and then compared to the repair reserves that the homeowners association has on hand. The report will say something like “Based on anticipated upcoming repairs in the next 5 years, the condo is 40% funded. To achieve 100% funding, this study recommends raising the monthly reserve contributions to $XX.”
Interpreting a reserve study
These reports are voluminous and confusing to someone who isn’t intimately familiar with the condo complex. However, there are a few key things to watch for.
Are the condo complex repair reserves underfunded? If so, there is a very strong possibility that you will face a special assessment to pay for repairs, or you will move in to a complex that chronically defers maintenance items because they don’t have enough money to pay for them. Understanding the difference between those two scenarios requires that you read the recent meeting minutes from the HOA to see what repairs are or aren’t being discussed.
Determining whether reserves are underfunded requires a bit of interpretation. If the condo has a $5M renovation project due in the next 3 years and is 15% funded, the homeowners are probably in trouble and a large special assessment is imminent. However, if the reserves have recently been completely depleted upon completion of a recent $5M renovation project, there may be no upcoming major expenses for many years, so it makes sense that it is “underfunded” at that point in time.
Since condo reserve studies may only be completed every few years, you need to look at how old the study is and what has happened since then. What repairs have been completed? What are the current reserve amounts being saved each month? Is the HOA following the reserve recommendations being outlined by the reserve study? What do the HOA meeting minutes say about plans for upcoming expenditures? Reading a reserve study without reconciling with the current condo budget and plans doesn’t give you the whole picture.
Reserve studies are just a rough estimate
I’ve read enough condo reserve studies in my day to know that you should treat them with a slightly skeptical eye. Some items are pretty easy to guesstimate. A roof has a finite life span and replacement costs are fairly easy to schedule and estimate.
Other items that are included in the forecast are a little more “squishy.” For example, it says that the paved driveway has “~15 years of useful life left and will cost $50,000 to re-pave” or “the mailboxes need to be replaced in 8 years at a cost of $2000”. Maybe that’s true, or maybe those items will be unchanged for decades. It’s good to have them in the cost estimates as a cushion, but recognize that some of these items will outlive their estimates.
Look beyond just the reserve study
Sifting through condo financial documents can be arduous. However, there are a few key metrics on the balance sheet and profit & loss statement that give a really strong indication on whether the HOA is financially healthy or not.
- What is the annual income and expenditures for the HOA? A healthy HOA will receive more income than it spends each year and will put the remainder in reserves in anticipation of large maintenance expenses in the future.
- What was the reserve balance last year? What is it this year? Is the reserve balance increasing to save up for future repairs? If it is not increasing, perhaps there was a large repair expense this year? In the absence of such repair expenses, if the reserve balance isn’t increasing, the HOA dues are likely not high enough and there is a distinct chance of financial problems in the future.
- Compare the annual contributions to reserves to the amount being recommended by the reserve study. If there is a big difference in the two numbers, ask why.
- What repairs are being discussed in the HOA meeting minutes? You will find proactive HOA boards that say “we are planning for such and such project next year, are getting estimates, will pay for it out of reserves, etc”. You will also find reactive HOA boards saying things like “the roof really needs replacement, we might have to do a special assessment to pay for it. You may also find HOA boards that talk about none of this, meaning no one is paying attention to the health of the building and perhaps deferring all sorts of important maintenance.
Proper due diligence is necessary when buying a condominium. Seeking the assistance of an experience real estate agent can help you wade through these documents and come to a conclusion whether a particular property is a well-run or risky investment.