Is your condo building’s reserve fund adequate? We’ll discuss this topic in the following video.
I’m Nick at Hauseit, based here in New York City. Check out our website hauseit.com to
learn how to save money if you’re buying or selling real estate. So let’s get started!
If you’re thinking about buying a condo or co-op, it’s important
to review the building’s financials before you sign a purchase contract. In New York,
your attorney will typically review the condo’s financial statements as part
of the overall buyer due diligence process which happens before you sign the contract.
However, it’s also possible to request the financials and perform a basic review
prior to submitting an offer.
We do have a separate, in-depth video which talks about how to review condo building financials.
Click the link above to check that out. But in this video, we’re going to focus
on condo reserves specifically. So first and foremost,
let’s answer this question: what are condo reserves?
Well, a condo’s reserve fund is basically a rainy day fund for the condo which it can use to pay
for large capital improvement projects, or to cover unanticipated expenses. In other words,
condo reserves represent the amount of available cash or cash equivalents
that a building has in their coffers. A condo building’s reserve fund appears on the
Balance Sheet. Larger condo buildings usually differentiate between reserve funds and cash,
while smaller buildings typically just show cash. But ultimately, cash or cash
equivalents identified as ‘reserve funds’ or simply as ‘cash’ perform the same function.
Let’s answer another question: who owns a condo’s reserves?
Well, the technical answer is that the Condominium Association owns the condo reserve fund. Neither
building management nor individual unit owners have any direct claim to these funds.
However, individual units owners indirectly own this money by way of their ownership
percentages in the condo building as a whole. Let’s say you’re buying a unit in a condo
building with 10 apartments. This condo building has been very thrifty with their finances,
and as a result, they have $200,000 in the bank. If you buy this apartment, you’re purchasing
roughly 10% of the condo building. Therefore, you indirectly own reserves of
10% x $200,000, or $20,000. That being said, reserve fund
money cannot be accessed or withdrawn on demand by individual unit owners. However,
the size of the reserve fund still matters. This is because the reserve fund is a buffer between
building expenses and possible assessments which you may be asked to pay as a unit owner.
An assessment is an additional, temporary charge levied against unit owners to pay
for building capital projects or other expenses which are not provisioned for
in a building’s regular operating budget. Let’s say the condo building needs to spend
$25,000 to upgrade the fire sprinkler system, and they have no reserves. This would all but
guarantee that the condo would levy an immediate assessment on unit owners.
So if you bought this condo, you’d have to pay your regular common charges,
and on top of that, for a few months or perhaps a year, you’d have to pay
a separate, additional assessment charge to pay for the sprinkler system upgrade.
Going to back to our previous example, let’s say the condo building has $200,000
in reserves in the bank. If this were the case, the building can easily pay
for the $25,000 sprinkler upgrade, and it won’t have to levy any assessments on unit owners.
So, on to the next question: how much in reserves should a condo building have?
Well, in an ideal world, a condo should have at least 6 months of
operating expenses in the form of cash reserves.
Here’s how we do the math:
First, let’s take a look at the income statement and figure out the total annual expenditures.
Let’s say the building spends $100,000 annually.
Now, let’s divide that by 12. So this building spends roughly $8,000 a month.
Now let’s go to the balance sheet and find the cash balance. In this case, it’s roughly $26,000.
Dividing the $26,000 in cash by the $8,000 monthly operating expenses
tells us that this building has just over 3 months of operating expenses in their reserve fund.
It’s important to keep in mind that it’s not necessarily an immediate red flag
if a building doesn’t have a large reserve balance.
Some condos simply like to keep common charges as low as possible and assess whenever they
need to pay for something. Other buildings may prefer to keep common charges slightly higher
than operating expenses in order to build a reserve fund over time.
Before we let you go, we want to share one other tip with you. It’s important to adjust
a building’s cash balance by any accounts payable balance when calculating the amount of reserves.
If a building has $57,000 in cash and accounts payable of $17,000,
the condo effectively only has $40,000 in unpledged, available cash.
So there you have it! We hope you enjoyed this video, and if you did, please like, subscribe and
leave us a comment. We’d greatly appreciate it. And if you’re looking to buy or sell, check out
hauseit.com to learn how to save money. I’m Nick at Hauseit, and we’ll see you on the next video!