On Misconceptions About Reserve Fund Planning and Reports

Thoughts from B.C., ahead of Québec's legislation update

By J.-F. Proulx, CRP

Reserve fund planning is part of boards and councils’ annual fiscal-year based budgeting process. Comparable Reserve Fund Studies/Depreciation Reports (RFSs/DRs) are vital to all stakeholders’ decision-making.

Predictable scheduled reserve fund expenditures may be infrequent, but common asset deterioration occurs every day. Reserve fund contributions are not a gift to future owners. Measuring the position of a reserve fund is like measuring a person's net worth – now, not in the distant future. Deviations on reserve fund current position and future standing calculations are unwarranted.

Since the 1990s, the Real Estate Institute of Canada (REIC) has promoted a standardized benchmarked version of reserve fund planning with its Certified Reserve Fund Planner (CRP) accreditation. While legislation prescribes a reserve fund’s floor contribution amount, the REIC CRP budgeting approach provides a ceiling amount at the point-in-time of a current fiscal-year.

The CRP approach has liabilities distributed fairly to all owners on a fiscal-year basis over the life of a development. Having two developments properly use it also means that two lots in two developments can be compared on a sound footing. Benchmarking measures performance with a fully-disclosed comparable method. It builds on past results so that decision-makers make targeted risk-management improvements. Benchmarked reserve fund contributions account for common asset deterioration – while owners are enjoying a development and gaining real-estate value. Each fiscal-year, reserve fund planning matches expenditures and contributions over a long-term horizon so decision-makers know how much liquidity they need, and how long to invest the remaining reserve fund monies.

Engineering has a crucial place in reserve fund planning – CRP reports recommend the scheduling and acquisition of specialized trade and building science engineer reports – and use all relevant findings. But corporations need their other leg – the financial analysis – to be just as long. Engineered reports that are based on Class D estimates – even Class A estimates within 5 to 10 percent of Quantity Surveyors new construction costs – derail reserve fund planning. They misrepresent aging developments’ actual major repair and replacement renewal costs. Doing so would have reports exist only to establish the present value of assets with prescriptive current costs.

This viewpoint is about return on investment; taxation; insurance premiums; and new construction, and not about the on-going performance of components once construction is completed and renewal projects are on the horizon. This explains why many people say: "I don't know why they call them depreciation reports?", or why some non-compliant reports extend projections to 45 years – demonstrating a lack of knowledge about the importance of renewal costs in the benchmarking of depreciating common assets. None of these deviations are acceptable.

In BC, the Association of Professional Engineers and Geoscientists of BC (APEGBC)’s guidelines state that the CRP approach is their first guidance document. The Architectural Institute of British Columbia (AIBC) endorses engineer guidelines – and therefore the CRP approach. The Appraisal Institute of Canada (AIC) rules and comments omit the CRP approach and neglect current requirements analysis, but do require the full disclosure of unit quantities and costs – which are often missing from non-compliant reports.

Non-CRP compliant reports focus on the product – reports, rather than on reserve fund planning – which is not formally taught to architects, appraisers, engineers, house inspectors or technologists. In non-compliant reports, a three year old development needing windows replaced in 35 years would have this component and expenditure excluded. The CRP approach recognizes each inventoried component in the benchmark’s current requirement analysis. Every fiscal-year will have its adjusted current requirements account for the windows – so that no surprise ¾ vote special levy suddenly appears in the future.

A projection's time horizon – five, ten, thirty fiscal-years – is less important than the benchmark or the economic lifespan of a development. Engineers' and appraisers’ work is geared to economic choices – developers' and buyers’ economic choices. Their focus is on the short-term, not on common asset needs from fiscal-year to fiscal-year, once the developer and consultants are gone. This explains why – along with unrealistic costing – construction inflation is rarely considered effectively in non-compliant reports. Tampering with construction inflation – or the historical interest income rate of return on the monies in the reserve fund – often has these reports pegging both at 2 percent, thus skewing the analysis.

Based on a component inventory’s tally of one-iteration current costs for each component, benchmarked current requirements are used to establish the needs of each development–phase–section, according to the performance of each component. CRP reserve fund planning adjusts variables on a fiscal-year basis. It does so based on the visual assessment of the performance of an active aging component inventory. It relies on benchmark analysis to produce a reserve fund’s current requirement ceiling, and optimized ceiling contribution amounts. www.reic.ca 9

The REIC approach is a common asset budgeting improvement over passive reactions based on past operating budgets, or on loosely related measures such as the changing market value of a development – Québec’s Ministry of Justice is considering having the reserve fund closing balance equal 0.5 percent of a development’s appraised market-value.

Interrupting the analysis at current costs means that the component inventory is skewed, depreciation excluded, a site-visit irrelevant, and riskmanagement unlikely.

Less than once a year expenditures are then scheduled over a legislation prescribed horizon. Decision-makers rely on adjusted current requirements profile(s) – dividing the closing balance by the adjusted current requirements – to proactively plan owners' contributions so as to sustain a reserve fund’s position.

Reserve fund current requirement calculations offer a financial snapshot at a point-in-time. Benchmarking projects progress over time, and provides a budgeting direction for determining the fair imposition of draws on owners, as well as the equitable allocation of monies.

Stakeholders must be able to compare two developments, their components’ performance and current requirements, the owners’ contributions, and the resulting reserve fund positions, on a fiscal-year basis.

Without a CRP benchmark to account for a development’s common assets, non-compliant reserve fund planning mislead stakeholders as to the true-cost-of-ownership – RFS / DR reports must come with current requirements analysis. We all depend on it. •