If you are not familiar with the concept of a reserve fund, we suggest you read the following article before reading on: A Strong Foundation: The Crucial Role of the Reserve Fund.
An integral part of managing a reserve fund is enlisting specialists—engineering firms—to conduct a reserve fund study that assesses the financial strength of the fund against anticipated expenses. In Ontario, reserve fund studies must be completed every three years as required by the Condominium Act, 1998. A condominium board may request studies from multiple engineering firms, evaluate their findings, and then inform owners of the results, which can lead to adjustments in condo fees.
Breaking Down a Reserve Fund Study
A reserve fund study consists of two key components:
Physical Analysis (Common Element Assessment) – Evaluates the condition and longevity of common elements shared by all owners.
Financial Analysis (Plans for Future Funding) – Provides projections and recommendations for maintaining adequate reserve funding.
Physical Analysis
The core of a reserve fund study is a physical assessment of the condominium’s shared elements, such as elevators, windows, roofs, and parking structures. These components require periodic repair and eventual replacement.
To conduct the study, an engineering firm will assess the current condition and estimated lifespan of these elements and estimate the costs of their repair or replacement. This evaluation helps determine how much funding will be required over time.
Financial Analysis
With a comprehensive inventory of common elements and their projected costs, engineers can develop financial projections, which form the actionable part of the study.
The recommended funding plan (also referred to as the notice of future funding) is used by the condominium board to determine how much unit owners should contribute to the reserve fund. Contributions are a significant portion of monthly condo fees and are essential for maintaining long-term financial stability.
A reserve fund study typically includes:
Projected minimum reserve fund balance over a 30-year period.
Estimated costs of future repairs, based on assumed inflation rates.
Assumed inflation rate influencing cost projections.
Recommended owner contributions to sustain the fund.
Estimated interest earned on investments, based on assumed annual rates.
Opening and closing balance projections, considering all the above factors.
Here is an example of a reserve fund study:
Limitations of Traditional Reserve Fund Studies
While reserve fund studies provide critical financial planning tools, they are often based on fixed assumptions that may not fully reflect real-world economic conditions. Some key limitations include:
Fixed Inflation and Interest Rate Assumptions – Studies typically use a set inflation and interest rate for the entire projection period, but in reality, these rates fluctuate with economic conditions.
Investment Accessibility Misconceptions – Many studies assume that the entire reserve fund is available in cash every year for reinvestment. However, in practice, many reserve fund investments have maturity terms exceeding one year, meaning some funds may not be immediately accessible.
To explore these assumptions further and understand their impact, read: Discovering the Simulated Forecast.
The primary goal of a reserve fund study is to determine appropriate contribution levels for condominium owners. These studies provide invaluable financial planning guidance, ensuring that the reserve fund remains adequately funded to cover future expenses. However, greater precision in forecasting can further help condominium boards reduce financial risk and improve fund management.
A Smarter Approach to Reserve Fund Forecasting
While the reserve fund study process is essential, there are ways to enhance its accuracy and reliability. At Vertical City, we offer a reserve fund forecasting toolkit that helps condominium boards independently evaluate their reserve fund studies. Our tool incorporates more accurate financial models, utilizes realistic assumptions, and runs simulated projections to provide a broader range of potential financial outcomes.
To learn more about how our toolkit can help you refine your reserve fund strategy, visit: Vertical City Toolkit - Reserve Fund Forecasting.
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