Why are reserve fund, status certificates important for condo owners?
13 Mar 2014 - {{hitsCtrl.values.hits}}
By Kirthi Hewamanne
A reserve fund can only be used for replacement and non-routine repairs of common elements and assets of the condo: for instance, replacement of roof, windows, boiler, carpets and security system. Other examples are non-routine repairs to the chiller, swimming pool and parking areas.
A reserve fund is like a savings account or insurance policy for special expenditures that may come up in the future. In some countries, condos have to have a reserve fund in a bank account that is separate from the general budget account. All monies in this account have to be placed in easily accessible and safe investments, such as government bonds and not in the stock market or any other risky venture.
In some countries, a condo has to carry out a reserve fund study ‘periodically’, according to their Condominium Acts. This generally has been interpreted to mean ‘every three years’. However, such studies can be expensive, especially for small condos that have tiny budgets. A good rule is to do an initial comprehensive reserve fund study and then three years later, do an update--which would be less expensive.
This study has to be undertaken by experts with a special designation. They may be members of the Appraisal Institutes or similar accredited groups such as the Association of Certified Engineers. The purpose of the study is to examine all the systems (i.e., heating) and other physical aspects (garage, balconies, windows) and give a reasonable expectation as to when they will need to be replaced or have non-routine repairs and how much this will cost at that projected time in the future.
The engineers present the results of this study to the board along with a fundraising plan. For instance, they may suggest that 10 percent of the condo fees go into the fund with an increase of 1 percent each year for the next 10 years.
The directors have 120 days during which to decide how to implement this plan or put forth another reasonable plan. After this, the board has 15 days to send to owners an overview of the reserve fund study and how they intend on implementing it. The board then has another 30 days to begin implementing the plan. Generally, this study and plan are sent to owners at the same time as the budget because implementation of the study may affect the budget.
So, all owners receive a summary of the reserve fund study along with an explanation of how it will be put in place. This is then indicated in the status certificate.
Any person planning on buying a condo should consult the reserve fund study and schedule included in the status certificate. Reserve funds that are insufficient could result in unexpected raises in fees or in special assessments in the near future.
Directors who fail to maintain an adequate reserve fund with increased contributions or special assessments could be sued by owners in the future. Indeed, owners may see the value of their property decrease or may fail to sell their units because of a deficient reserve fund. The directors’ liability insurance may not cover them if due diligence has not been done.
Problems with reserve fund
In every country, the Condo Act specifies that a reserve fund can be used only for replacement and major repairs but not maintenance or regular repairs that result from normal wear and tear. These have to be covered in the regular budget.
Take window frames: the normal wear and tear of the caulking requires that it be redone or reinforced periodically. This may be expensive maintenance, especially in high rises. But this expensive maintenance has to be paid out of the regular budget. In order to be covered by the reserve fund, such maintenance repairs have to turn into a creative interpretation of what ‘major repairs’ can mean. Or, yet, condos may not carry out this maintenance and as a result, window replacement or major repairs to the frames may arrive much sooner than anticipated.
Construction costs, price of new windows or even boilers can rise much more than predicted in the reserve fund study. It is difficult to anticipate how much it will cost to replace windows in 20 years.
Some older condos, built before 2001, have never carried a reserve fund study or have done one only recently. As a result, the fund may be deficient and special assessments may be levied.
Building standards have deteriorated so that what used to last 10-15 years may now last five to eight years only. Examples: underground garages develop cracks much earlier than expected (and colder climates do not help this situation). Garage paving may wear out after only five to eight years while the reserve fund study may have predicted 15 years. Therefore, reserve funds may have to be tapped earlier than predicted.
Upgrades can’t be paid out of the reserve fund. For instance, a broken tile floor cannot be replaced by an expensive marble one. If it is, the difference in cost between a tile and the expensive marble has to be paid out of the regular budget.
Why status certificate so important
The status certificate is a document, stipulated in the Condominium Act in many countries that provides basic and essential information concerning the financial status of a unit and of the condo corporation. Its main focus is to inform a prospective owner of the fees, of any large increase that is going to come into effect, of any special assessment that is being contemplated by the board and any arrears or lien that a particular suite might have.
In addition, it contains the condo declaration, by-laws, budget, reserve fund, insurance, management contract, rules, minutes of the last annual general meeting and mention of any lawsuit involving the corporation. This certificate can run into 100 pages.
The purpose of status certificates is to allow potential buyers of condo units to have as much information as possible about their unit as well as the physical and fiscal situation of a building. Certificates also allow prospective owners to find out what the rules are, including whether pets are allowed.
Status certificates are ultimately the boards’ responsibility. Many board members are unaware of this responsibility because this certificate is generally prepared by management companies. It is a good idea for board presidents to check the contents of status certificates, at least once a year, and to do so when the fiscal structure of a condo is about to change or has changed.
Status certificate and special assessments
For instance, as soon as a board becomes aware that a steep increase in fees is forthcoming or a special assessment will be levied or a large expenditure will substantially lower the reserve fund, this information has to be included in the status certificate.
When a management company fails to include this key information, the board is ultimately responsible for this lapse. (The board may fire the manager but the damage will have been done.) This is a problem which happens far more frequently than believed. What can happen if this information does not appear in the status certificate?
Here is an example: A prospective buyer obtains a status certificate and one month after purchase, a special assessment for window replacement is announced. The new owner is asked to pay US $ 3,000, which is the proportion of the special assessment determined for a suite of its size. But there had been nothing about this special assessment in the status certificate: the new owner confirms this with his lawyer and refuses to pay the levy. The manager makes his life difficult and insists that he pay up. Who is right? The new owner is.
Indeed, it is very unlikely that the board and the manager were not aware, if not of the exact sum, at least that there were serious expenditures forthcoming for large-scale replacements and repairs and that additional funds were to be levied. This should have appeared in the certificate. It if had, the owner might have decided against buying the suite or, yet, might have budgeted accordingly or might have asked for a reduction in the price of the unit.
In other words, failing to announce a special assessment or a steep increase in fees or even an important expenditure against the reserve fund in the status certificate is akin to trying to sell a car with a rolled-back odometer: It constitutes false advertising.
So, what happens? Well, the new owner will not pay. Instead, his US $ 3,000 will be added to the total sum levied and will be paid fractionally by all other owners. Or, if the owner has paid, he can go to Small Claims Court to get the money back.
It is important that all prospective buyers obtain and carefully inspect status certificates. They can’t refuse to pay for a special assessment that is clearly announced if they have not read the certificate or have not requested one. The responsibility of reading it is theirs and their lawyer’s.
In fact, many offers of purchase contain a clause stating that acceptance of the offer is conditional upon the buyer receiving the status certificate and being satisfied with its contents—although it is generally the buyer’s lawyer who examines it, hopefully closely.
New owners should always ask their lawyer if he/she sees any problem in the status certificate. In theory, an owner could go against the lawyer if the latter fails to inspect the status certificate carefully and inform the owner accordingly.
Obtaining a certificate
Who can obtain a status certificate? Anyone can, in theory. However, each unit’s certificate may have slightly different contents because a certificate always lists arrears and changes in the exclusive-use common elements made with board approval, for instance. Therefore, in practice, owners who are selling and prospective buyers are the ones who obtain a certificate or their lawyers or real estate agents or a bank.
One can only presume that if there is a case of identity theft that is suspected by management, they will refuse to deliver a certificate. Simple curiosity about a suite may not be an acceptable reason to obtain a certificate but I am not aware of what decision this would entail on the part of management.
Persons who request a status certificate should receive it within 10 days after they have applied and paid for it. The request should be made in writing--in order to protect the owner (see below).
Generally, the fee for the status certificate (US $ 100 + HST) is paid to the management company if it is so stated in the management contract. However, one president and his board have renegotiated their contract with the management company: the fee will now go to the condo corporation.
In the past year, several owners have written to report that a manager had refused to provide them with a status certificate until he or she inspected their unit. The manager is wrong: suites are private.
What to do if manager does not provide status certificate?
You can still try to sell your unit. Prospective owners should be informed that when a status certificate is not forthcoming, it should be taken to mean that ‘everything is fine’. Therefore, if the new owner finds out that there was a special assessment right after moving, he or she does not have to pay it.
However, it is suggested here that sellers who have requested a status certificate keep a copy of the requesting letter and provide a copy to the buyer for legal purposes later.
(Kirthi Hewamanne, a graduate of the University of Ceylon, Peradeniya, is an award-winning realtor with wide experience in all aspects of real estate, including specialized knowledge of the condominium concept. He held membership in the Canadian Real Estate Association, Ontario Real Estate Association, London St. Thomas Real Estate Board Ontario and was a member of the Realtor Political Action Committee Canada. He can be contacted at [email protected])
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