When is a condominium corporation’s reserve fund adequately funded?

The Condominium Act, 1998, simply requires a condo board to review its reserve fund and propose a plan for future planning that will ensure the fund will be adequate for its intended purposes.

This means a condo corporation only has to have sufficient funds to meet planned expenditures. If expenditures occur earlier than planned or the economic climate deteriorates, the corporation is exposed to the risk of special assessment or deferred maintenance, which increases the future cost.

Risk management
A risk-based approach to project planning seeks to identify the potential risks and their impact, and then devises appropriate remedial measures that reduce or manage the impact of a risk event.

The main risk to a reserve fund plan is that expenditure requirements may exceed the reserve fund amount in any given year. There are many reasons for this, most of which are beyond the control of a condo corporation. So, if a corporation can’t control the risk, it must prepare for it to occur.

One way is to set reserve contributions so high that the reserve fund can accommodate any event. However, a large reserve fund does not translate directly into benefits for unit owners and higher contribution amounts can scare off potential buyers.

Annual funded ratio
A good way to assess the health of a reserve fund is to use an annual funded ratio (AFR) – the three-year moving average from the reserve fund starting balance to planned expenditures.

Using a 3-year moving average allows the AFR to look forward to the future health of the reserve fund and acts as a barometer on the relative health of the reserve fund.

The higher the value of the AFR, the less likely unexpected or sooner than anticipated expenditures will have a negative impact on the reserve fund. A fully funded reserve in accordance with the minimum requirements of the Condominium Act has AFR = 1, with the reserve balance just meeting the anticipated expenditures.

It is recommended that a corporation have a rating of AFR ≥ 2, so that, in any given year, the reserve fund can accommodate a sudden expense in the amount of the average of the next three year’s planned expenditures.

With an AFR ≥ 2, however, there is some risk of over-inflated future-year reserves, depending on economic conditions. So, to ensure the most efficient contribution rate, the funding plan should be reviewed on a regular basis to maintain the condo corporation’s desired level of risk mitigation.

Jeff Truman is the owner of Truman Engineering Services Inc., a facility engineering and project management company servicing Southern Ontario.