Functional Reserve Fund Study
We use the refined methodology, developed for the Real Estate Institute of Canada with their certified reserve planner program, it is the "functional reserve fund study". It was developed by the late Hans J. Moehring, FRI, CRP, John Molnar's former mentor with reserve fund studies. Hans had a very long and distinguished career as an appraiser and realtor. The program is the only one available for reserve fund analysts who want to specialize, rather than dabble, in this profession.
It balances the focus on the condominium corporation's physical components with it's financial requirements, while being reasonable and realistic about the many variations in individual condominium board operating policies and maintenance practices. The functional reserve fund study is essentially a "business plan" and differs in many ways from the typical "engineered reserve fund study" model. It is the one we use when we do a reserve fund study for you!
First, the focus is on gathering as much accurate information as possible, both about the physical site and the financial aspects of the condominium's operations. The development of a reserve fund history, plots the previous reserve fund contributions and expenditures - sort of like taking a medical history on a patient before coming up with a diagnosis. In older developments, many revealing clues can be discovered about problematic areas when this is properly done and far too many reserve fund analysts totally ignore this element.
Next is the quantification and inspection stage of the reserve fund study. Quantification (how many square feet of roofing, paving, how many windows and their sizes, doors, etc.) is extremely important in the development of current replacement costing. The quantification method used for the functional reserve fund study uses the modified uniformat building classification system, a standard recognized worldwide. If your check your audited financial statements, you'll notice that their categories and ours are very much alike with the reserve fund expenditures shown.
Inspection of the individual reserve fund components is then done in order to determine where each one is in its respective life cycle. Here, the experience of the analyst is so important, as wrong numbers can really lead to expensive and unexpected surprises. We do not send young pups into the field for this, preferring the experience of our "old dogs" in the business.
The cornerstone of our functional reserve fund study is the "benchmark analysis", a one page spreadsheet that employs the "sinking fund method" of computing future replacement costs while factoring in the interest that is collected on the reserve fund as the condominium contributes each year. This methodology was developed many years ago and is very well understood by appraisers and valuation experts who devised it for huge capital infrastructure projects to ensure that the funds were on hand when needed.
"Straight line" calculations, while they are simplistic and easily done, often lead to very misleading results in terms of the annual contributions that condominiums should be making to their reserve funds. Far too many analysts take the easy way out and simply recommend increasing the Reserve Fund contributions by, say 5%, per annum, FOREVER. That demonstrates a lack of understanding and can lead to needless over-funding of reserve funds.
Another important ingredient of the functional reserve fund method is the 'deficiency analysis'. It is very important to know the difference between a reserve fund that is "deficient" vs. one that is "adequate". A reserve fund can be deficient yet still adequate. The model is designed to plot the point when the reserve fund is no longer deficient and can then rely on a constant and flat contribution with no annual increases.
When all is said and done however, the longer the forecast period, the less accurate the numbers are. There are so many factors that can arise and throw them all off. The two largest variables are the construction cost index and the inflation factor. They can be very volatile. Changing these two numbers alone can have wide ranging effects on the reserve fund forecasting. Other factors such as latent construction deficiencies, no longer covered under the Tarion home warranty legislation, the maintenance practices of the corporation and the management company also play a large role in either shortening or lengthening the life cycles of individual reserve fund components.
THIS IS THE REASON FOR RESERVE FUND STUDY UPDATES - a very wise move on the part of the authors of Ontario's Condominium Act.