More Canadians are looking to buy condos, but they’re being warned not all are equal. The Canadian Institute of Actuaries (CIA) released a study on condo reserves this week. In the 140-page report, the organization warns low reserves often create misleading overvaluations. Over the long run those values may not benefit the current owners though. Most condos they looked at had insufficient reserve funds, meaning owners could be hit with bills for tens of thousands of dollars to cover sudden repairs.
Condo Reserve Funds
Every condo has a reserve fund, a type of account with funds to mitigate the risk of emergency repairs. The funds can be tapped if an expensive or large repair is needed. It’s generally funded by a surplus of maintenance fees and managed by the condo’s board. Some are better managed than others and have stronger reserves, just like any company.
Many Condos Are Suffering From Shortfalls
The CIA found many condos have extremely low reserve funds, to keep maintenance fees low. Buildings targeting investors often boost valuations at the expense of long-term maintenance. “… low reserve fund contributions will likely lead to overwhelming annual increases and require lump-sum payments from owners to cover shortfalls, and could potentially lead to the loss of homes, especially in the context of rising interest rates,” reads the study.
Adding, “This deferral of contributions from current owners to the next buyers will create intergenerational inequity as well as a false overvaluation of the market value of condo properties.”
The study is referencing the impact of carrying costs on home prices. Buildings with low fees leave credit capacity that can add thousands to the price. People will also spend more to be in a building with lower fees. If low fees come at the expense of well-capitalized reserves, value can vanish fast.
Owners can be hit with a special assessment of tens of thousands of dollars. When this occurs, it often happens with very little time to round up the cash. This can mean having to leverage your unit for a home equity loan, or visiting a private lender. Even pricey cities like Toronto can see the value of a condo vanish in almost no time.
New Condos Aren’t Setting Aside Enough Funds For A Rainy Day
The association studied a sample of reserve funds and found many are under saving. “In aggregate, not enough money is being set aside for future expected payments or to cover unexpected repairs,” says Jean-Sébastien Côté, FCIA, and co-author of the paper.
Recent buildings were revealed to be particularly bad. Shiny new buildings often start with low maintenance fees, then require an adjustment. Brand new buildings don’t need much maintenance, after all. They’re also pricey, so people try to save as much as they can. This is a reckless combination.
If you’re not saving a little when things are good, you can be hit with a big bill when they’re bad. “There are large bills to be paid soon, and very few condos have saved enough, especially those constructed since 2000,” says Côté.
The organization suggests strengthening legislation across Canada to address the issue. Currently there’s a patchwork of provincial legislation, some better than others. This leaves the management of condos largely up to boards with little training. Even worse, they found boards often had undeclared conflicts of interests. Failing the standardization of legislation, they suggest buyers look at reserve studies. They can be obtained for a small fee by anyone, and they often reveal upcoming issues.