Reserve fund question for the pros

how much of a reserve fund would you like to see? Based on what you said roof repair already done. How old is the building?

I would be more concerned with how the common charges are against actual expenses. are they breakeven, do they have to fund a bit from the reserve fund or are they adding to it.

To me as long as their is some sort of reserve fund that is good enough. Remember you are pulling out of your own pocket now for a future expense, how much do you want to see there. at 40 apartments it is almost $2k per apartment in reserves.

I do know that my building, new development, started with 2 months common charges per apartment.

It's what the owners of the building want. Do they want cash sitting in a reserve earning zero percent or are they happy to write a check when then building does need the funds and not before. There is no right or wrong answer here, as long as everyone understands the financial needs of the building and that current normal operating expenses are being met by the common charges.

Okay, so it's not a red flag? I have no idea how much I'd like to see on a building this size. I don't know what normal is. I've seen larger buildings with more apartments, more amenities and higher monthlies, and often they had $500k+ reserve funds. One large complex I looked at had $7m. So this seemed low to me.

I guess the answer is: pore over the minutes and discuss with lawyer if I decide to make an offer.

one way to look at a reserve fund is in terms of burn rate: go to the P&L (which is probably called something like "statement of income etc." and look at the total expenses -- labor, heat, utilities, insurance, phone, whatever .. but before depreciation and amortization.

So your total expense number, let's say its $260,000, can be divided by 52 to estimate how much the building is spending per week (in this case, $5,000, since I'm making up easy numbers.)

Then divide the reserve fund by the number of weeks it would take it to run out without any changes.

In this example, the $70K reserve fund is roughly 14 weeks of reserves.

ali r.
DG Neary Realty

Ali, thanks, that's really helpful.

Mikev, the two months of common charges was not a reserve fund. It was working capital.

Some buildings would rather tap into a line of credit at a good rate than have reserve funds. Not really a read flag.

Ali G...that makes no sense. You are looking at it like an individual losing their job and how many weeks in reserve they have to live. A building does not work that way unless all tenants stop paying their maintenace at the same time, no income is coming in, and the building must survive on its' reserves. Is that rational?

The reserve is there for major outlays/emergencies, not to pay everyday expenses. If you are worried that all owners will stop paying their maintenance and the building must survive on its reserve, then you should never buy.

Did you work on some of those RMBS default models when you were on Wall Street, because that would explain alot.

Apt-Boy, I think it puts it in perspective. Grunty, thanks. I hadn't thought about that. I just didn't really know what to make of it, but it doesn't sound like a cause for concern.

I agree with Apt_boy. The analysis was off-mark. The point of a reserve fund is to deal with the unexpected cost or a needed capital outlay not part of the normal budge process.

evnyc - also you want to see if the condo budget shows a line item for reserves collected from year to year. Fannie Mae and FHA both now require that condos have a line item that allocates 10% of the budget towards reserves. sunny.hong@bankofamerica.com

10% is absurd. it's a fixed number with no regard for anticipated expenditures.

EV, this is a hard question to answer in the abstract. While Ali is right that burn-rate is "one way" to look at it, you would be more concerned about common charge arrears if you are really concerned about burn rate. As A-Boy and R'sider point out, a "reserve" fund is really a rainy day fund, where the "what ifs" have more to do with unexpected expenses than with operating budgets.

I *suspect* that $70k is relatively low for a 40-unit COOP building, but probably not for a CONDO (I have no hard data). For reasons that are (to me) more historical then logical, condos tend to operate with smaller reserves than coops, and *much* more frequently assess for big expenses than coops do.

This is one of those relatively subtle reasons why *some* more 'conservative' buyers prefer coops to condos. Condo owners are more likely to have to count on their fellow owners to have the liquidity (or credit) to pay an assessment when needed than coop owners.

If you are comfortable from due diligence that the condo board has been a good steward (i.e., that major unexpected expenses are truly not likely), then it comes down to how comfortable you are that you (and your neighbors) can pony up $5,000 or $10,000 quickly if the need arises. I know of buyers who anticipated an assessment for facade work in the near term, and put away a chunk of their own money anticipating a Building Rainy Day contribution. (Some do this in a separate account, others do it only mentally.)

Based on my 15+ years as a board member in two major Manhattan condominiums, including years spent as first treasurer and later president, Ali's analysis is right on the mark.

A well-run condominium keeps in the range of 3-to-6 months' worth of operating expenses in its reserve account. These monies are conservatively invested and kept 100% liquid, held in the event of an unexpected event that could interfere with a building's operations: e.g., an abrupt economic circumstance that prompts a large number of unit owners (or a few of the largest owners and thus those who contribute the most to the condo's income) to pay common charges either late or not at all; an external event (e.g., a fire) that makes common areas useless; an infrastructure crisis (e.g., a boiler erupts). The condominium needs enough cash on hand at any time to deal with the unexpected while continuing to operate the building. And you can't discount the perfect storm -- when say a building's largest unit owners default and at the same time, in the middle of winter, the boiler blows: you'll suddenly be short on cash and needing an immediate ability to pay for emergency repairs. So the reserve fund is directly linked to operations.

This is not unlike being an individual having 6+ months of income saved in case of a personal emergency or losing a job.

A well-run condo also has a capital plan, e.g., when to replace windows or a roof or upgrade the hallways. At the time of the capital outlay, the condo computes a special assessment based on the actual expenditure to pay for it. Not the reserve fund. Moreover the reserve fund shouldn't be used for future capital improvements because it is unfair to have current unit owners fund future improvements that they may not see. Instead the assessment should take place when the bills have to be paid. That said, some condos are flush enough to have significant monies in their reserve fund (more than 3 to 6 months) and these have the option of either reducing common charges or else move the extra funds into a still-conservative but longer-term investment earmarked for future capital improvements. This is a philosophical decision that should be based on how much money we're talking about, the age and condition of the building, and the socio-economic profile of the condo's population.

Keep in mind that condos, unlike coops, cannot borrow money. This is why the reserve fund needs to be adequate for sudden changes in operating circumstances. And why special assessments pay for the big stuff.

Finally, every building is unique. The OP's scenario of a 40-unit building in good physical shape, with no doormen (i.e., a small staff and thus a more modest operating budget) and no big work in the pipeline, could mean that $70,000 is indeed adequate. If I were buying in such a building and doing my due diligence the documents I'd ask for are operating budgets (at least this year and last year) and any capital improvement plans/future schedule that may have been prepared. And of course, as many audited financial statements as are available (these often include notes pertaining to capital improvement plans).

I can't speak to the Fannie Mae and FHA rules that Sunny noted except to say it suggests that these agencies finally recognize the importance of a well-funded reserve account to a condo's stability.

Very, very, helpful - thank you everyone! I really appreciate everyone's insights.