So… would you buy a classic used Caddy if you knew there was a 50/50 chance you’d be on the hook to replace the engine? Similarly, and close to home, despite our Association Treasurer now hawking “we’ve got a million in the bank and no debt,” would you buy a used condominium at risk of a Special Assessment? Probably not. Begs the question: So how is it that with a million bucks in the bank, we’re at risk of a special? But we are.
So where are we now
Think of 111 East Chestnut Condominium Association as a fully-loaded ‘72 Coupe Deville 4-Door Hardtop. She’s got a couple hundred thousand miles on her. She’s had a lot of work done. She’s in pretty good shape but keepin’ her roadworthy has taken, and is gonna take, a pretty fat wallet.
In 2017, the Association sponsored a Reserve Study that plots out total repair and replacement through 2046. And that’s where we see what it’s gonna take to keep this ole classic beater on the road. Our reserves are presently only about 5.3% funded (analysis here). And after the imminent building-wide concrete repair project is paid and reserves reconciled, we’re probably back at near zero, i.e. busted and back livin’ on a credit card.
Understanding the Risk
So we are clear, it’s not definite that we’re gonna have a special. This discussion is all about risk. And sure, you can run with scissors all day long, no problem. The point about risk is the degree to which one is exposed to harm or loss. It might not happen. Then again, it might. Or, it might very well be more than likely.
According to Chicago area CPA and Condo finances expert Michael Novak:
“As a general rule, Associations under 30% funded have a risk of special assessments and deferred maintenance and their Reserve Fund is considered ‘weak.’ At the ‘strong’ end of the funding spectrum, special assessments and deferred maintenance are rare at Associations with Reserves that are at 70% funded or above. In-between represents a ‘fair’ Reserve Fund status.”
Robert Nordlund, PE, RS of Association Reserves, Inc. is aligned with Novak’s assessment. According to Norlund, there are two reasons why % funded is so important:
“The first reason goes back to that Treasurer acquaintance who’s preparing to address the homeowners at the upcoming annual meeting. He knows the amount of the Reserve Fund is ½ a million dollars and he’s ready to publicly pat the Board on the back for having so much money set aside. But does he really know if the Reserve Fund has ‘kept pace’ with the actual common area deterioration? Can he assure the homeowners that the Association is in a position to perform timely repairs & replacements? Is he prepared to have prospective buyers rely on his personal assessment of the situation to make an informed purchase decision? Reserves ‘% Funded’ is the only meaningful, independent, and reliable measure.
The second reason Reserves ‘% Funded’ is so important is that it can be a reliable predictor of the likelihood of special assessments.”
Bottom line: We’re in the danger zone. We presently have about a 50/50 chance of a special. It’s a coin-toss.
But wait, it gets worse. Novak said:
“The 2017 Reserve Study by Reserve Advisors, Inc. recommended a $658K, or 18.74%, increase in assessments due to reserve funding. But in order to avoid assessment increase shock, they recommended that it be phased in over the next seven years 2018-2024. At the end of the 7-year phase-in, the minimum recommended annual reserve contribution is $1.608MM as compared to annual ‘wear and tear’ of $646,498.768 in 2024 dollars. The extra $961,501.23 per year, which is 1.49x the ‘2024 annual wear and tear’, is due to the Association’s failure to maintain intergenerational equity. That is, current unit owners have been left holding the bag. Because your Association kicked the can down the road as it applies to funding reserves, the current/future owners are the ones that are/will pay for it.”
To date, contrary to their fiduciary duty, the Board has ignored Reserve Advisors’ advice.
But is that unusual? According to Association Reserves Inc., some “70% of association-governed communities are under-funded by 70% or more.” But where 111 East Chestnut Condo sets itself apart, we are more than 95% underfunded. Ironically, among the highest-risk condominiums, we excel.
Like pensions, under-funding comes with consequences. The cost of borrowing is more. The value of our investment in our homes is less. Like under-funding pension plans, it can amount to a death spiral. Like Illinois’ budget crisis, we are mortgaging the future on the backs of the next generation. Someone’s gonna pay.
“Prudent,” Not So Much
As discussed many times here, “prudent” is at the core legal measure of a board member’s fiduciary responsibilities. And “prudent” is “acting with, or showing care and thought for, the future.”
That said, again the board has ignored Reserve Advisors. And as to plans for rectifying our exposure, there are none. Both Treasurer Carolann Randall and Board President Jane Santogrossi were asked to comment here. As of this posting, neither responded. And as the Buddhism monk might say, silence isn’t the volume turned down; it’s the volume turned full up.
So hey, wanna buy a ‘72 Caddy? Or, as the ad for it at Jane’s Used Cars reads, “Vision transforms into reality when you choose the luxury, comfort, and security that beckon you.” Good grief, what nonsense. Fact is simply this: 111 East Chestnut Condo is an okay ride. That is, if/when: she’s not in the shop; and you don’t care where you’re going.
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EDITOR’S NOTE: And Milazzo’s got his Unit for sale. Coincidence?