Preparing to Repair – Year by Year

The board of the Riverwalk Court condo on Roosevelt Island was concerned about its building’s health. It was 2013, and the property, relatively new construction, had just switched from sponsor to owner control. It was now confronted with the age-old question of buildings young and old: what is the physical and financial state of our condominium and what should we do about it? That’s when the board took a different approach from most in New York – and commissioned a reserve study.

Never heard of a reserve study? You’re not alone. Although it is frequently used by condominiums in several states, the study is generally unknown to Big Apple residents, who typically rely on engineering reports to warn them about potential problems.

Let’s be clear: an engineering report is not a reserve study. The latter is a similar – but different – budget planning tool that combines a physical and financial analysis of your building. Those who promote it, and those who have used it, say that it can help plan for future repairs, predicting how much to save for capital improvements.

Why Do One?

Every building eventually needs to pay for capital repairs. Roofs age, boilers break, and façades need pointing. But no board has a crystal ball that can predict when these things will happen and how much they will cost. Unlike co-ops that can raise large sums by refinancing an underlying mortgage or taking out a line of credit, condos have fewer choices to fill their reserves. Added to that, lenders require condos to save 10 percent of their annual income for capital expenditures, unless a reserve study can show that they need to save less.

So a condo faces a conundrum: if a board saves too much, carrying costs are unnecessarily high, to the dismay of unit-owners. If a board doesn’t save enough, it might face the dreaded “A” word: assessment. Residents loathe assessments because they inflict a sudden financial hit and turn off potential buyers.

One way for a building to know what problems might lie ahead and to save adequately for them is commissioning a reserve study. It involves a complete inventory of every common area component and projects repair expenses, then analyzes the current reserve fund and funding plan, and, finally, makes an alternative recommended reserve funding plan and projection.

At Riverwalk, engineers from Kipcon Engineering took samples of the common area components, inspecting them for signs of wear. Using that information, and the original design plans and repair history of the building, the company delivered a detailed report with an item-by-item, year-by-year financial plan to cover the next 30 years of building upkeep.

“I’d rather not play ostrich,” explains Howard Hillstrom, a board member at the Riverwalk. “If there’s a crack in the basement, I don’t want to wait until it floods [to deal with it].”

Engineering vs. Reserve

Reserve studies might be unfamiliar to many in New York, but engineering reports are not. How similar are the two? In both cases, a board will hire a professional. He or she inspects the building, points out problems that need to be addressed, and provides a timeline for the work involved. That’s where the similarities end. A comparison of a sample engineering report and a sample reserve study from two unrelated projects reveals significant differences in approach.

The engineering report reviewed by Habitat offers a spreadsheet listing various components of the building, including the roof, exterior walls, and interior common areas. Over a period of 15 years, the report projected which elements would need to be repaired, how much the repairs would cost, and in what year the repairs should probably be done.

For example, it anticipated that skylights would eventually need to be refurbished, a $4,800 task that would be scheduled to take place in two years. But for most capital projects, such as a $157,500 roof replacement, the report didn’t provide a timeline, nor did it provide guidance on how much to save each year for the looming expenses.

The reserve study (see page 31) presented the findings in a different way. This included an “executive summary,” laying out a 30-year picture of the building and the repairs it would eventually face. It recommended that the building reduce its annual contribution to its reserve fund by about $30,000. The study looked at every component of the building, projecting not only how much it would cost to repair a concrete sidewalk, for example, but also when those repairs would probably happen. For each item, the report broke down the total life (30 years for the sidewalks) and how much life was left (12 years).

The study also provided cash-flow charts and graphs that estimated which years would be the costliest. In short, it made a specific recommendation for how much money the building should build into its reserves, as well as backed that recommendation up with detailed suggestions for what repairs would happen, when they would happen, and how much they would cost.

For example, the reserve study projected that the community would not have to spend much of its capital reserves at all between 2013 and 2018, but 2019 would be one of the costliest years because of a looming pool resurfacing project. So, it showed the building how much to save each year in anticipation of projects like that one on the horizon.

In Riverwalk’s case, which was not the building in either of the two sample reports discussed above, its reserve study “gave us concrete goals about how much we should salt away,” says Hillstrom. “We don’t want to under-capitalize and have an assessment. The reserve gave us some pointers on what to expect in the next 10, 15, 20 years.”

However, because such studies don’t take inflation or fluctuating interest rates into account, they should be updated periodically (lenders require them to be updated every two years). Their costs depend on the size of the building, says Mitch Frumkin, founder of Kipcon Engineering, but for a large high-rise, the price can range from $7,000 to $15,000.

Ten Percent Every Year

In the wake of the housing crisis of 2008, mortgage giants Fannie Mae and Freddie Mac tightened lending rules. Among the stringent new requirements is one that requires condos to set aside 10 percent of their income every year for capital improvements. The only way to avoid that is to conduct a reserve study that can demonstrate that the building doesn’t need to save so much. (Co-ops are not included in the lending requirement; they avoid the attention of the mortgage giants because, although they are in the majority in New York, they do not exist in large numbers nationwide.)

For some buildings, 10 percent can be a great deal of money. “Ten percent is sometimes overkill,” says Orest Tomaselli, CEO of Strategic Inspections, which provides reserve studies for condominiums around the country. “The most accurate way to show the agencies that ten percent is too much is to do the study.”

Reaching that benchmark can be difficult. For several years, a condo on West 58th Street implemented an assessment on its owners to meet the 10 percent requirement. Finally, the board decided to do a reserve study, which showed that the building had enough money in its coffers to cover three years of capital improvements. To the relief of residents, they were able to stop the endless assessment.

“From a lending standpoint, banks will look at that study and those numbers,” says Justin Verret, a property manager at Blue Woods Management Group, which managed the Midtown Manhattan condo at the time.

And at another Manhattan building, the board struggled to set aside a whopping $500,000 every year – 10 percent of the $5 million income it collected. As new construction, it was unlikely that the condominium would actually need that much cash for capital improvements.

“There was no way that a new construction building was [going to be] able to save that much money,” says Rebecca Farley, a property manager with Douglas Elliman Property Management. “So they could never be one of those buildings that get the Fannie Mae loans.” Ultimately, the development commissioned a reserve study, allowing it to put considerably less money away each year.

In fact, many new developments decide to conduct reserve studies when they finish construction to meet the Fannie Mae and Freddie Mac lending guidelines. After all, a new building isn’t going to need much work done, so it would make sense to use that 10 percent of the annual income for other things. “They know there is not going to be an issue for years. Everything is brand-new,” says Daniel Shlufman, mortgage banker at Classic Mortgage. “They could have lower common charges, or they could use the money for other things.”

However, for condos aimed at moderate-income buyers who will need a mortgage, the building’s financials should satisfy the Fannie and Freddie rules. If not, sellers in the building could watch as potential buyers fail to qualify for mortgages, with devastating consequences for apartment values. Even existing unit-owners could face problems if they want to refinance their mortgage or take out a home equity loan. So these condos need to either meet that 10 percent requirement or conduct a reserve study.

Sour Views

Reserve studies might be rare in New York, but 30 states, including California, Florida, and Washington, require them by law. They’re usually intended to disclose the real condition of the building to residents. “My firm has been doing reserve studies nationwide for 30 years, and Manhattan is the only place that doesn’t do them,” says Frumkin.

One reason is that New York City has long been predominantly a co-op town. Until recently, condos were rare. But the city is changing and although the vast majority of residential developments are still co-ops, most conversions and new developments are condos. Although many condominiums appeal to the all-cash luxury buyer, others do not. And, in order to stay competitive in a booming housing market, they need to be Fannie Mae-compliant.

“It’s important, you want a finance-able building,” says Melissa L. Cohn, an executive vice president at Guaranteed Rate, a mortgage bank. “If you look on Streeteasy or ACRIS, and the building hasn’t gotten any mortgages in three years, limited lenders would offer financing.”

Downsides of Knowledge

But reserve studies have their risks. While the goal of a study is to prove that a building is saving too much, it could find the opposite. A study could point out that the boiler is beyond its natural life, even if it’s working just fine. It could also shine a light on unwanted news that 10 percent is not nearly enough money. In other words, knowledge isn’t always golden.

A study of an old building could show that the roof is old, the windows are drafty, and the plumbing dates back to the 19th century. Perhaps the building already knew these things, but now the bank knows them too and might be wary to lend. “It can backfire, certainly,” says Farley, of Douglas Elliman. (So long as a reserve study is still a draft, the board doesn’t need to show it to residents or lenders, but it could create problems, nevertheless.)

A study could also expose a building to liability. If it shows that a water tank is in desperate need of repair and an injury subsequently occurs because of the aging tank, the study can be used as evidence that the building was negligent. “If you’re being accused of negligence, it has to be that you failed to take action when you had knowledge that action was required and a reasonable person would have taken action,” says attorney David Berkey, a partner at Gallet Dreyer & Berkey.

Who Needs It?

A reserve study makes a lot of sense for a condo that is struggling to set aside 10 percent of its annual income for capital improvements. It’s also good idea for a condo that thinks 10 percent is too much.

But it can be a good tool for other buildings as well – even co-ops. Supporters say it doesn’t just help with budget planning; it attracts buyers. Through both the extra financing capability and the security of knowing the condition of the building, smart buyers will be attracted to a building that’s done a reserve study.

Reserve studies are good for any board that wants a road map for the future. It makes it easier to justify spending a huge sum on a capital improvement project if other owners understand that the next big-ticket item is a decade away.

Riverwalk Court saw the reserve study as a tool to help the board plan its budget and consider its long-term needs. It also provided the community with peace of mind: they knew what they were in for down the line.

“I can see how a study would appease lender concerns, but that wasn’t our primary goal,” says Hillstrom, of Riverwalk Court. “We were just looking out for what was best for the building.”