Don’t Get Thrown Under the Depreciation Report Bus
Jan 29, 2015
Council Members & Strata Managers Should Provide Specific Instructions to the Reserve Planner
When engaging a reserve planner to prepare a Depreciation Report or Reserve Study, or even to prepare a quotation, the strata manager or council if self-managed, should provide specific instructions as to what information the report should, and should not contain.
In a recent Condo Smarts article Tony Gioventu stated:
“There are a few terms and conditions we are seeing in depreciation reports that are not consistent with BC Legislation that specifically relate to funding models. Strata corporations do not have to pick one of the funding models. The models are simply examples of the different levels of funding and how they impact the future funding needs of the strata owners. The funding is approved each year as part of the annual budget by majority vote of the owners. The term, ‘underfunded’ is not a legislative requirement and does not apply to strata corporations in BC.
There is no minimum funding requirement and strata corporations may choose to either contribute to the contingency for future expenses, approve special levies or some model that includes both options. This does not imply that a strata corporation is appropriately funded in any capacity. That decision is left to each strata corporation to consider as part of their annual planning.”
There is no provision in the Strata Property Act for the “qualified person” providing the Depreciation Report to rate the adequacy of the reserve fund. The purpose of the report is aid council in their long range planning. The purpose of the report is not to rate the adequacy of the current balance or any future balance for that matter. If the Strata Act does not require an opinion of adequacy, why would you want one in the Depreciation Report?
Many reserve planners use component funding methods of calculating percent funded ratings of the current and future reserve balance. This analysis, for the majority of strata properties, will likely indicate that the current reserve balance is less than 100% funded and, as such, will be rated by the planner as being “under-funded” or “deficient” when in fact the funding plan provides sufficient funds when required.
C.H.O.A. warns that the inclusion of these terms in a depreciation report, which if it diminishes the valuation or assessment of the property in any way, may result in the planner being sued.
The planner may not be the only defendant. Inevitably a sale will collapse due to derogatory terms found in the Depreciation Report and may even be used as a final attempt to collapse the transaction. Many questions will likely arise.
The component funding method attempts ensures that the accumulation of funds makes up for accumulated depreciation with little much focus on the cash flow. The analysis centers around the past instead of the future. This method also ignores the effects of the pooling of funds and instead segregates them into imaginary accounts.
I recently read a depreciation report that suggested the result of the Benchmark Analysis provides an estimate of how much cash should be in the contingency reserve fund. Further that the recommended level of funding closely matches the contingency reserve requirements under the Strata Act, if the present level of contribution is increased over the next few years. This type of statement is completely false and misleading.
Tony Gioventu, CHOA says “It isn’t up to the planner to provide any analysis of the adequacy of funding, and it simply confuses the consumer”.
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Sauder School of Business in its Fundamentals of Reserve Fund Planning course material state that “In some cases, a deficiency analysis creates more questions than benefits – the deficiency analysis is an optional item at the discretion of the reserve planner”.
The International Capital Budgeting Institute in its Generally Accepted Reserve Study Standards states that “The component method should be avoided”.
The Ontario Condominium Act specifically states that the contributions to the reserve fund be calculated on a cash flow basis. The Strata Property Act B.C. requires that the qualified person completing the depreciation report provide at least three “cash flow funding models”. There is no mention in any condominium Act in Canada specifying a component funding or percent funding analysis.
Strata council should be involved in the creation of the funding plans as the reserve planner has been engaged to assist them at the expense of the owners. The funding plans are to be presented to the owners at the AGM. The more involvement council has in the creation of the plans increases the likelihood that one of the three plans will be ratified by the owners. There is little value in a funding plan which has not been accepted by the owners and is not being followed. The reserve planner should provide three funding plans which closely resemble the likely outcome of future events and council should be satisfied that they are prepared to follow the plans as approved.
Under-funding is costly, over-funding is illegal.
The strata corporation is not legally empowered to collect more funds than that which are “needed”. The most accurate way to determine the amount of funding required is to analyze the cash flow in the future. Regular contributions go in, interest is earned and expenditures are funded. Observing the ending balance each year and ensuring the reserve is never fully depleted over the long term is sufficient. Setting a threshold minimum balance can provide a contingency to the reserve for any unplanned expenditures.
The objective of council is to establish a funding plan which provides sufficient funds for the repair and replacement of the assets for which the corporation is responsible, through the lowest level of contribution possible. The contributions should be fair to current and future owners. Contributions should be regular and stable, increasing steadily as to keep pace with inflation. There is a fine balance between maintaining the property and maintaining affordability.
The Strata Manager and Strata Council should take great care when instructing a reserve planner to complete a depreciation report. The report should contain all information required by the Strata Property Act. Any additional analysis and/or conclusions should not be included unless approved by council.
The most effective way to protect the consumer is through knowledge and accurate reporting, not confusion. ARPC’s goal is to standardize the format and performance of reserve studies in Canada. All members are required to comply with ARPC Generally Accepted Reserve Study Principles and Standards including quality assurance of the calculations meeting the ARPC software requirements which comply with ICBI Software Standard. ARPC has endorsed RFA Pro, Reserve Fund Analysis software as meeting and exceeding those standards. RFA Pro has been independently audited by a national accounting firm for accuracy.
ARPC members are required to comply with standards aimed at the protection of the condominium owner and other consumer of the reserve fund planner’s services. Complete transparency.
Brian A. Hill B.Comm., DRP, DAR
