Low maintenance reserve - what are the consequences

The building is a ticking time bomb. Anything can happen -- the roof could go, a steam pipe could burst, etc. -- and all of a sudden the building is facing a $40,000 bill that of course will have to come directly from the shareholders via an assessment.

Some co-ops and condo associations like to keep a low reserve, leaving it to owners to always be ready for an assessment. Others like to do the owners' saving for them, by accumulating a reserve. Don't know that it makes much difference, as it all comes from the owners in the end anyway. A reserve does give a board a lot more flexibility in responding to crises.

Since this is a condo, the board could always borrow to whatever limit they're allowed (I see $500K a lot) but that takes time.

Fannie/Freddie lending standards require that Condo budget contains a line item allocating ten percent (10%) of annual revenues for the association’s reserves. I have not seen any other standards talked about from the lenders, otherwise I agree with NWT.

How much maintenance is "too little"?

For example, I saw a coop with $2 million in reserve fund for a $500 million building - that's only 0.4% of reserve for the value of the building. Is that too little?

I don't think looking at reserves vs "the value of the building" is a valid methodology. First, I'm not sure where you come up with the value of the building. Second, if you have 2 pretty much equzl buildings size and vintage wize, but one is worth $500 million because it's a know address on Park Ave and teh other is worths $90 million because it's a "nothing" building in an off location, would you think the reserve funds should be 80% different?

But there is also an advantage to buildings which don't accumulate reserves but assess instead: capital assessments ad to your basis in the unit, excess common charges/maintenance does not. So if you exceed your exemption when you go to sell, you get a tax savings in teh "assessment" buildings which you don't get in the "reserve fund" buildings.

Can a building keep a reserve fund, but if a big capital expenditure arises, distribute out the cash and immediately call it back as an assessment? That way the board and shareholders get the comfort of knowing the cash will always be available, but the shareholders get the tax benefit of paying an assessment instead of extra maintenance.

I presume there's some kind of accounting or tax rule that would prohibit this, but it strikes me as a "best of both worlds" approach.

I'm not positive about Condos, but I'm pretty sure that Coops can't (or at least coun't) make distributions to shareholders. i think I know where you are getting th idea from, which is what most buildings do with the tax rebates, but I'd bet if this was done in this case, the IRS would not look kindly on it.

I've heard the $2m reserve/$500m building value from the broker. Given tony address and over 500K square feet of residential and commercial space, ballpark $500m building value seemed reasonable @ under $900 per SF. I don't know if $2m reserve is true. (Is there a way to check building financials without making an offer?)

Question is, what is a valid methodology for evaluating reserves and financial health of the building? Is it reserves per apartment? Per building SF? Something else?

When discussing this issue with my attorney they told me they look for reserves of at least 25% of the mortgage on the building - not sure how they came up with that

"When discussing this issue with my attorney they told me they look for reserves of at least 25% of the mortgage on the building - not sure how they came up with that"

I'm sorry, but that is totally ludicrous. Again, take 2 identical buildings: 100 units, 10 floors, average unit 1,000 sf. First building has a $112,122.06 underlying (they are an older Coop with a 30 year self liquidating underlying). Same building next door went Coop MUCH later and has $3,000,000 underlying. So the first building only need a $30,000 reserve fund and the second a $750,000 reserve fund? I think not.

One reason that the condo might have had a non-existent reserve fund ( if it was new ) is that all new construction starts with zero in the fund. The fund is built up by new buyers who are required to pay into the fund when they close on the unit. If there are only a few closings in the building, then you are looking at a low reserve fund. Yet another risk of buying in a poorly sold building.

30yrs_RE_20_in_REO, can you please explain what you mean about the exemption when you go to sale -

"But there is also an advantage to buildings which don't accumulate reserves but assess instead: capital assessments ad to your basis in the unit, excess common charges/maintenance does not. So if you exceed your exemption when you go to sell, you get a tax savings in teh "assessment" buildings which you don't get in the "reserve fund" buildings.?

Let's say you pay $500K for a co-op, and your share of the underlying mortgage is $50K. At the same time the co-op refinances into an amortizing mortgage, payable over ten years. At the end of the ten years you'll have paid your share, the $50K. If you then sell for $600K, your basis is $550K rather than $500K, so your capital gain is $50K rather than $100K.

At the end of each of those ten years, the co-op's accountant's tax letter will tell you how much per share went to mortgage interest and RE taxes, and will also specify how much per share was "capital contribution to reduce your basis."

Not sure what the financials at your building looks like, but most people look too deep into these things. Always look at the reserve fund on the balance sheet, not the cash. (Sometimes under CD's or long-term investments. Check if FDIC insured) 200 unit buildings with 2mill in reserves could be insufficient, but at the same time, 20 unit buildings with $20K in reserves could be very sufficient. It all depends on how well the building is managed, and what future major capital improvements need to be performed.

VERY important to also look at the EBITDA (Earnings before interest, taxes, depreciation, and amortization) or two years on the building's income statement. (this can be obtained by the managing agent, or the listing broker should already have them at hand) If both years are positive, the building is in great shape. If on year is negative and the other year is positive, then look at the individual line items of expenses and determine what caused the deficit in a particular year. (oftentimes in well managed buildings, these tend to be from an unexpected rise in FUEL/OIL prices, taxes, or repairs)

If both years are negative, assess if they are large deficits, the amount in reserve that can absorb these deficits, and if there are future events that will turn the financials positive?

Also be on the lookout for any pending major capital improvements, and maintenance/common charges increases.

All that being said, like many fortune 5's have plenty of defects, there are no such existence as a perfect building. There will always be a million reasons why not to go forth on a particular unit based on the buildings financials.

Good luck!

But is a capital gains tax payable on the sale of a primary residence?