Don’t fall for sophistry

One of our clients is, unfortunately, facing a special assessment. 15 years of accumulated damage must finally be addressed. At a cost of $5,000,000 for the complex of 200 units. And before you ask, no, the reserves are woefully inadequate as past boards did not want to increase the dues because everyone is too poor to pay.

So, against the advice of multiple experts, the board is crafting a new plan. They want to have a contractor perform “Targeted” repairs. The contractor has estimated about $2,000,000 for this work.

This is not the only cost of the targeted approach though. The siding and windows are both 25 years old. The siding may have another 15 years left before it should probably be replaced and the windows are at the end of their serviceable life and we are seeing 3-7 window failures per year now. Because of this, the reserve study specialist indicates that the reserve component for future repairs, replacements, and maintenance needs to increase from $180 per unit monthly today to $350 per unit monthly.

In addition, because the current windows and siding are being re-hung, there is a recommendation that the units pay an additional $10 monthly towards operating repairs and maintenance.

The upside of the full reconstruction project is that the reserve specialist believes that the reserve assessment portion of the dues can decrease to $150 per unit monthly and the operating maintenance portion of the dues can drop by $5 to $115.

Naturally, everyone believes that the targeted approach saves money. Not that the financial impact of the project should be the only consideration, but sadly it is first, second, third, and fourth and the list of top five matters related to a special assessment. So, understanding that the money is paramount, how can members know which works out best for them?

We use a discounted cash flow model using the PV function in Excel. In this case, we know the cost for the full reconstruction and we eliminate the possible savings just to show we are not trying to make the numbers work in favor of the option. The main focus is on the impact of the cash flows for the targeted approach.

The PV function requires an interest rate, a number of years (months) and either the future value or the payment street in today’s dollars. The Excel function is =PV(rate,term,payment). For this analysis, lets use a highly aggressive 3.0% rate of return and a 15 year (180 month) term. The payment is the increase of $170. We are ignoring the $10 increase for operating maintenance for the analysis.

Thus the formula in Excel is =PV(.03/12,15*12,-170) This calculates out to a present value, or the value of that payment stream in today’s dollars, of $4,923,000. The additional reserve assessments alone are worth as much as the full reconstruction project! When you add in the $2,000,000 to be paid to the contractor, it is almost a $7,000,000 investment.

By focusing on what you want to see instead of what is really facing you, you could end up paying almost $2,000,000 more to get the work done. How is this in your financial best interest? A $2,000,000 targeted approach also has so many variables and potentials for massive cost increases as to make it an impossible target to hit. This targeted approach will likely balloon out of control and the owners have not assessed sufficient amounts to cover those costs that a 2nd, and possibly 3rd special assessment will come. No one benefits from this approach.

So, if you are facing a special assessment, do the math. Open up Excel (or your favorite spreadsheet program) and plug in the present value formula and see for yourself if the cheap route is remotely in your best interest. If it works out that it is, then you can consider the other potential costs. But, if it is more expensive right up front, then why would you think this approach could save you money in the long-run?

C.O.R.E. Services is dedicated to helping condominium projects by providing strong, effective operational, accounting and financial management. If you have questions or would like to discuss how C.O.R.E. can be of service to your association, feel free to email us and we will gladly give you our thoughts.

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