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A Day Late, a Dollar Short The Dangers of Underfunding

In a world where the cost of services and goods are generally rising, even in the absence of any substantive inflation, co-op and condominium boards and management are always looking for ways to hold the line on increasing monthly costs.  The question is, is the short-term benefit to owners of holding the line on monthly carrying charges ultimately detrimental to the financial health of a condominium association or co-op corporation?


Operations vs. Capital Expenses


Perhaps the best starting point is to reiterate the difference in two major categories of expenses: operations vs. capital expenses. Simply stated, operational expenses are line items such as labor, real estate taxes, energy costs, and insurance, to name some of the major ones. These are expenses incurred on a regular, recurring basis and funded through monthly common area or maintenance charges. 

By contrast, capital expenses relate to the useful life and replacement of building systems such as roofs, facades, boilers, and so forth. These expenses are budgeted for on a separate basis, and may be paid for out of reserve funds, special assessments, or a combination of the two when repairs or major improvements are necessary.  

These two do have an overlap in a category of expenses in the operations budget known as repairs and maintenance. These must be budgeted for annually as part of operations, but these repairs are smaller and more limited.  A good example would be repairing a leak from the roof as opposed to replacing the roof.


Underfunding


So what does ‘underfunding’ mean?  “It’s when a board approves a budget that won’t be sufficient to operate the building based on its historical expenses,” says Dan Wohlman, CEO of Gumley Haft, a management firm in New York.  “Candidly, some boards nickel and dime a budget to achieve a smaller annual maintenance increase.  It happens all the time.  The fact is that there are things like taxes and labor you can’t fiddle with, but with other line items, such as regular repairs and maintenance, boards will often try to lower projections of future costs.  When we create a budget, we look at both history and at what we see going on in front of us.  Some boards will dissect the numbers to try to fidget with them.  They say they won’t spend as much on intercom repairs this year and cut a grand from the budget.  Well, they may not spend it on intercom, but they may spend it on plumbing.  We try to dissuade them from this, because it will come back to haunt you.  Look at it on a big-bucket basis - not on an individual item basis.  You may not have intercom repairs this year, but you might have plumbing, or a roof, or other items.”

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