Why Cash Reserves Can Be Misleading

At least in Minnesota, anyone buying a property in a Common Interest Community (“CIC”) — typically, a condo or townhome — has 10 days after completing the Purchase Agreement to review the related Association documents.

doc reviewWhat should Buyers be on the lookout for?

Not the Association’s pet policy — that’s something that Sellers should disclose and Buyers should confirm much earlier in the process (though the Association’s pet policy may sound innocuous, it’s easily in the top 3 “deal killers” for CIC properties).

And it’s not simply how much money the Association has in the bank; I’d rather buy something in a 100-unit complex with $100,000 on hand that was in terrific physical condition than a same-sized complex that had $1 million — but was facing $3 million in imminent capital repairs and/or improvements.

Or was embroiled in a multi-million dollar lawsuit regarding defective stucco (true of at least 3(!) Twin Cities projects I’m aware of in recent years).

In order, as a veteran Realtor (and former attorney and CPA), here’s what I think is most important:

1. Physical condition of property;
2. Financial strength of owners;
3. Association liabilities (current and potential);
4. Potentially uncollectible Association receivables;
5. Cash reserves.

Deep or Shallow Pockets

The catch with the above list, of course, is that the two most important items can be hard to verify.

Assuming that the property isn’t a New York co-op — where apparently everyone knows everything about everyone, and huge down payments (if not all-cash purchases) are de rigueur — exactly how are prospective Buyers supposed to determine the financial strength of their fellow owners?

The short answer:  with difficulty.

Assuming the building registry doesn’t list any “Dayton’s” or “MacMillan’s” (the founding family of Cargill), about all you have to go on is what percentage of the complex’s units are non-owner occupied.

While investors can be fine, upstanding people, as opposed to owner-occupants, they generally have less commitment to a property when the going gets rough.

Which is why so many buildings with a surfeit of investors were plagued by high foreclosure rates after the housing market dived beginning in 2006.

Which leaves the remaining owners holding the bag, in varying degrees — see “#4. Potentially uncollectible Association receivables” (note:  Minnesota law actually changed a few years ago, to give Associations more leverage to collect delinquent dues from bank-owners that had foreclosed on units).*

Inspecting . . . Air Space?

The other challenge is to determine the condition of the overall building or complex.

While condo and townhome buyers should always have a professional inspection done (my opinion), in general, the scope of the inspection is limited to what’s within the four walls of the unit** — things like plumbing, wiring, and HVAC (if the units have separate a/c and heat).

What does that leave out?

Just the big stuff, like the building’s roof, exterior and HVAC (note:  sometimes windows are the individual owner’s responsibility . . . sometimes the Association’s).

Which is why prospective Buyers are (very) smart to inquire about the age and condition of those things — and to scrutinize recent Association minutes for any discussion of same.

In general, well-managed Associations will have capital reserves that rise as the age of such items increase (and their remaining useful life dwindles).

In addition, many larger Associations now rely on outside consultants to determine the appropriate amount of reserves.

*Buildings with commercial tenants can also have problems with uncollectible receivables.

**Legally, what condo Buyers are buying is air space — specifically, the space inside their unit’s walls.

About the author

Ross Kaplan has 19+ years experience selling real estate all over the Twin Cities. He is also a 12-time consecutive "Super Real Estate Agent," as determined by Mpls. - St. Paul Magazine and Twin Cities Business Magazine. Prior to becoming a Realtor, Ross was an attorney (corporate law), CPA, and entrepreneur. He holds an economics degree from Stanford.

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