Our condo corporation passed its budget recently; we got by relatively unscathed with a small increase after several years of no increases. But for many condo owners in newer or older buildings, this may not be the case. Why do condo fees escalate, setting aside natural inflation of expenses of time, and what are the implications to the potential buyer of condos?

Condo fees is short-hand for the aggregate of maintenance and operating expenses of the common expenses such as the building exterior, lobby, meeting/party room, exercise room, insurance, security staff, superintendent. In other words, all the elements everybody shares, regardless of whether you use them or not. The total condo fee is divided among the unit-holders by square footage.

What the largest reasons why condo fees going up? There’s really two large and inter-connected reasons.

1. There are too many common element expenses. At the height of the real estate boom, one particular condo developer was known for building condos with the latest common element bells and whistles: water falls in the lobby, golf simulator room, indoor/outdoor pool. You name it, they built it. One condo along the lake actually owned a boat that it docked in the harbor (since sold from what I have been told). One problem- the more frills there are, the higher the condo fees (a condo corporation is just like government in that respect). All of this “stuff” looks great when you buy the condo, but the price to be paid is in higher condo fees which becomes a much larger headache over the years because…
2. Reserve fund shortage. A reserve fund is a fund which is intended to be accumulated for the expected repairs and replacement costs of the common elements in  a building (as opposed to normal operating expenses). The size of the reserve fund is determined by numerous assumption as to future events of the common elements as determined by engineers (for example, the roof needs to be replaced every 10 years). Many jurisdictions require a condo corporation to pay for a reserve fund and to update it periodically given chronic under-funding before legislation was enacted. All condo corporations contribute to the reserve fund every year. The issue is that as common elements age, the reserve fund contribution has to increase and the more common elements there are to maintain, the greater the reserve fund contribution.

What does this mean for you and I?

1. For the buyer of new condos: Expect a spike in condo fees in year 1-3. Condo fees are typically low when a condo corporation is first formed because, well, there’s nothing to maintain. Everything is brand new. However, as the building ages, two things tend to occur: (i) the condo corporation has to start making reserve fund contributions; and  (ii) all those great common elements were either too rich (24 hour security for a 30 unit building is simply not practical) or begin to require maintenance. All of these factors tend to drive up the cost of condo fee. In fact, it is commonly assumed that developers under-estimate condo fees to entice people to purchase new units.
2. For the buyer of old condos: Expect more and more of your condo fees to be used for the reserve fund rather than actually providing better service. As condos get older, large items need to be replaced so the reserve fund contribution tends to go up. What makes the situation worse is that, until many jurisdictions passed laws requiring reserve fund studies to be undertaken and reserve funds topped up, some condo corporation reserve funds were woefully under-funded so there’s been a catch up in contribution or a special levy made.

Condo fee are one reason that I tend not to consider condos to be ideal real estate investment. It is hard to control the expense variable in a condo (which is the only real variable you can control in any business). Expense control is taken out of the owner’s hands and into the condo board’s hands.

Since most landlords include the condo fee in the rent, increasing condo fees tends to mean less profits especially if you live in a rent control jurisdiction where you cannot simply pass on the cost of doing business to the tenant or you rent in a competitive market.

If you are buying a condo for any reason, make sure you add in a condition of sale a thorough review of the condo corporation’s financial statements. On the common element side, look to see whether there has been a year over year cost escalation which seems unusual (a spike of more than 5%) and ask why. On the reserve fund side, head to the notes to the financial statement, it should tell you what the reserve fund should be and what the expected expenditures should be. If there are large expenditures in the future and large reserve fund shortage, look out!