 Well, happy holidays and thank you for tuning in to another episode of Kondo Insider Hawaii's show about association living. Well today is December 7th and we all know that is Pearl Harbor Day, the day that we'll live in infamy. So I'd at least like to take a second as we start the show to thank all of our veterans and servicemen for all they do to protect our values and our way of life here in the United States of America and Hawaii. It's certainly appreciated by all of us and happy holidays to you and your family. Today we're going to talk about reserves and there's been a lot of comments about that recently because of all the surprises and things coming out today with potential sprinkling and cast iron pipes. So I've asked a very, very dear friend of mine, Kim Becker to join us today, who is a reserve specialist and has been doing this a long time and I would say probably noteably remember for having the best person to train you on the entire planet. Welcome to the show and elaborate on that. Thank you Richard. Yes and thank you for training me to be a reserve specialist the past five plus years. So who do you work for and what do you do? I'm a reserve specialist and also manage a few community associations for Associate Hawaii and I'm actually just recently became in charge of the reserve study division. I got my reserve specialist designation a couple years ago and we're putting together a great program at Associate. Let me ask you this question. We're going to talk about some more complicated issues but just for our viewing audience, let's just review what is a reserve study? Reserve study is a capital improvement budget so it's a long-term planning rather than the operating budget would be for monthly and yearly expenditures. Reserve budget is for long-term future expenditures for large items such as roofs and painting, railing replacements, elevators, large components. Now is this something that's optional? They don't have to do that at the association or? Actually in Hawaii the state law requires boards to have this to do this annually as part of their budget process. So it's not like you do it once and you never have to do it again. You say annually it makes me believe that it's a living document for lack of a better word. Yes, yes it is updated annually, depends on what they've done the prior year. You update it, you update their beginning balance on how much savings they have toward their reserve contributions, so yes, the living document. Well a lot of people I hear sometimes say there's a level one, level two, level three reserve study which kind of sends a signal to me that there's different types of reserve studies. Yes. What are either level one, two, and three and what's the difference? There are, there are three levels, level one being the most comprehensive. Level one would include a site visit, it's basically a reserve study from scratch. So you look through the governing documents, you perform a site visit, identify all of the common elements, you look at their condition and evaluate their remaining useful life, what the replacement cost will be for them and then you come together with a budgeting plan for their reserve contribution so that they can fund for these projects in the future. So technically I mean you're supposed to identify all the components over a thousand dollars under Hawaii law, you're supposed to estimate the remaining life of those components, what it's going to cost when you have to replace them and you've got to figure out, well I'm making contributions so I'll make interest or interest income on that money but then there'll be inflation on the components. Right, so that kind of balances the inflation. Is this science? Is this something that, I mean, I mean how do you know it's going to last four more years versus five or six or two or three? Well there are, so we do refer to third party vendors who are third party professionals for roofers, for roofing, things like that. There are also industry standards for the useful life of certain components so we do refer to those documents and we use a lot of different tools and techniques to come up with those numbers. But still a forecaster, I hate to say guess, it's an educated guess, right, right. So it's a budgeting tool for lack of a better word. Sure, I mean you could put pipes in there and all of a sudden with the weather or, you know, Hawaii has a lot of salt air, different things affect the components differently. I've had railings fail ten years sooner than they were anticipated to fail because of the salt air, you know, in Waikiki. I've had buildings where they were painted that one side of the building deteriorated, the other three sides didn't because of its facing the wind or the water, whatever, and so they would paint one side more often than the whole building because of that exact varying circumstance. Right, right. And we also have heard in the law, you have this plan where you calculate how much money you should put in the reserves and we hear these that the law has two basic types, percent funded and cash flow. Right, the law does require them to fund it one of two ways, the percent funded, which is a minimum of 50 percent funded and or they can use cash flow, which I know cash flow funds for 100 percent of the cost of the component. So you have painting due in ten years for $100,000, at that time you will have the full $100,000 to use toward that expenditure. Well correct me if I'm wrong, but I would warn you I haven't been wrong since 1977. All right. So let me see if I can accurately describe the percent funded and cash flow. In a way we have accrual and cash accounting. Yes. And the way it's calculated and accounting is different. Under percent funded and cash flow in a reserve study the way it's calculated is different. Yes. So percent funded is typically a single year plan where you're looking at the amount of money you have in the bank versus the amount of money you should have in the bank of that period of time and if you have 50 percent of what you need you're 50 percent funded and if you have 60 percent or 60 percent funded it's a single year study. It really doesn't give you a future look at what's required or what your funding level is. Where cash flow funding by law is a 20 year forecast where you're looking out every year for 20 years recycling components but you're treating the money more as a pool of money versus percent funded you calculate each component separately. So it's very very different in the calculation but that's basically the difference but the law says you have to disclose which one you're using. Right. And typically when we do reserve studies at Associa we do use the cash flow current assessment funding method and that allows for boards to fund for all of their projects and have all of the necessary money required to do them at the time that they're done that way they can avoid special assessments or loans barring any unforeseen issues. And the good news because it's very hard in the 28 minute show to really explain this but you and I in March of 2018 are doing a Douglas trade show seminar on all about reserves and what this means and so we would want to invite everybody watching to come to our trade show the Douglas trade show in March and we can really explain the percent funded versus the cash flow then we can give them our 500 question test and see how well they can do. I will forget the test you know we don't want to do that but I guess essentially we can say that what I find interesting is the administrative rules which supports the law in Hawaii is very specific on your responsibilities of calculation. So boards can't simply just throw it into an Excel spreadsheet and not think it through more carefully without potentially exposing themselves to some criticism from owners or liability under the statute. Yeah they need to be thorough and do their fiduciary duty. So moving along on this issue let's just review what I said earlier so how often do we do a reserve study is that association. Annually. Annually once a year do they have to hire a professional like you and I or can. The state law does not require them to hire a professional. They can opt to do it themselves. And what are the pros and cons. There's some liability and risk if they omit certain components or fail to fund it properly and not confer with a reserve specialist. Well I think that's true and I think obviously as a volunteer if you're a very small association with very few components it may not present much risk. The real risk is that you don't do it correctly. You're going to end up with a loan or a special assessment and a big surprise down the road and maybe the homeowners will be upset about that. Yeah homeowners do not like special assessments. You know it's funny because the digress in this for a moment at the last legislature there was a resolution that I don't think a pass but it may have by our legislature requiring the governor to do quote in different words a reserve study on all the buildings owned by the state and the state of Hawaii. Oh I hadn't heard that. And considering all the deferred maintenance and come back to report the legislature about the condition of their assets to these buildings. Wow. And you know. That would be a big undertaking. And I'm not so sure anybody wants to hear what the issue is. You know we talk about sixty seventy one hundred million dollars short at University of Hawaii Manoa alone on the building to take all the other components from the highways to the buildings and all the buildings they own and all the outreach centers. I think government very much like associations. We obviously would all like to have a magic wand have a thing perfect. But the reality of it is you have budget constraints you want to make sure you're still affordable for people to live there. So you'll make choices during the year that might be kicking the can down the road or maybe not fully funding something because you also have to balance the needs of the homeowners to be able to pay to live there. So I don't think it's an easy target. No it's not and some associations do do band-aid fixes to prolong the life as long as they can before they need to replace it. Sometimes that works sometimes it doesn't it definitely does kick the can down the road. Well I think the thing I'm saying lately the complaints I'm saying during the newspaper or email are these large assessments that are coming forward and they weren't anticipated they may be not in the reserve study. And it's a complex issue to be honest with you. Let's take a simple one the most common one. Wastewater pipes or sewage pipes cast iron pipes typically right. And they're starting to fail and you're starting to see assessments which are increasing in owners maintenance fees by an amount. So the increase amount is two three four hundred dollars a month. Why do you think that's happening. That's a good question. I think the cast iron seems to be failing a lot sooner than the anticipated useful life for them. And I know a lot of reserve studies in the past that were done years ago didn't even include the pipes in them. I've seen reserve studies where they're omitted or or they have a useful life of 80 to 100 years and they're failing a lot sooner than that. And so before we take a break let me just make a comment that's leading us into the second half. If you look at most of the architectural reference manuals you say what is the useful life of a cast iron pipe. It will say a hundred years. Well if you get technical within Hawaiian law you don't have to start reserving for it until it's 80 years old when you have 20 years left because the current law says when you have 20 years remaining or less you have to put in a reserve study. So you're looking at a reference manual and you're saying oh we have a hundred years but what happens if it's only lasting 50 years. You know all of a sudden you're you thought it was going to last longer but you're starting to get leaks then some expert comes in with a camera and analysis and says your pipes are failing and you're going to have catastrophic problems plus continued water claims which means insurance goes up. So it seems to me that because it's a forecast and it's not science people will make decisions and think about it this way if you said it's a hundred years and you said no I'm going to make it 50 years you've doubled mathematically how much money you have to you're only giving yourself 50 years to save the money versus a hundred years. So when you make these decisions on how long it's going to last you're affecting how much you put in the reserve study and if you're wrong you end up possibly with some unfortunate surprises out of this whole thing. Right. You agree with that. Yeah and then there'd be some concerned homeowners who are paying what they would consider double for something that they shouldn't be paying for. And the big thing to me is maybe you won't agree with this but you will. I guarantee you government's not going to come in and save the pay for their cast iron pipes. I would agree with you. They're going to make the owners pay for it. People who live there and get the benefit of it. So what we're going to do right this second we're going to take a very short break come back with Kim Becker and talk some more about the magic of dealing with reserves specifically we're going to get a little more detail about some of these surprises that are causing great stress on the maintenance fees and including discussion about some fire protection systems. So we'll be right back in a minute. Research says reading from birth accelerates the baby's brain development. And you're doing that now. This is the starting line. Posh. And this is over. You're dead. Read aloud 15 minutes. Every child. Every parent. Every day. Hi guys. It's RV Kelly. I'm your host of out of the comfort zone where I find cool people with cool solutions to problems that all of us face. Now the thing is we're really cool and I only invite really cool people. But the thing is I think you're kind of cool too. So I think you should come and watch that Thursdays at 11 a.m. here on OC 16 television with Think Tech Hawaii. I'm RV Kelly, host of out of the comfort zone and I will see you next Thursday. Welcome back to Kondo Insider. We're sitting here talking with reserve specialist Kim Becker about reserve studies. And we've learned a little bit in the first part of the show as a maybe a little tutorial what the law is with regard to reserve studies and what the basic components are. We basically have set up the budgeting tool. It's not science. But board members are charged with the responsibility annually to do a reserve study. Maybe just be an update to include in the budget how much money they should be saving towards the reserves and then be reviewing that on a regular basis to make sure that they're doing what they're supposed to do with regard to it. But what's happened in time in real time here in Hawaii is the one we've heard so much about in the press is that owners are being assessed two, three, four hundred dollars a month because their wastewater pipes have failed. And what we're learning is that when you've made the predictions, a lot of people didn't even include cast iron pipes in the reserve study because all the reference manuals said they'll last a hundred years. We're finding out they're only lasting 50 years and the state law doesn't require you to save for it until it's only got 20 years left. So some of this is a surprise to all of us, you know, with respect to that. So now you're the association and you said our systems are failing. We need ten million dollars to replace the pipes and you don't have ten million dollars in your reserve fund. What do you do beside suicide or quit or sell your home? Well, they have a couple options. They can solicit a loan. They do need homeowner approval to get a loan, but that is one way to proceed. The other way would be to special assess the homeowners and they can do that as a lump sum or they can spread it out over a period of time. But they've got to come up with the money somehow. Those are the two best options. Well, let's just take my example. You need ten million dollars. The pipes are failing. Well, if we assess the owners in a hundred unit project, ten million dollars and we need it this year to replace the pipes this year. If I'm mistaken, that's like a hundred thousand dollars an owner. Yeah, I think they would be quite upset. Yeah, I mean, I'm not sure every owner would have an extra hundred thousand dollars. No, usually homeowners will have to rework their mortgage or get a second loan to pay for the special assessment. So it is beneficial for the association to obtain a loan. And I would say something like use bitcoins. But I don't I don't have a clue what a Bitcoin is. You know, I haven't had experience with that. No, I thought you asked me about that in a Christmas party that day, thinking I know something. What do you think of bitcoins? I said, all I can think is how to spell it. I don't know anything about it, you know, with Bitcoin. But the other thing about a loan is on a project like that, can you get a long term loan? I know you can get 10 years. I think you can get up to 20 years. Yeah, I think so. And I know the interest rates right now are more extremely low. So it is desirable to do that at this time. But could it be said that the boards have to do something that is can't let the pipes fail in the building fall apart? No, they're legally required to maintain the common elements, the pipes, everything that's part of the building that that is not owned by the homeowner. Let's just say you and I lived in the same building. They can't say, Richard, you go use Kim's shower. No, I don't believe so. Unless there's a provision in the bylaws. Yeah, I guess so. Well, I guess that's not going to work anyway. But anyway, so besides wastewater, to me, the big thing in all the press lately has been wastewater pipes. And the best solution is to, I mean, there's all sorts of piped linings and partial repairs. You need to hire a professional to find out what the real issue is because even a partial repair might be a short term fix, meaning you still have to do the full repair five years now. And when you compound it, you've now spent more money than if you just fixed it right the first time. Yeah, a lot of times you can spend more money bandating it and you just delay the problem and end up paying more in the long run. So it's not always ideal. I've seen actually associations where the board was removed by the owners because they didn't want to fix the pipes. And then the new board came in and the lawyer said, well, you have to fix the pipes. Yeah, you know, and there's all sorts of risks to that if they don't do something besides protecting the value of their property and the other things that go along with it, plus environmental fines and all sorts of disasters. What else besides wastewater pipes you've seen that are kind of coming out of the woodwork and surprising everybody? I think the biggest one besides that that I've encountered over the past five plus years would be spalling repair, which is concrete spalling. That's where the moisture gets into the rebar and it expands and it causes the concrete to crumble. And so the repairs for that, it's really hard to estimate because you can't tell the extent of the damage until the contractor gets in there and really, you know, breaks it apart and sees how deteriorated it's become. That's a hard one to budget for. Usually we put it in the reserve study to coincide with the exterior painting. So it's done right before the painting's done and then you get a good seal and hopefully keep the moisture out and keep the damage, the future damage to a minimum. That's a pretty big one. The other ones, I know some associations and buildings are responsible for the windows. That's a big one. There's a high rise that just special assessed, I think in Hawaii, for windows and it was several thousand dollars because they had, they're replacing all of them. What's interesting about windows, I've seen in both those cases two examples. One is where the insurance company refused to renew the liability insurance because the windows were falling out and they can fall on someone and so they get hurt or even killed. And so the declaration itself said the windows are the owner's responsibility. So owners took the position, well, you can't make me replace my windows, it's my responsibility and the declaration. However, the state law does provide for high-risk components with a board can say we've determined that the high-risk component that we're going to replace all the windows as a common expense and charge you your pro out of share. They can't let owners just impede the ability to have the association have insurance or whatever it may be. And sprawling, I remember a small project in Makiki I was looking at where there's no way to know how the cancer is under the concrete. It may look perfect, but still it's starting to delaminate from the rebar. And I remember we were at a project and they had what we call leading edge sprawling. So we can imagine the exterior walkway and that edge that's on the edge of the walkway. And we can see a little hairline crack about three feet long. And so the sprawling guy was to repair it so he'll chip that out and they'll reform it and pour it. So when he chipped it, started to chip it out, about 50 feet of concrete edge fell off because you couldn't see the hidden damage of the delamination along that entire forward edge. So you don't really ever get a fixed bid for sprawling repairs. It's always where the contractor will give you based on the kind of repair that's a different cost, whether it be a lineal or whatever. You do that a lot. So you could put in 50 or 100,000 in your reserve study. When you get there and you actually do it, it might be five hundred thousand. Yeah, it could be well over what you have budgeted for, even what the contractor has quoted. You know, they get in there and it could triple or quadruple or more and they don't know until they get in there. Well, the new elephant in the room is this proposed ordinance by the city council to require certain older buildings to retrofit with mandated fire sprinkler systems. And I should say fire sprinkler systems. And what's interesting about that is that there's about 350 buildings have fallen in that category, although they have said that one to have exterior walkways will not be subject to the mandated rule and they have a matrix. But the way that matrix works, you get points to and against for fire systems. If you're a building with an interior hallway, there's nothing you can do other than put sprinklers in, which I'm not sure it's fair, but that's what the proposed ordinance says. Well, what's interesting about that, like I read in the paper, it says 4512,000 to put a per unit depending on the building. That's what I've heard, too. And what I found is that I seem to remember our governor said that he could air condition in all the schoolrooms for 10,000 a classroom. And that's really about 60,000 a classroom. The problem I see when you go to fire sprinkler retrofitting, A, you need to have a pump room to push the water upstairs. So you have to have a 10 by 10 room somewhere. If you don't have a 10 by two room sitting there unused, that cost is not considered in the aspect of I've got to build a fire pump room and have the space for a fire pump. I think most associations are going to struggle to find that room. That's right. Yeah. And then you take the next step that if you're an older building and you have lead paint, you know, and you're starting to open up all the, with regard to asbestos and lead paint, they're going to be forced to do asbestos and lead paint remediation. Those are just unforeseen costs. Yeah. And so then you add into that and the putting a soffit over it. So it looks nice. Most of our experts say it's going to be 30,000 or more. Wow. And that's going to be $300 a month per unit order. Well, you know, we are actually, we always run out of time in this show. So it's a great topic. We're going to wrap this up and I'm going to thank you for being here. Thank you for having me. I'm going to remind all of our viewers. The most important thing to do is put some attention to the reserve study. Look at it. See if you're putting everything in that belongs to it and then talk to your management company or other people who you know of ways to deal with funding this because there are ways to deal with it, but you can't ignore it. Thank you all. Happy holidays. Next week we're going to have an expert on association fraud here and the problems of internet banking and the big risk today, how associations are losing money through fraud. Thank you and happy holidays.