 Welcome to Kondo Insider, as I've said many times, what you show about association living, both condominiums and homeowner associations, although probably we talk more about condos and the homeowner associations. And today we're gonna talk a little about budget reserves, but kind of the backdrop to that story is gonna be the catastrophe in South Florida at the surfside condominium south, which as we've all seen the news over and over again, has collapsed, killing hundreds. They're still searching for the bodies and very few survivors. And the two relevant things I wanna talk to about that particular issue, besides the great tragedy it is and a loss of life and all the things you would expect the one to say during a tragedy. But basically two specific issues. One, structural integrity of buildings and spalling, and what does that all mean? Although I have to say upfront, there hasn't been any final conclusion made about what caused that point to collapse, but the evidence is pretty significant or what probably caused that point to collapse. But we wanna talk about what spalling is. And then number two, we wanna talk about the reserves and what your obligations are to reserves because Hawaii is an interesting state. We have a reserve law that requires condo boards and to include in this budget reserve calculations and collect the same from the owners. Now, let's look at the surfside from this perspective for a minute. It was 156 units. And if you read the news, I'm gonna round the numbers off, they were talking about a $16 million assessment or more, which is about $100,000 an owner. Well, what we find in Hawaii and everywhere in the country, people who live in condo never wanna pay for anything. They wanna have the low maintenance fees, never contribute to anything. And in this case, they had structural reports in 2018, three years before the tragedy of severe concrete destruction. But what's interesting about spalling, and that's what I wanna get into first, what is spalling? Give me a second. Spalling is the deterioration of the rebar inside the concrete, the structural stability of a concrete slab is the rebar. Now, if you think about it, you have the concrete slab or the concrete vertical or horizontal, in the case of decks that like the pool deck at surfside, a horizontal slab, the rebar provides the strength of that concrete from breaking apart. Well, all concrete is porous. The thickest concrete that I know of is 253 angstroms, and that's about 153,000 of an inch of an angstrom. But that's porous enough, the water will over time seep into the concrete and eventually get to the metal strengthening rod, the rebar in the middle and cause it to rust. When rebar rusts, it expands. And that means the concrete has this enormous pressure from inside the rebar itself and causes the concrete to crack. And of course, as you get concrete to crack, water gets in much easier, maybe considering allowing the rebar to rust even faster. Most concrete repair of rebars common in all buildings, it's usually tied into the painting of the building. And most people, when they paint these concrete buildings, they paste them with an elastomeric paint, which is, I'm gonna call it a plastic paint that is a waterproofing material. I keep the water from getting in, but like a hang exposed to the wind and the surf and the water and the elements, over time, the thickness of that paint deteriorates. It has to be repainted again about every 10 years or so to maintain the waterproofing value of the elastomeric paint. It's not a paint that's really cosmetic, but it's not the real purpose of elastomeric paint. It is to protect the concrete from water getting into it so you don't have spalling, which is the deterioration of the rebar within the concrete. Hope you've followed that so far. So anyway, when you look at rebar and deterioration, the earlier you catch the issue, the better off. So earlier detection of light cracking or problems, and there are certain tests they can do to check for spalling, usually done before painting, the earlier you deal with it, the less expensive it's gonna be. An example would be if you catch rebar very early and you can chip it out, and the rebar is only on the top because it's just starting to rust, you can very easily take the rust off and apply a corrosion protection on it and put the concrete back down and that piece of rebar is in perfect condition. If you wait too long, what happens is that rust goes around the entire rebar, so it's around the 360 degrees circumference. And you now have the issue when you chip out the concrete, you just can't chip out to get to the top. You now got to chip out so you can expose the entire rod, both top and bottom, left and right. And then again, take off the rust and apply a corrosion material to it. Now that is a much more expensive process than if you just had simple corrosion on the top of the rebar. But then the worst case would be, you don't attend to the rust at all and it eats away the rebar and there's no rebar left to speak of. There's no strength left. Now you have the mass of expense of providing structural integrity while you do the repair, replacing the rebar, which has a whole much more steps to it. And it is far more expensive. You know, when you look at the paper and just rounding off the numbers, the proposed assessment was 16 million for 156 owners in the surfside condominium. And that was in 2018. And there was statements about unknown condition, it might be worse. Well, if you look at that as a simple value, that's $100,000 at owner. That's a lot of money. Now they would have to borrow it or assess it or whatever. And if they borrowed the money over a 10 year loan, which is typically the commercial loan or at least the period of time you can amortize a commercial loan for a major expense like 15 million. You'd be amortized over 20 years, but the 10 year maximum fixed term often lasts. You're talking about that assessment to each owner and over $1,000 a month. So to wait and wait and wait, it would have cost them $1,000 a month in this loan to pay for the repair. And of course, nobody wants to pay their unfixed incomes, a lot of seniors in that project. And it can't be that bad as the mentality. I see it with condo boards here in Hawaii that nobody wants to address the reserve study in a way it was intended to be implemented within the law. So anyway, if you go back and even forecast saying they realized 30 years ago, they started to have a problem and they needed to save $16 million, that equates to about $250 a month per owner. That's a lot of money. But the probability is, if they had repaired these items early, had dealt with these issues when they first got, like cancer, when they first got when that there were some problems with the cracking of the building, it would have probably been a third of that cost for $50 a month per owner. So what do you have? You have a board that allegedly they relied on the building experts of South Florida, the governmental agencies. They looked at this, I haven't seen in the news, anyone saying your building is in catastrophic state, it's gonna fall down in a minute. I think they're all saying it's just an expensive repair. But the boards who didn't want to do anything about it long ago, and boards prior to that board and boards prior to that board kicked the can down the road, were a simple $50 a month through the reserve fund and addressing the issue when it was identified would have been a far better solution for getting the lack of the loss of life and the things we're dealing with with the surfside condominium. And so what you have to recognize when you start looking at the surfside condominium, there were a lot of things that went wrong. One, Florida has a reserve law as well, by the way. Two, they had inklings of this for years and never did anything about it because of the cost. And three, when they started to do something about it, the cost became so exorbitant, nobody wanted to pay for it. And four, because they didn't act quick enough, there's been tremendous loss of life. And that's a sad thing. And what is the odds of that happening here in Hawaii? I don't know, but I've been doing reserve studies. Some of you may know that I wrote part of the reserve law in Hawaii and I'm very involved in reserves and national statistics and national data. And so I often speak as an expert witness on lawsuits locally here on reserve study issues. But if they had just done a more prompt, conscientious job of maintaining their building, recognizing it under Hawaii law anyway, you're a fiduciary, you have an obligation to maintain the building. It's not a choice, you have a fiduciary obligation to maintain it. And now we're gonna see all the lawyers get rich because they're gonna be arguing about when you knew what you knew, why you didn't do what you should have done and the end result is, you have catastrophic loss of life and the loss of an entire building. And I don't know, I haven't talked to an insurance expert lately, but I'm not sure that the building is insured for lack of maintenance. We insured buildings under our insurance policies for perils, hurricanes, spires, things that happen, water claims are covered under Hawaii law with the condominiums. But with regard to that building that has been now demolished, I'm not sure their insurance covers it. So all those owners may be out, the total value or investment they have in that unit. And of course, the mortgage holders who took us collateral the property don't have any collateral anymore. And will some owners walk away from the mortgage companies and follow bankruptcy, who knows? It's just a mess. And the truth of the matter is that Surfside's a perfect example of an association board of directors failing to exercise good business judgment and evaluate what the problems are in the building and maintain them timely. Because as I said earlier, the longer you wait on spalling repairs, the greater the numbers going to be with respect to the cost of the repair. And it's not nominal amounts of money because in workers' comp world, people who work on buildings, high rises and deal with spalling are one of the highest work comp rates in the country. So it's not a cheap repair. And I've seen a lot of associations say that's not that bad. I just got a handyman that puts more concrete on it. But that's not going to stop the rusting. You know, it's going to be a serious problem. So you've got to attend to the building and all of its issues, not just spalling and painting and roofing and the rest of it. You have to tend to them timely by putting these things into a reserve study and collecting adequate funds so you can repair these things and avoid these types of catastrophes. Now on that note, I've kind of set the stage for part two of the show. We're going to talk about the Hawaii's statutory obligations reserves and the types of reserve studies. So we'll be right back in one minute. 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Come watch us, listen to us, email your questions to us at questions at thinktechhawaii.com every Thursday morning and you'll see what we mean. Thanks. Well, I'm back and I pretty much set the stage in the first part of the show about using the surfside condominium as an example. The potential risk of failure to maintain your building. And what I was gonna say as I was ending that is I'm sure all those individual directors current and past are gonna be sued as a part of this process as the attorneys get a hold of this and they start looking at all the issues and trying to find all the insurance they can get. Certainly I said that I don't think the building structure itself is covered by that catastrophe, but I do think they're directed off for liability insurance that they have it will cover them to some level, but you're talking about a huge economic cost that I'm sure that there are limits of liability and their insurance are gonna cover it, but let's just review what the obligations are in Hawaii. And the keep it simple, the state law says you have to do a budget every year. That's clear. And you have to distribute it to the owners every year. It's clear. And boards usually go into that and say, initially I don't wanna raise the maintenance fees. Well, that's not so clear. I'll just say it this way. Associations are nonprofits. That means they don't make profit. They don't have retained earnings. They're collecting just enough money from the homeowners to pay the bills and fund the reserves. So costs go up like in your medical insurance for your employees or your property insurance because of all the fires in California which do affect local insurance rates by the way. And your vendors charge you more and the utility company raised the rates. Why wouldn't you think to some inflationary pressure just to maintain break even to raise your rates on an inflationary level on an annual basis? Rather is gonna be some exceptions if there's something, some immediate cost savings you find you didn't have before. Maybe you put a cellular antenna on your roof and that provides income you didn't have and helps subsidize some of the inflationary increases in the short run. But the reality of it is that if you have to do a budget, you should expect that there should be reasonable inflationary increases in the budget. Now what I was saying, the budget shall include a reserve study. That means that you don't have an option whether you wanna do a reserve study or not. Now certainly you can hire a professional or the board can do it themselves on an Excel spreadsheet. There's all sorts of things you can do but the reserve law says you have to do a reserve study. And it has, as you have to identify in the administrative rules, every individual replacement item in your building with a value of over $1,000. So that means your doorknobs on your common element doors, your light fixtures in the hallway, your fans in the rec room, all of these things have to be included in the reserve study. And you're supposed to be planning to collect enough from the owners to collect that. In a little side story, you might know that 1990 back when, believe it or not, Macy Hirono, Senator Hirono was in the house. She was on the Consumer Protection Committee. She was instrumental of setting up the reserve law here in Hawaii along with the other legislators. And it said as of January 1, 2000, they gave you a grace period to get to a period of what they call, this was 1995, 50% funded. Well, they realized after they passed that law 95 that in reserve study world, there's two types of reserve studies. One bases its analysis on a percentage, the other on cash flow. The most prevalent way is cash flow, almost 98% of the condos in the world use that method. Well, they didn't provide for the law. So 1997, the law was amended to provide for what we call cash flow funding. Now those aren't reserve studies cash flow and percent funded, those are funding models. The reserve studies are called pooling and component method, which I'm not going to get into too much detail on today. But the reality of it is you have to do this reserve study which requires you to look at all the items over $1,000. You can pool them as a group. So you could say pool equipment, which would consist of the pump, the filters that are, and make that one item instead of defining the pool and the pump separately. But you have to do a reserve study. And what I find is that more and sometimes starts saying, well, I don't want to deal with that. I think that we'll get another 10 years out of the roof or we'll get another 20 years out of the air conditioning system and they put unrealistic numbers in so that that calculation of the reserve contribution is lower than it should be. When I look at national statistics and locally statistics specifically, and I look at high rise buildings which will be different than a townhouse and all those CPR condos. When I look at those, the average contribution for reserves falls between $150 to $250 a unit per month. So that means within your budget, you should have between, if the statistics apply to you, you should be somewhere between $150 and $250 a month going to reserves. And you should be putting that money into the reserves every month in a separate segregated savings account to save that money. And whether it's $150 or $250 is going to depend on the reserve study and you identifying all the components. If you have a lot of amenities, gyms, dog parks, all these different things, high end furniture in your lobby, it's going to be more closer to $250. If you're more of a bare bones condominium and there's some reserved housing type condominiums out there, that the number may be closer to $150. What I see all the time happen is that condo boards say, I don't want to deal with that. And they cover the number to put into reserves. And that cash flow plan, the 20 year analysis, shows that every year you have to raise the contributions to reserves. What they do for this year is they get by and say, okay, that's what we're going to do this year. And they kick the can down the road and next year, where they've already admitted, they should increase the reserve contributions. They find a way not to do it by saying, the roof's going to last longer or the paint's going to last longer, it might be. And if anything, the South Florida incident did tell us that there's a price to living in a condominium and maintaining it. And that we should be very judicious and putting some serious attention to the reserve study, so you don't have these types of problems. So I've been an expert in several cases in involving reserves. And the problem is, is that even on new projects, developers provide a number and they say it's an estimate. Well, a new project, the problem doesn't go away because the statute condominium, I think it's 514B-9, but don't hold me to it. It says it has to be an accurate estimate of estimates. So if they use numbers that are just made up or really they can't validate when you realize all these people have the same resources available to them, they'll have a professional managing agent maybe, they'll have national statistics, certainly, get them on Google. You'll have like condominiums here in Hawaii that if you have a managing agent, say you should be able to give you an example of what other condominiums are doing. Although you have to understand they may not be doing the right job either, so their numbers may not be perfect. But you can look at this and just say to yourself, how much are you putting in reserves? And if you're putting in $30, $40, $50 a month for your reserves, I assure you, you're not doing a good job if you're a high-rise condominium, you're not gonna have the money to fix these items when they come due. So kind of the message I have today is that, once a year, we all are given a clean state. We can do our budget and our reserve study. And so we should be judicious in looking at the real costs. We should be judicious in looking at the reserve study and the impact it has on your building and maintaining your building, not your maintenance fees, but how it impacts you properly to maintain the building. Because it's certainly a little bit easier for South Florida if they saw they had spalling 10 years ago and they had put charge more on a monthly basis and they had a couple million bucks in the bank and they could deal with it then and preserve and protect the building, which is gone now. And at the same time, have done it in a more business judgment judicious way by charging, as I used in my example, $50 more a month per reserve. By accurately and properly doing your reserve study with regard to the obligation. But it's kind of a reminder that reserve studies are requirement by Hawaii law. They have to be done annually as a part of your update of your annual budget. They have to be distributed to the owners. You have to identify all the components. They're useful lives, remaining lives, estimated replacement costs. You have to apply inflation to those costs and you have to, when the segregated fund you're saving apply the interest earnings. So you have kind of a whole picture when you look at the whole thing. That and the strategy could happen to Florida but should be a lesson in history for all of us of the importance of doing a proper job on your reserve study. And that may mean bringing in architecture engineers at times. It may be hiring a professional if your project is big and your volunteer boards don't have the resources to put together a good plan under the current statute. And I can assure you, if you don't, at the end of the day, you're gonna find out that you're gonna have major assessments which will protect your value. You're gonna have all the same fights the service I had about, I don't think it's that bad. We don't need to do it now and that type of a thing. So I would just encourage you all to use this moment in the history, realizing the tragedy we wouldn't want to have happen to anybody but realizing that you have the board member, the chance to crack the road you might be on. And I would tell you there are some associations that do a very good job of this but you have the chance to correct the road you're on because if we don't, I can assure you the dark side is gonna interfere. Our legislature is gonna get involved and they're gonna pass laws and require engineering inspections and require you to spend more money to do what you should be doing anyway. So on that note, I'm gonna thank you for watching Condo Insider. I hope you have a good day and we hope you tune in next week to another edition of Hawaii Show about Association Condo Insider Aloha.