#18 – Depreciation Reports

The reader will appreciate that, while the information presented is one person’s opinion, the author is considered a “Qualified Person” under the Act.


In December 2011, the Provincial Government enacted, by Order in Council, several sections of the revised Strata Property Act (2009), which had been held in abeyance while the Regulation supporting them was completed. While these changes have impacted a number of areas of Strata operations, the most significant is the requirement that all Strata Corporations in British Columbia (with minor exceptions) must develop a Depreciation Report by the end of 2013, and have it updated every three years.

There are some strata owners who may find this an example of further government intervention in their private lives, but this change is one that many more owners, along with every Strata Owners Association and advocacy organisation, has been lobbying for, for many years.

What is a Depreciation Report?

The Inventory List

At its elemental level, a Depreciation Report is an inventory of a Strata Corporation’s Common Property components. It is intended to identify all of the systems that make up a building, and all the services that support it and the occupants. Many of these components are obvious to most strata owners – roofs, exterior cladding, driveways, parking structures, landscaping, and a wide variety of other common amenities available for the use of the Owners Group.

Less noticeable to many are the “hidden” systems such as water and sewer systems, site drainage, electrical and plumbing systems, common heating and hot water systems, and a host of others, which can vary widely across the broad range of building types that operate under the Strata Property Act (SPA).

The Depreciation Report is intended to generate a list of all the different common systems the Corporation is responsible for, make observations on their condition and anticipated life expectancy, and provide financial information on their current replacement values.

Using these figures, the Report is then required to show the projected cost of replacement at the end of a system’s anticipated life expectancy, including an allowance for inflation and interest. In turn; this should provide the necessary information for the Strata Corporation to make decisions on how it will address these inevitable maintenance and replacement projects by developing a Long Term Maintenance Plan.

Periodic Maintenance vs. Operational Maintenance

The Act requires those who develop a Depreciation Report to separate those systems which require scheduled or regular maintenance within the Strata’s fiscal year, from those that require periodic maintenance, whether scheduled or as required, outside a normal 12 month period.

A simple example would be the exterior painting of a building – something that should be a necessary part of the building’s scheduled maintenance plan, but not something that takes place annually. Regular painting is required in order to maintain the condition of the exterior cladding system to help avoid, or constructively delay, its eventual replacement. This kind of work is called Capital Maintenance, and must be included in a Depreciation Report, and any subsequent financial planning considerations for the Strata’s Contingency Reserve Fund (CRF).

System Replacement

A Common Property system that most readers grasp easily is the Strata’s roof. Most roof assemblies, sloped or “flat”, and assuming they’ve been properly installed and maintained, will fall within the 30-year time-frame for replacement that the Regulation requires the Report to address.

Roof maintenance and inspections should be carried out annually (at least), and funded by the annual Operations Budget. The roof’s replacement must be planned for and included in the Depreciation Report’s financial section, with values based on its type, age, current condition, and estimated remaining life span.

While every Strata has a roof to consider, each one will have a unique list of systems that others may not, simply because of the style and/or design of the development.

Depreciation Report – Financial Reporting

We expect this to be an area where every Consultant will take a slightly different approach – some simple, and others more complex. We can only remind the reader that any of the resulting numbers are “guess-timates”, based entirely on the quality of the Consultant’s understanding of the existing systems, and the current replacement value of their components.

It is this point that makes the requirement for a review and renewal of the Depreciation Report every three years most obvious. The Report is a “living document” requiring regular adjustment to changing economic, financial and other conditions.

The Government believes it important that periodic review and updating by a professional is necessary, but Strata Corporations and Councils are well advised to take an active role in monitoring and managing this information annually, to adjust the projections for the current conditions, and make any corresponding adjustment to the CRF contributions within the annual budget.

Financial Reporting Models

The Act requires the Consultant to provide three different “cash-flow funding models” including:-

  1. the funding of the Contingency Reserve Fund (CRF) at a rate where the contributions will provide adequate cash to pay for the project at the time of replacement

  2. the amount that will be required at the time of replacement to be funded by a Special Levy on the Owners

  3. an anticipated cost to the Owners should they choose to borrow funds at the time of replacement.

We consider the first to be the very basic reporting level, as most Strata Owners have at least some understanding that contributions to a CRF are necessary, even if there is no specific plan for their use.

The second – Special Levies – are probably the most common method that Owners Groups (are forced to) use to fund the major maintenance and replacement projects, and are necessary because the work was not anticipated and planned for. In identifying this reporting method, there is an opportunity to compare the two values and give individual owners a chance to choose between them.

The last model, while technically possible under the SPA, is not one that has been explored to any degree because there are few, if any, (conventional) lenders prepared to do so. Even with this funding method recognised within the Act, recent (informal) discussions with members of the banking community suggest there is little likelihood that their position will change. In addition; because Common Property cannot be “encumbered” under the Act, it is only those Strata Corporations that have specific, owned assets (e.g. a “Caretaker’s Suite”) that might be able to satisfy a financial institution’s requirements for “collateral”.

Qualified Person

Part 6.2.6 of the Act makes the definition of Qualified Person appear quite broad in its range, as it doesn’t list any specific professions which might be considered qualified. Our own interpretation suggests that there are several potential groups that may be considered including Engineers, Architects, Insurance and/or Real Estate Appraisers, Quantity Surveyors, Building & Facilities Managers, private Building Inspectors (not municipal) and, potentially, some experienced Tradespersons and General Contractors.

There are likely others who may be included in this list, or believe they should be, and this leaves it up to individual Strata Councils to develop their selection criteria based on the direction the Regulation does provide.

The extent of the Regulation’s guidance [Part 6.2 (1) (d)] is as follows:-

(d) the name of the person from whom the Depreciation Report was obtained, and a description of:-

  1. that person’s qualifications

  2. the Errors & Omissions insurance, if any, carried by that person, and

  3. the relationship between that person and the Strata Corporation

It’s not a lot to go on.

Consultant’s Proposals

The governance structure of Strata Corporations dictates that the engagement of a Consultant, or any contractor, must be undertaken as a ‘public’ process, which is most commonly seen as “getting three quotes”. In this case, the language of the Act lends itself to having the invited proponents present complete proposals for the work as defined, and an opportunity for them to provide additional information on aspects of their report’s content that extends beyond those basic legislative requirements.

The one thing to remember is that while each proposal must cover the required content, every one will be different in how the information is presented – its depth and quality – and ultimately, how useful it is to the Owners. Discerning the difference between proposals may present some challenges for those tasked to vet the proposals.

Qualifications

The Consultant’s qualifications will (should) be presented “up front” to save the Council’s time in deciding whether he has the experience and knowledge to develop and present the Depreciation Report. This will come in the form of an individual’s “Curriculum Vitae” (CV) outlining his background, experience, and any recognised accreditations from a wide variety of educational organisations. There are many types of professional accreditation, but the Council must decide which of them is pertinent to the work.

Small vs. Large

Individual consultants, and small firms, will need to present a broad scope of experience from those involved, not only with different buildings and their wide variety of facilities and systems, but familiarity with how Strata Corporations operate under the SPA, their individual Bylaws, and the influence of specific agreements with individual owners. While there may be a large number of individuals who meet the “technical” requirements, it narrows considerably when examining their experience with, and understanding of, Strata law, finance and operations.

Large engineering firms will likely take a multi-disciplinary, “team approach”, and those with a Building Science division are likely better suited to doing the work, rather than a firm that concentrates on one or two disciplines. The simple question is whether a Structural or Geo-technical engineering firm can show an appropriate level of practical understanding of a building’s Fire Alarm System, Roof Assembly, or Boiler System, among many others.

A large, multi-disciplinary firm may have the resources to review all the systems, whether one individual or many are involved, but it does bring significant operational overhead, which is likely to reflect on either the cost of the report, or its depth of content. They must also show that they have the same familiarity with Strata Corporation law, regulations, bylaws and operations as any other qualified consultant.

Financial Reporting

With no prescribed reporting methodology save the three models noted above, every Consultant’s approach is likely to be a little different, ranging from simple to complex. A spreadsheet format such as Microsoft Excel will probably be the preferred choice, but each firm’s approach to the calculation formula will have its differences from the next.

As also noted above; the entire spreadsheet, and the numbers it presents, is nothing more than a “guess-timate”, and the most important information comes from the Consultant’s current knowledge of industry maintenance and replacement values for the broad scope of systems found in any given building or property.

Most readers will understand the acronym “GIGO” – Garbage In, Garbage Out. If the initial value(s) of cost and life expectancy assigned to the Capital Maintenance and/or Replacement of the various systems aren’t reasonably accurate, the value of the Depreciation Report can be seriously diminished.

This is particularly true of a report that doesn’t offer a “live” view of the spreadsheet, where values can be manipulated by the Owners, to generate answers to the “What if??” questions.

While accountants may look for details around long-term interest and inflation values within the spreadsheet projections, and a complete report should include them, it is more important that the lay person easily grasp the information presented. This is a tool for use by the Owners and Council to develop the Long Term Maintenance Plan to maintain the Corporation’s assets. If the tool is too complex to operate or understand, it won’t be used.

Errors & Omission Insurance

While the Act does not require a Consultant to carry Errors & Omissions (E&O) insurance, the fact that it is included in the section under Qualifications is indicative of its importance to both the Strata and the Consultant.

Insurance underwriters do not offer this kind of coverage to those they consider “unqualified”. The examination of anyone asking for such coverage is thorough, and includes many of the same questions that Strata Corporations could be asking about any proponent’s experience and qualifications.

Simply put; if a Consultant can show that he carries E&O insurance, it is an indication to the Owners Group that he has already met a standard of qualification that will satisfy their own insurers. As the cost of such coverage is not insignificant, a Consultant with E&O insurance is displaying a level of professionalism which separates him from those who don’t…or cannot.

The Relationship Declaration

The reason for this requirement may not be apparent to some, but it amounts to a clarification of potential conflict of interest – perceived or real – between the Strata and/or its owners, and the Consultant. It is intended to expose personal or other relationships between the Consultant and Council members or Owners of the Strata.

For example – the declaration should expose the fact that “Council President George” has asked his brother “Carl” to present a proposal for a Depreciation Report, and there is a familial relationship between them. That shouldn’t dismiss Carl’s proposal from the Owners’ consideration, provided he meets the other qualification requirements, but it will draw attention to any proponent who doesn’t meet them, and is included for consideration solely because of the relationship.

Summary

It is this writer’s opinion that the changes to the legislation are long overdue, and the now required Depreciation Reports will bring to light the real maintenance needs and costs of a Strata Corporation’s assets. With no previous legislation to demand it, many Strata Corporations have fallen far behind in planning and funding major maintenance, repair and replacement projects.

Despite the recent explosion of property (market demand) values in British Columbia, real estate is a long-term investment, and properties require continued re-investment in order to maintain long-term value. For Strata Corproations, that re-investment comes in the form of developing, and funding, Long Term Maintenance Plans. Those plans can only come from an understanding that all the various systems, which make up a Strata’s Common Property, have predictable life-spans.

We encourage Strata Councils and Owners to move beyond the shock of the legislation, and consider the value that a Depreciation Report will present.

It will provide:-

  • A comprehensive inventory of the Strata Corporation’s Common Property assets for which it has full, or partial, responsibility for maintenance and replacement.

  • An assessment of the condition and anticipated life-span of the various component systems

  • An estimate of replacement and/or renewal costs for each component, based on current market values, extrapolated over their estimated life-spans.

  • A  financial overview of the costs and options in funding methodologies to support the Long Term Maintenance Plan through the Contingency Reserve Fund.

We will also note that Depreciation Reports will not provide definitive answers on how a Strata should proceed with a funding plan, nor will most offer any significant information on how a well designed Annual Maintenance Plan might influence the longevity of various building components and systems, and potentially defer major replacement expenditures.

This will be a “living” document, requiring regular updating. While the SPA requires it to be reviewed and updated by a professional every three years, a prudent Owners Group will be actively involved in annually monitoring and adjusting to the impacts of changes in market pricing and economic conditions, as they affect the funding needs of the various projects the Report identifies. The chosen Consultant should also be able to provide ongoing support and advice to the Owners, as they progress towards a Long Term Maintenance Plan that works for their Strata Corporation.

A Depreciation Report should be a very powerful planning tool for any strata’s Owners Group. The challenge will be to find a consulting firm whose report will synthesize a great deal of complex technical and financial data into a format that makes the “tool” accessible, and “user friendly”.

To Next Article: “Contingency” Reserve Fund Allocations vs. Special Assessments

Advertisements