Should Hotels Complete a Reserve Fund Study

By Larry Mogelonsky - Partner at Hotel Mogel Consulting Ltd. and Adam Mogelonsky - Partner at Hotel Mogel Consulting Ltd.

26 September 2022
Larry  Mogelonsky
Larry Mogelonsky
Adam  Mogelonsky
Adam Mogelonsky

One of the obligations of moving from a home to a condominium is to take your turn on the board of directors. Don’t let anyone fool you into believing that this is a simple, 10-hours-a-month task. The time investment is significantly higher, and even though there is no financial remuneration, your fellow unit owners will treat you as if you’re a paid servant. Perhaps this situation strikes closer to home for many of you already.

As we’ll examine later on this article, everything is up for grabs as inflation rolls through various sectors of the economy. This is a critical-yet-still-underappreciated variable for today’s hotel finance.

Condo Reserve Studies

Apart from the day-to-day administration, aptly executed by the property manager, the main responsibility of a condominium BOD is to ensure that there are sufficient funds generated through monthly maintenance fees to keep the building operational. The ying and yang of this exercise is balancing the monthly fees versus the quality of service and maintenance expenses. No one wants to see their fees increased, but at the same time they want to ensure the property is well-maintained. And importantly, no one wants a special, one-time assessment.

While the specific rules vary by state and country, here in our home province of Ontario, Canada legislation mandates that condominium corporations provide adequate funding for long-term repairs and replacement. This is managed through a reserve fund study – an independently developed forecast of expenditures necessary to maintain the building structures. Produced by engineering specialists, this 50-year plan identifies major building systems as well as their forecasted replacement costs and dates. We don’t doubt the capabilities of your engineering team, but the emphasis is on ‘independent’.

As an example, our building has a roof replacement coming up in just under a decade at a forecasted cost of three million dollars. Rather than have a special assessment when the replacement is due, our owners will pay a much smaller amount each month, setting aside these funds so that when the roof needs a serious overhaul, the funds for this project will be available. As the building is already 20 years old, by the time the roof needs replacement, unit owners will have been paying for some 30 years, the expected life of the asset. Our roof is but one of over a hundred items that are identified in the reserve find study, each with a different dollar value and replacement timeline. Moreover, every few years the replacement study gets updated, reflecting differences between expected and actual life cycles.

Hotel Reserve Studies

Each year, hotel asset managers develop a capital budget outlining what is required for the upcoming year. Capital projects tend to be irregular in nature, resulting in some years being significantly higher in need. Thus, there is a dance of sorts where capital requirements get jockeyed from year to year, often delayed to meet available cash flow from operations or debt service coverage. Most troubling, decisions of this nature are frequently made to fit some hypothetical available capital budget, an extreme need (in other words, it’s already broken), or a legal obligation (mostly related to safety). It can all be haphazard and leave hotel owners exposed to uneven annual returns.

A reserve fund study approach would strongly help to eliminate this issue. Instead of asset managers or general managers – who seldom possess an accredited degree in mechanical engineering – making decisions on capital projects perhaps with the assistance of the maintenance team, a schedule of physical requirements would be available annually with more realistic timelines.

Having a reserve fund study does not force the asset manager to upgrade or replace assets just because they are on the schedule. Rather, it serves as a guideline for budgetary decisions in the present to avoid more drastic measures in the future. In our condominium, we made the decision to move several maintenance items ahead a few years while others have been delayed because their useful life was underestimated.

The Impact of Inflation

Many projected costs of capital asset replacement are still based on the values assessed before average inflation moved from 2% to 7.5% or higher. Right now, the narrative around inflation has been centered around commodities and direct-to-consumer goods, and yet it will snowball through nearly ever other industry, as we are starting to see in higher costs of new construction.

The impact here is that your long-term capital expenditure budget may be underfunded, failing to anticipate the inflationary pressures on periodic investments like window replacements, new water systems or bathroom renovations. The most dangerous word from the previous paragraph is ‘average’ because it undermines the erratic variable costs that some materials are encountering as global supply chains ebb and flow. For instance, while the average reported by the news is at around 8%, specific goods may be at 25% or more.

This is cause for alarm and yet more one imperative for a commissioning a reserve study for your property. For a condo, having the reserve funds allows us to make highly rational decisions without asking our unit holders for additional capital or, more so for commercial real estate, having to plead to a bank for loan. It’s all about preparedness so that any unforeseen, one-time expenses don’t stymie your business in a world of hyperinflation.

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For more information about Hotel Mogel Consulting Limited, visit hotelmogel.com

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Hotel Mogel Consulting Limited

3600 Yonge Street, PH 36
Toronto, ON M4N 3R8
Canada
Phone: +1.647.284.9791
hotelmogel.com

Larry Mogelonsky

Larry is managing partner of a hotel consultancy that assists independent luxury hotels meet their goals and helps technology companies understand how their solutions work in the hospitality filed. Together with his son, Adam, they are the world's most published author in the field of hospitality, with weekly columns in many leading industry publications, as well as seven, 400+ page books on hotel management. He has been recognized by Hotel Sales and Marketing International (HSMAI) as "One of the 25 Most Extraordinary Minds in Hospitality" and by TravelClick as "Worldwide e-Marketer of the Year." He is also much sought after as a public speaker. His broad base of hospitality experience has led to multiple consulting commissions ranging from acquisition/divesture, to asset management, and all forms of marketing and operational initiatives. His team has helped several technology firms successfully introduce their solutions to the hospitality industry. Larry is in high demand as a keynote speaker, and has participated at numerous conferences throughout the world. His motivational presentations focus on SOLVING THE LABOR SHORTAGE with topics addressing the need to improve marketing, sales, advance new technology and enhance customer service. In particular, he focuses on how the hotel industry can revitalize itself in the face of the sharing economy and now the post-pandemic environment. Previously, Larry founded LMA Communications Inc., a multiple award winning hospitality and tourism focused communications company that develops multi-disciplined solutions for client needs. Specialties include: hospitality travel industry, marketing strategy, branding and identity, public relations, digital marketing and social media management. He completed the sale of the Company in 2015.

Adam Mogelonsky

As one of two principals at Hotel Mogel Consulting Ltd., Adam Mogelonsky is a strategic advisor primarily for independent properties, small hotel groups and technology vendors for the industry, specializing in helping brands determine the best path to increased profitability whatever that direction requires. As a thought leader, he has coauthored seven books on hotel management and over 1,200 articles over the past decade across a variety of trade publications, in addition to regular podcast and conference panel appearances. Lately, the focus for Hotel Mogel has been on automation, tech stack auditing, labor efficiencies, employee retention programs, heightening managerial productivity and upselling practices to maximize total revenue per guest. With a keen eye for the profound demographic and demand trend changes that will over the decade ahead, Adam also helps hotels develop roadmaps for future innovation in areas where they can realize profound growth including wellness, experiential travel, AI- driven personalization and other emerging technologies.

Larry Mogelonsky

Canada
larry@hotelmogel.com