Transition Report & Reserve Study Versus a Property Condition Assessment Report 

When dealing with homeowner associations (HOAs) and property managers for residential communities, condos, etc., we often get requests to provide a Property Condition Assessment (PCA).  However, the PCA is not the right product to address the unique reporting needs of HOA’s and property managers of Common Interest Real Estate (CIRE) market products, which include properties such as residential communities, condos, co-ops, time shares, etc.

There are many report variations to a PCA, developed over the years in response to unique reporting and analysis needs of other parties in the real estate industry; for example, Disposition Reports, Compliance Reports, Completion Reports, Transition Reports, and Reserve Studies. These specialized reports were developed to address reporting needs specific to the client needs. Aside from Reserve Studies*, none of these other report variations are governed by national standards. The subject of this paper is to compare the PCA to the two report types typically provided to the CIRE market, Transition Reports and Reserve Studies.

The PCA was developed to meet commercial real estate lender requirements for mergers, acquisitions, and refinancing situations, and is prepared in accordance with ASTM E2018. The primary purpose of a PCA is to identify undisclosed issues (such as deferred maintenance and faulty construction), and to provide unit cost benchmark data from which to appraise the true value of a property.  PCA reports consist of a narrative report describing each property improvement, the cost of required repairs, and a budget for major capital expenses anticipated to occur during the term of the real estate loan plus two (2) years.

In a PCA, when issues are identified, cost estimates are provided to correct the issue, which are then summarized in an immediate repair budget. The purpose of the repair budget is for the lender and purchaser to identify those items not disclosed by the seller that need to be addressed to bring the property to par condition. As part of the negotiation process, the seller agrees to either correct the deficiencies, or the sales price is adjusted, thereby leaving the repairs to be accomplished by the purchaser after the sale. If repairs are to be accomplished after the sale, the lender will either reduce the loan amount or establish an escrow account based on the repair budget. When repairs are escrowed, the escrow funds are released once the repairs are accomplished. Lenders will typically set the escrow at 1½ to 2 times the total value of the immediate repair budget.

As previously noted, in addition to the immediate repair budget, a capital replacement budget is provided for the term of loan plus two (2) years. The capital replacement budget is limited to just those major expenses that are not included in common area maintenance (CAM) for retail products or in annual operating budgets for residential products. Typically, the PCA capital replacement budgets are limited to about one-half dozen major budget items required to establish a per-unit cost that can then be compared with nationally recognized benchmark data. The primary reason for the PCA capital replacement budget is so the lender and purchaser can compare actual budgets to their respective nationally-recognized unit cost database so a fair appraisal value of the property can be made. Therefore, the preparer of these capital replacement budgets must have experience in the market he is providing budgets for as to which expenses are to be included, and which are not. PCA capital replacement budgets are not intended to establish Reserve Study budgets and funding plans.

Although the Transition Report and Reserve Studies share similar concepts with a PCA, there are significant and fundamental differences. The Transition Report and Reserve Study need to be and are provided as two separate and independent reports, versus the PCA which is one combined report. The Transition Report is written to strictly identify repairs and those issues not properly constructed in accordance with design documents and industry standards. However, cost estimates associated with such issues (such as those items detailed and priced in a PCA immediate repair budget) are not included in a Transition Report. The reason pricing is not included is because in situations where the developer is responsible for addressing these issues, the price is irrelevant.  In the event the developer refuses to take responsibility and address certain issues, costs associated with such then may become relevant, assuming legal recourse is pursued. These costs would be addressed at that time with the client and client’s counsel.

Reserve Study budgets are prepared in accordance with National Reserve Study Standards (NRSS), versus the PCA replacement budget, which is prepared in accordance with ASTM 2018. It too should be noted that the consultant preparing a Reserve Study must take into account any reserve funding requirements of the property covenants and others as may be dictated by state law.

The NRSS Reserve Study budget typically results in considerably more budget detail/expenses than the typical PCA replacement budget. A primary purpose of the Reserve Study budget is to manage funding for all expenses not part of the annual operating expense budget. More importantly, NRSS requires the consultant to provide various reserve funding plan options. Reserve funding plans are not a requirement of a PCA. As previously discussed, the PCA capital replacement budget is a replacement budget limited in scope specific to its respective market budgeting practices, so its findings can be analyzed and compared to nationally recognized unit cost data. This data is used for evaluating and approving loan appraisals for real-estate transactions and financing, not for managing properties and establishing reserve funding plans.

John zumBrunnen is CEO and Founder of zumBrunnen, Inc., an independent construction and building consulting firm founded in 1989. zumBrunnen has a BS in mechanical engineering from the University of North Dakota, completed the US Army Corps of Engineers Training Program in 1972, and is a member of the Association of Professional Reserve Analysts (APRA) and numerous other national and state associations. zumBrunnen has 40+ years of experience in construction, property assessment, development, and reserve budgeting.  He is the inventor of the FacilityForecast® software system and a respected author and speaker in the industry. 

* Reserve Studies are prepared in accordance with National Reserve Study Standards (NRSS).

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