Reserve Data Analysis, Intl.
 
Articles and Information
 

 

Reserve Funding Strategies

 

prepared by

 

Edwin G. Edgley, CEO/Founder

Reserve Data Analysis, Intl.

June 1, 2010

 

“Preparing the annual budget and overseeing the association’s finances are perhaps the most important responsibilities of board members.  The annual operating and reserve budgets reflect the planning and goals of the association and set the level and quality of service for all of the association’s activities.” 

                                                                                                             – RDA, June 2001

 

The board of directors of an association is charged with the responsibility of  maintaining the community in a good state of repair in accordance with the provisions of the association's governing documents.  When a major repair or replacement is required, the association has essentially four options available to address the expenditure.

 

The first option is to pass a special assessment.  Although not commonplace, I am aware of special assessments in excess of $10,000 per unit occurring in associations in Virginia, California and elsewhere.  When a special assessment is passed, the association has the authority and responsibility to collect it, even by means of foreclosure if necessary.  However, an association operating on a special assessment basis cannot guarantee that an assessment, when needed, will be passed.  Consequently, it cannot guarantee its ability to perform the required repairs or replacements to those major components for which the association is obligated to maintain when the need arises.  Additionally, while relatively new communities require very little for major reserve expenditures, associations reaching 12 to 15 years of age and older will find many components reaching the end of their effective useful lives.  These required expenditures, all accruing at the same time, can devastate an association's overall budget.

 

The second option is for the association to acquire a loan from a lending institution for the required repairs.  In many cases, banks will lend money to an association using future bank-mandated assessments as collateral for the loan.  With this method, not only is the current board of directors pledging the future assets of an association, they are also required to pay interest fees on the loan in addition to the original principle.  Whereas, if the association sets aside reserves for this purpose, using regularly collected membership fees, it would have the full life of the reserve component in order to accumulate the necessary monies.  In the case of a roof this could be as much as 18 to 25 years.  Additionally, those contributions would have been evenly distributed over the entire membership and would have earned interest.

 

The third option, too often used, is simply to defer the required repair or replacement.  This option can create an environment of declining property values due to the increasing deferred maintenance and the association's financial inability to keep up with the normal aging process of the common areas.  This, in turn, can have a seriously negative impact on sellers in the project by making it difficult or even impossible for potential buyers to obtain financing from lenders.  Increasingly, many lending institutions are requesting copies of the association's most recent reserve study before they are granting loans, either for the association, a prospective purchaser into the community, or for an existing individual within such a community.

 

The fourth and only way the board of directors can ensure its ability to properly maintain the association’s assets, distributing the cost evenly over the entire membership, is to assess an adequate level of reserves as part of the regular membership assessment.  The community is not only comprised of present members, but also future members.  Any decision by the board that would disproportionately burden future members to make up for past reserve deficits would be a breach of its fiduciary responsibility.  Unlike an individual determining their own course of action, the board is responsible to the “community” as a whole. 

 

Edwin G. Edgley is the CEO and founder of Reserve Data Analysis, Intl.  Mr. Edgley is a published author, routinely lectures at a national level, and teaches on the subject of reserves and reserve analysis preparation.  He is the author of the RDA RESERVE MANAGEMENT SOFTWARE program, and is actively involved as an expert witness in his field.  This document may be freely quoted, copied, reproduced and/or distributed, in whole or part, for non-commercial purposes, provided all credits and copyright information remain intact.

 

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