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Every planned development and organization should keep an adequately funded reserve account. This account can be what protects your community from certain financial doom when major costs crop up in the future.
A reserve account is a financial account that holds the money set aside by an association over time to pay for future repairs and replacements of the association’s assets. By saving money for these major expenses every year, an association can equally distribute the costs among the members who stand to benefit from these assets.
With a reserve fund in place, an association can realistically anticipate major replacement or repair costs that may be necessary in the future. Many associations suffer from a severely underfunded or a total lack of a reserve account. These associations will likely need to levy hefty special assessments or take out a sizable loan when faced with a major replacement or repair of an asset.
Reserve funding also helps enhance property values. All homeowners wish to protect their investments and aim for a high resale value. And they are smart enough to know that an association with a properly funded reserve account is less exposed to risk. Mortgage lenders and loan providers also typically consider an association’s reserves before approving applications and setting rates.
Associations normally maintain two main accounts: an operating account and a reserve account.
The operating account or operating fund covers expenses that occur on a regular basis (at least once every year). Operating expenses are predictable and have no adverse effect on the yearly operational budget of an association. Even if the expense is large, if it is something the association pays for at least annually, then it is considered an operating expense.
Some common examples of operating expenses include:
In comparison, the reserve account or reserve fund covers major expenses that must be budgeted for in advance, i.e. before they are incurred. These are typically expenses that occur less regularly and would have a sizable impact on the yearly budgetary process of an association if unaccounted for.
Some common examples of reserve expenditures include:
The goal of a reserve fund is to set aside enough money to cover the cost of major repairs and replacements when the need for them arises. An association with substantial reserves, for instance, would not need to levy special assessments or take out a loan once its roof deteriorates beyond repair.
A reserve account is funded through regular fees. For a homeowners association or condominium, these fees come in the form of owner dues. Similar organizations such as golf clubs and country clubs use the same blueprint and draw from membership dues. These due are then allocated appropriately between the operating budget and the reserve account.
Associations, though, should not rely on pure speculation when determining how much money to deposit in their reserves. Instead, they should invest in a reserve study. A reserve study provides calculations on the correct level of funding and presents a funding schedule that associations can follow.
In some states, reserve studies are mandated by law for homeowners associations and condominiums. The governing documents of an association may also indicate whether or not a reserve study is required. Even if state laws and governing documents are silent, an association would still be wise to conduct a reserve study to ensure that its reserves are adequately funded.
As with reserve studies, reserve funds may or may not be required by state law. There are a few states that require associations to maintain a reserve account. California is one of them, with the requirement outlined under Civil Code Section 5550. In addition to state laws, an association’s CC&Rs or bylaws may also require it to maintain a reserve fund.
Some shareholders may feel that a reserve fund is unnecessary because they don’t get to experience immediate benefits. However, a reserve fund acts like a fair-share plan, where each member only pays for what they use. Relying on special assessments every time a reserve expenditure comes up would be unfair.
A reserve fund also ensures that an association’s assets and components are well-maintained. An HOA board has a fiduciary responsibility to maintain the common areas and elements of the community. Part of that responsibility is making sure the association has enough funds to cover such costs.
Safety is another top consideration. When components aren’t properly maintained, they can malfunction and break down. In due time, these components can fail altogether, bringing about disastrous consequences. The Surfside condominium collapse in 2021 is a prime example of the tragedy that may come with an underfunded reserve account.
All in all, it is easy to see why a reserve account is so crucial to a homeowners association – or any other organization, for that matter. There is a lot at stake, and a well-funded reserve account can be the only thing that separates success from total failure. Many associations find it difficult to come up with a funding plan themselves, though, so hiring a professional is always the way to go.
A reserve study can be a valuable tool that keeps your organization from financial ruin. It is important to understand what a reserve study is and how it can help your community. In doing so, you can make smarter financial decisions for your association.
Before you can understand what a reserve study is, you must first understand how reserves work. Reserves are funds set aside by an association to pay for the major repairs and replacements of assets in the future. Many organizations maintain reserve funds, including homeowners associations, condo associations, country clubs, and even religious facilities.
Reserves come from the monthly fees that members pay. These fees are typically divided between the operating fund and the reserve fund. The operating fund covers the cost of day-to-day expenses, i.e. the expenses that the organization regularly pays for. In contrast, the reserve fund covers the cost of replacing or repairing components that the association is responsible for.
So, what is a reserve study?
A reserve study, also known as a reserve analysis, is a comprehensive report or guide that associations use to determine the right level of funding for their reserves and the correct dollar amount for contributions. It involves an inspection and inventory of the association’s assets as well as an estimation of each asset’s remaining useful life and cost of replacement/repairs.
Reserve studies are integral to the successful operation of any organization. The primary objective of a reserve study is to provide a framework for associations that they can use to guide their reserve funding decisions. It is essentially a funding plan that ensures associations have a sufficient budget to cover the cost of repairs or replacements as they come up.
With a funding plan, members can make reserve contributions in small increments as opposed to the alternative, which is a large, one-time special assessment. Additionally, there would be no need for associations to take out a hefty loan.
While preserving the community’s assets is the main goal of a reserve study, there are other reasons why it is something every association needs.
Board members have a fiduciary obligation to maintain the common elements and areas in the community. They can’t feasibly fulfill this obligation without a reserve study in place. A reserve study lets board members know how much money must be available at any given time to cover the cost of repairs and replacements.
Delaying repairs or replacements may seem like a viable option. However, that would only have a negative impact on the association. The components will deteriorate, which will hinder functionality as well as appeal. Both of these factors can significantly affect property values.
Furthermore, many lending institutions require associations to produce a copy of their reserve study before qualifying for a loan. Homeowners may also need to present a copy of this study to mortgage lenders when taking out a first or second mortgage.
Reserve study companies generally offer three types of reserve studies: a full reserve study, an update with a site inspection, and an update without a site inspection.
A full reserve study includes all the bells and whistles. It involves a physical walkthrough of the community to determine the condition of assets and take accurate measurements.
An update with a site inspection also involves a physical walkthrough of the community, but it does not include any measurements. Finally, an update without a site inspection doesn’t come with a walkthrough at all. Instead, the company will simply make adjustments based on an existing study and update it to account for economic changes.
There is a fourth type of reserve study, though not all companies offer it. It is a DIY reserve study wherein the association conducts the site inspection itself. The company will then make calculations based on the collected data.
More often than not, all types of reserve studies come with a funding plan, budgeting charts, and a comprehensive evaluation of the components. The only real difference is the site inspection. If your community recently underwent a full reserve study, then you can simply opt for an update.
Ideally, all organizations and institutions that are responsible for maintaining common areas or elements should hire a professional to conduct a reserve study. These include homeowners associations, condo associations, timeshare communities, golf communities, country clubs, churches, schools, and the like.
A reserve study is not always required, though. There are two factors to consider when determining reserve study requirements. First, your association must look to state laws.
Some states clearly require associations to conduct a reserve study. For instance, California Civil Code Section 5550 requires reserve studies at least once every 3 years. Because reserve study requirements by state can vary, it is important to check your state laws for guidance.
The second factor is the governing documents. An association’s governing documents may require it to conduct a reserve study every so often. Again, governing documents can differ from one organization to another. Thus, you should review your bylaws and CC&Rs to know if such a requirement exists for your community.
Some associations might want to skip the reserve study and simply keep their reserves funded according to a general rule. Unfortunately, there is no rule of thumb that applies to all associations in this aspect.
Every association is different. One association may need a smaller sum in its reserves due to the nature and number of common elements it maintains. Another may need a larger sum because it has more facilities and common areas.
The only reliable and accurate way to determine how much you need in your reserves is to conduct a reserve study. An analysis of your association’s assets, inventory, and current funding balance will help you better plan for your association’s future.
Clearly, a reserve study plays a key role in the success of any organization. Attempting to make the calculations yourself, though, is not recommended. For an accurate and comprehensive report, it is best to seek the help of a reserve study company.