A reserve fund is like a nest-egg that every association needs for unexpected events and major expenses. This money comes from the owners’ monthly fees, which are split between the operating budget and the reserve fund. Over time, the money put into the reserve fund accumulates so that when the HOA needs to replace mechanical equipment or a roof, the funds are available to do so without asking for a special assessment.
A reserve fund study is a document that determines how much money owners need to contribute to the reserve fund. This study also looks at the components that the association owns and predicts future repairs and refurbishments. This way, the engineer or professional performing the study can provide a realistic contribution amount. Doing a reserve study helps to guarantee the association’s long-term financial and physical well-being.
Read on as we dive deep into the nitty-gritty of reserve study preparation, its benefits, and what HOAs should consider when looking for a reserve study company or analyst.
What is a reserve study?
A reserve study is a report that’s designed to provide a framework of the common areas that the HOA is responsible for. This study also provides replacement cost projections based on a 20 to 30-year trajectory. This gives the HOA plenty of time to plan for the long-term maintenance of components.
The HOA can use the reserve study to create a detailed timeframe for the replacement of each major component, including windows, HVAC, paint, roofing, etc. This gives the association an indication of how much is needed to replace and maintain these components without asking for special assessments.
A reserve study usually comprises of the following elements:
- A summary of how much the HOA has in its rainy-day fund (aka reserve account) to fund current and future projects
- A list of relevant components that the HOA is responsible for
- Projected expenditure for said components as it relates to current and future refurbishment
- The remaining useful life of the various components
- A detailed repair and replacement schedule for all components
- Funding plans that concur with local and state legislation as well as any professional recommendations
Benefits of a reserve study
The HOA board has a fiscal and legal responsibility to maintain the common interests of the community. Among other things, the board is legally required to ensure that the HOA is adequately prepared for common area repairs and maintenance costs. This places a huge responsibility on board members to ensure that the HOA doesn’t fall on financial hardship that might lead to special assessments, lawsuits, and other legal liabilities.
Help to maintain community values
If left unchecked, communal property values will naturally depreciate over time. A long-term reserve study makes it easier for the HOA to maintain the property, no matter how many board members it goes through.
A well-prepared reserve study provides a detailed framework for funding long-term maintenance projects over the years.
Without proper planning, a community will eventually have to rely on loans and special assessments in order to operate.
It makes the association more favorable to financiers
Modern-day lenders know all about the importance and processes behind an HOA’s reserve account and often use it as a benchmark to judge the fiscal health of a community before engaging in a partnership.
Modern lending guidelines reflect this knowledge as they require HOA boards to allocate a predetermined amount of their budgets to a reserve account.
To this end, most lenders will also ask for a minimum 12-month reserve study that has been prepared by a reserve study company for the HOA board. HOAs must meet these requirements in order to acquire loans, refinancing, and sales.
How do you know if an HOA reserve is adequately funded?
Unfortunately, you can’t just look at the reserve account balance and decide that an association is adequately funded. In addition to checking what’s in the bank, it’s important to check for completed projects.
If work has been completed and the balance is low, then the reserve is adequately funded. On the other hand, an association could have a large balance and an even bigger backlog of projects to complete, which leads to an inadequately funded reserve account.
It’s important for owners to hold HOA boards accountable by ensuring that they follow a sound reserve fund study. You can’t just rely on the numbers. You have to balance it out against the work that has been done or pending projects that are coming up.
How to prepare a reserve study?
The process of preparing a reserve study starts with a review of the HOA’s key documents, including the community blueprint, governing documents, well-articulated minutes, documentation for votes and communal maps. This provides a thorough understanding of the association’s responsibility towards the reserve account.
Next, a reserve analyst must review and note the association’s financial information, starting with income from member dues/fees. Below the income are a few expense lines that include all of the association’s regular operating expenses, as well as reserve account expenses.
Below that there’s usually a summary line that shows the balance between income and expenses, thus determining whether the HOA has a positive or negative overall balance. This part shows both the HOA’s operating bank account and reserve bank account balances.
Next, the analyst should place all of the association’s recurring expenses under ‘operations’, and escalate them at a typical rate of 2% per annum. After that comes the association’s extra capital improvement expenses in the appropriate years where they belong. For instance, if the roof has five years left in its lifespan, provisions must be made for a roof replacement in year 5, or even year 4. However, there must be corresponding revenue coming in during that time period to support this expense.
From here, the analyst needs to plug in all of the association’s expected major reserve expenses, from roof, siding and window replacement to concrete repairs and any other large capital improvements that should be done over the next 30 years.
Next, they’ll take a look at the association’s net operating reserve accounts to see if the balances support all of the day-to-day operations, as well as the long-term reserve costs. If they don’t balance, there are a few options to consider. The HOA can either;
A. Raise the dues: Instead of increasing HOA dues by 2%, the association my try a 3, 4 or even 5% increase to see if that fills the gap. The goal is to prevent a negative balance on HOA accounts over the next 5 to 10 years.
B. Special assessments: Homeowners generally dislike special assessments because it’s an indication of poor planning. It means the HOA didn’t properly foresee upcoming expenses or capital improvements. I can also mean owners have to pay the HOA thousands of dollars all at once.
That’s why it’s very important to map out a detailed reserve study to help avoid special assessments altogether.
C. Loans: If special assessments aren’t feasible for the HOA, the board might consider taking out a loan. Some smaller, local banks are willing to offer loans against member dues. Sometimes, they will put a lien on the physical property to facilitate the loan, or provide the loan against the receivables as stipulated by the HOA.
Although this option may help to avoid special assessments, the association ends up paying interest, thus escalating the repair costs due to the loan and the interest costs.
HOA board members should communicate clearly with one another to ensure that the type and timing of the improvement, and the cost is understood by all.
Also included in the reserve study is a component analysis which involves a site inspection that helps the analyst to compile an accurate list of components. The analyst must also determine the quantity and value of the components, as well as the remaining useful life. Here are common components that are often included in a reserve study:
- Roof replacement
- Replacement of HVAC equipment
- Asphalt overlay/ seal coat
- Replacement of fencing
- Pool re-plastering
- Replacement of siding
- Replacement of lighting
What should be excluded?
The following common area components may be excluded from the main component list and mathematical models, but may be listed under a section titled “unfunded component.” This includes components that are:
- Below threshold costs. This includes component replacement costs that are usually covered in the association’s maintenance and replacement budget
- Operational expenses. This includes predictable annual expenses like lawn care, janitorial services, and pool cleaning, for instance
- Unpredictable useful life expectancy. Components whose useful life expectancy is unpredictable, but whose maintenance can be funded by the association’s operational budget
Make sure the study meets statutory requirements
Every state has laws that make provisions for reserve study requirements. This provides a framework and a standard that every reserve study should meet. Most importantly, these laws are meant to ensure that the reserve study is of acceptable quality and will provide clarity to association members.
Whether the board decides to prepare the study on its own or hire a reserve study company, it’s important to ensure it meets statutory requirements.
When do unit owners get involved?
Every time a reserve study is done, unit owners receive a notice of future funding. This document contains vital information about upcoming contributions and unit owners should look at it to see if an HOA is indeed following the reserve fund study. This document also gives members a sense of how much that contribution increase is going to impact their monthly fees.
Steps to follow when hiring a reserve study company
We’ve already shared the benefits of a reserve study. Now, it’s time to look at the considerations that an HOA board needs to make before and during the reserve study company selection process.
HOA boards can follow these steps to narrow down their options and help them make an informed choice:
1. Ask around
As with anything, it helps to get the opinion of others about a service provider before you hire them. This gives you the opportunity to to make sure that their reputation matches their sales pitch. Ask board members from neighboring communities what their experience has been with certain service providers, or ask them to recommend a company based on their experience.
A reserve study company with a positive reputation is likely to exhibit the same performance over time.
2. Consider experience
When performing due diligence on a reserve study company, it’s important to find out how experienced their analysts are. A company is only as good as its employees and internal experts.
A seasoned reserve analyst will have experience in dealing with different types of properties. That means they already have an understanding of what it takes to ensure the long-term success of almost any community.
Experienced analysts will use their depth of knowledge and experience to create a relevant and accurate funding model for each association.
The reserve study industry has created two main designations to ensure professionalism and adherence to industry standards. First, you have the Community Associations Institute ‘s Reserve Specialist (RS) qualification and the Association of Professional Reserve Analysts’ (APRA) Professional Reserve Analyst (PRA) qualification.
The purpose of each designation is to provide an ethical and professional framework for reserve analysts to follow. It also gives peace of mind to association boards knowing that they’ll provide a reliable and comprehensive reserve study based on industry standards.
Also, it takes years of work and study involving peer review, references and work experience to acquire just one of these designations. Analysts who hold these designations are also required to undergo continuous education in order to uphold ever-evolving industry standards and legislation.
Some companies will hire inexperienced analysts in order to save money on overheads, but this leads to subpar work that ends up costing their clients more in the long run.
The reports are usually inaccurate due to an inability to adequately perform a site inspection. Keep in mind that the component list is the foundation of the reserve study, so it’s important to ensure that it’s absolutely accurate.
HOA boards should ensure that a reserve study company has a team of qualified and experienced reserve analysts with proper designations.
4. Look for local professionals
Hire a local reserve analyst to avoid being swindled by out of town fraudsters. It’s not uncommon for professionals in other fields like engineering or construction to start a reserve study company in order to capitalize on an opportunity without understanding the industry standards, legislation and other requirements of preparing a reserve study.
Once they’ve balanced their checkbooks, these operators will often return to their own neck of the woods, leaving you without any support after the initial reserve study is completed, and forget about getting any revisions done.
A reserve study offers factual data that the HOA can use to make informed decisions about the community’s future.
It enables the association to prepare a reserve budget to plan for the replacement and repair of important infrastructure and building components. This helps to ensure that the HOA has enough stored in its coffers to cover large unexpected expenses.
A detailed list of reserve components improves the board’s ability to protect property values, save on expenses and make informed decisions.
All told, reserve study plays an important role in ensuring the long-term maintenance of the property. But, all of this is possible only when the reserve fund is well funded to cover any expenses that arise. Also, associations are advised to maintain a healthy reserve fund in order to avoid unfair and burdensome special assessments.
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