Preparing for and overseeing a homeowner association's finances are perhaps the most important board responsibilities. It takes money and careful planning to maintain and preserve common area property. One of the best forecasting tools is a "reserve study", needed to identify common element components, their useful lives and cost of repair or replacement. Unlike the weather, this is one forecast that actually happens pretty much as predicted.
Reserve plans generally cover a 30 year projection period so that roofs, decks, fences and other long lived and expensive components can be included. They analyze several aspects of the components:
Physical Analysis. A site inspection evaluates the current condition of each reserve component with the goal of determining it's a) remaining useful life and b) useful life when new. (If the construction is new, both a) and b) will be the same.) The inspection may also reveal improper construction or material which the board should consider correcting sooner (if structural failure, dryrot, etc. is indicated) or later if improved materials and designs are now available and it just makes sense to upgrade.
Financial Analysis. The financial analysis includes taking into account what the HOA currently has in its reserve fund, how much it will cost to fund future repairs and replacements, current rate of area inflation and rate of return on invested reserve funds. The term "Percent Funded" is an important indicator and it works like this: Each reserve component has an ideal amount that should be set aside each year to be 100 percent Percent Funded.
For example, if a roof has a 20 year life and costs $200,000 to install, $10,000 ($200,000 ÷ 20 years) should be reserved each year to be 100 percent Funded. So, in the roof's third year of life, $30,000 should be in reserve. If, say, only $15,000 of that $30,000 is reserved, the roof is only 50 percent Funded at that point in time. Repeating this exercise for all the reserve components will produce an overall Percent Funded.
The value of being 100 percent Funded is that there will be no need for special assessments in the future. The 100 percent Funded approach is fair to all members along the 30 year time line since all are paying their full share as years pass. If the reserve plan indicates the HOA is less than 100 percent Funded, a contribution plan can increase that level toward 100 percent over a period of years to close the gap.
Reserve Fund Investing. One great part of the Financial Analysis is that the board has a clear picture of when reserve funds will need to be spent. This permits an investment strategy to generate interest income. The better job the board does on investments, the less money needs to be contributed by the members. Since there are a variety of investment options available, the board should typically look for the highest returns on Certificates of Deposits which exceed the current rate of inflation. Money market and savings accounts typically yield far less than the rate of inflation so reserve funds will actually lose value. The importance of getting the highest (yet safe) yields cannot be understated. Interest revenues can yield tens or hundreds of thousands of dollars over a period of 30 years.
Answer the Nay Sayers. Some members are reluctant to contribute to reserve funds because they feel that reserves will benefit future owners which may not include them. In reality, a properly and consistently funded reserve plan fairly divides costs up in proportion to the benefit received. If reserves are collected monthly, for example, each owner pays for only the actual benefit received for that month. While the reserve money may not be spent for years in the future, those paying in get exactly what they paid for, no more, no less.
Be Lender Friendly. Mortgage lenders are paying closer attention to the signs of a well managed HOA when they qualify buyers for loans. The reserve study is routinely found on lender information request forms. Lenders know that the better the HOA's planning is, the more secure their collateral will be.
Be Buyer Friendly. Most home buyers are stretched to the limit on home purchases. The last thing they need is a special assessment to complicate their finances. With a proper reserve plan, large expenses can be anticipated and funded years ahead of time. When the board advises all owners the plan, surprises and special assessments are eliminated. It just makes sense that homes in HOAs that are well managed sell for more and faster.
Update Your Forecast Yearly. The key to keeping a 30 year forecast accurate is by making small course corrections along the way. Reserve plans need to be reviewed each year and adjusted as needed. Even if no reserve related work is done, the rate of inflation, return on invested reserves and Starting Balance in reserves changes each year. Each of these variances has a significant impact on the projections.
There is a great future in forecasting. Don't let your future become your past.
For more on reserve planning, Reserve Planning and apra-usa.com.