A reserve study analyzes major repair and replacement needs like roofing and painting and provides a funding plan for accumulating money to perform this work when its needed. It is a fundamental planning tool that all homeowner associations (HOA) need.
There are several parts to the reserve study: First, all major HOA maintained components are identified. Next, the cost to renovate each item is then determined by contractor bid or construction cost estimate. Then, the remaining useful life in years of each item is established. These items are plugged into a mathematical formula:
Cost ÷ Remaining Useful Life = Money Needed Yearly for Reserve Fund
For example, if roof replacement costs $100,000 and the remaining useful life is 25 years, then $4,000 should be reserved yearly to pay for the work when it’s needed. Doing this procedure for each component will show the total money needed yearly to fully fund reserves. Each year, the reserve fund needs to be adjusted by area inflation and the interest earned on the invested reserve funds.
How should these reserve funds be accounted for? Reserve funds should be kept in a separate account from the normal operating funds. It’s conceivable that reserves will grow to thousands or millions of dollars. Prudent investing of these funds will reduce the amount of money contributed from owners. Since the reserve study shows when money will be needed, long term investments can be purchased that will return more than savings or money market accounts. Insured investments like government securities or Certificates of Deposit are recommended, however, there are other options so consult with a knowledgeable financial advisor.
When should a reserve study be performed? All homeowner associations, regardless of size, should have a reserve study done. Once done, yearly updates are needed to keep it accurate. If the HOA has inadequate reserve funds to begin with, the reserve study will provide a funding plan for "catch up". To replenish the fund, several options are available:
- Special Assessment (lump sum contribution from each owner)
- A phase-in period of several years where HOA fees increase each year
- Combination of #1 and #2
Whatever course of action taken, the goal should be to reach "100% Funding" which means the HOA will have the funds it needs to meet future repair and replacement events.
What sorts of financial problems can homeowner associations encounter with inadequate reserve funds set aside? Without adequate reserves, HOAs must rely on high interest rate loans or special assessments. Special assessments are unfair because owners that have bought and sold in the past fail to pay their fair share and current owners end up "holding the bag". Special assessments are always a hardship on some owners and may be uncollectible if an owner’s equity and assets are small. Also, since special assessments are unpopular, the tendency is for the board to postpone doing renovations. This deferral accelerates the deterioration process, detracts from curb appeal and erodes resale values. A reserve funding plan with regular and adequate contributions from all owners is fair and insures that renovation is done when it’s needed. Rarely, if ever, will special assessments be necessary.
Can poorly managed reserve funds affect the sale of units? Absolutely. Buyers and lenders look closely at how reserve funds are handled by the HOA. Lack of reserves is a red flag for an inevitable special assessment and a sign of poor board planning. If given the choice between buying into an HOA with healthy reserves or one with little or none, which would be the wiser investment?
Which types of repairs must be paid for by HOA funds vs. individual property owners? In common wall HOAs like condominiums, the owners are usually responsible for windows, entry doors and unit interior repairs while the HOA is usually responsible for items like roofing, landscaping, siding, painting, paving, sidewalks, pools, clubhouses, signage and fencing. But the governing documents are the authority on who does what.
What kind of qualifications should a reserve study provider have? The reserve study provider should have good budgeting skills, general construction knowledge, construction cost estimating experience and a clear understanding of HOA operations.
How much does a professional reserve study cost? Reserve study professionals typically base their charges on the number of components included in the study, the number of units/homes, the age of the HOA and availability of historical information. Travel expenses are a cost factor for distant properties. The charge is usually several thousand dollars and up depending on the complexity and location.
Are their professional qualifications for reserve study providers? Yes! Using an objective, knowledgeable and experienced professionals who carry the Professional Reserve Analyst (PRA)TMcredential is highly recommended.