Below is a list of common questions we hear and answers to them from a professional reserve analyst.
We have no reserve account. Should we?
Yes, all common interest communities with any significant common areas to maintain / repair / replace should be reserving for the inevitable outcome from years of use and deterioration of common area components. We often see HOA communities which have signage, fencing and landscaping but with no reserve account established. When there is a large reserve project expense such as a fence to replace, there are often no funds to draw on to pay for it. These communities typically must special assess the homeowners which is often a difficult process. The implementation of a reserve account early on in a community’s history will help to alleviate the reliance on special assessments as long as the reserve account is funded adequately from the beginning. Special Assessments should remain an extremely rare occurrence and should not be necessary for expected expenditures.
Do we need a separate reserve account?
We always recommend communities have separate accounts for operating expenses versus reserve expenses. Pooling money into one account and trying to keep track utilizing accounting software is difficult and requires more time than what the typical Board member is able to provide to a community. Additionally as the reserve account grows it is extremely tempting to dip into the reserve funds for other maintenance items, specifically when there are economic downturns and membership is against raising HOA dues. A separate account entirely helps to mentally separate this; much like a personal retirement account versus your checking account.
Should we invest our reserve account funds?
Communities which have a large reserve account balance often choose to invest their funds which in our opinion is a great option as long as the funds are in very low risk government backed instruments that are also liquid enough to withdraw when needed. During “Peak” year cycles a community may need access to a very large percentage of the reserve account funds so adequate planning and making sure the funds are available (without penalty) is important.
How often should we have a Reserve Study Completed?
Many states have annual disclosure laws to the membership of the community. Typically these disclosures requirements indicate the membership must be told the “Percent Funded” level a community currently is at. This is not a self-evident concept and requires a review of the components costs, useful life and review of the account balances. So to meet disclosure requirements reserve studies must be completed annually. After an initial Full Level I Study many states require subsequent years of Level III Update Studies which are sufficient for the Disclosure Requirements. After several years many States require a Level II Full-Update for a physical re-inspection of the components to determine if assumptions, condition assessments, useful life expectancies, etc. are holding true. So how often – We suggest annually but with different levels of studies depending on where a community is at in their timeline of studies.
We are at a Poor Funding Level – What Now?
Well you are in good company first of all. A very large percent of communities are in a Poor to Fair funding level when reliance on loans and special assessments is highest. Additionally Associations with Poor funding levels are at much greater risk of litigation, typically due to membership feeling that the Board/Association has not met their fiscal responsibility to the community over time. A reserve study is suggested first of all. From there implementation of the reserve study is important to make sure the community is set on a path of adequate funding in the future. Many communities will have to make touch decision and raise hoa dues, implement assessments or delay repairs in order to get on track. It's important to remember that an underfunded reserve account is typically due to the lack of adequate funding in the past. At some point in time someone will have to pay for the reserve project expense. Adequately planning ensures membership is fairly charged their fair share of this deterioration.
What type of issues arises from being at a poor funded level?
A poor funding level results in a higher risk for reliance in special assessments, reliance on loans, deferred projects, higher litigation risk, lower marketability and tougher lending requirements. With few exceptions it has been our experience that these negative consequences always come to fruition with enough time at a poor funded level.
Can any community expenses be paid from the Reserve Account?
Reserve account balances are set aside for the repair / replacement of common areas outlined in a reserve study. Operating expenses such as lawn mowing, insurance, utilities are monthly or annual contracts which should not be paid from a reserve account. Reserve Account balances typically cover larger expense items that are infrequent (sometimes over 20+ years) but that will come due at some point. It is extremely tempting to utilize reserve funds for other purposes especially when the account grows to a size that appears to be more than adequate to an untrained eye. There are tax and legal consequences to utilizing reserve funds for other matters and it is best to address these with the help of a professional in those fields.
Are Reserve Study Professionals licensed?
Reserve analysts' are not licensed in most states (Nevada the exception). There are National Reserve Study Standards and designations from the Community Associations Institute (RS) and the Association of Professional Reserve Analysts (PRA) which require a significant amount of experience and understanding of concepts to obtain. When hiring a reserve study company ask about these designations.
How much does the Study Cost?
Reserve Study providers typically charge based on the amount of time needed to complete the inspection, complete the necessary research and compile the data into a report. The larger a community is and the greater number of common area components will result in a higher price. We provide free proposals for our services after some preliminary research is conducted on the property.
Written by Joel L Tax - Professional Reserve Analyst - 03/05/2016