What a Reserve Study Is and What a Reserve Study is Not
There is often confusion with Board Members and other Vendors as to what the reserve study is and what it is not. Below is a breakdown of what you should expect of a reserve study when ordering for any Association you are working with:
A Reserve Study Is:
- A budgeting tool utilized by an Association for the long term allocation rates to the reserve account
- A timeline for expected common area expenses and it provides related expenses for these common area expenses.
- An indicator of where the Associations funding level is in relation to the reserve account balance.
A Reserve Study Is Not:
- It is not the annual recommended budget or a document to rely on for annual maintenance expenses – a reserve study may give guidance for the ongoing maintenance of some common areas in order to maximize or extend the useful life of the component (e.g. remove oil stains from asphalt, carpet cleaning or pressure washing recommendations) but there is not related costs for these recommendations.
- The reserve study is not a comprehensive building inspection, engineering report, an instrument to perform deconstructive testing and does not provide the reasons for common area component failures.
- The reserve study does not provide recommendations for upgrades or replacement of components with materials that are materially different in quality, appeal and expense unless the reserve analysts are notified of code requirements that dictate so or the Association has a scope of the upgrade to provide in the study. An example of this would be replacing chain link fencing with more costly decorative cedar fencing as this would typically be considered a capital improvement and not a reserve expense.
- Lastly a reserve study is not set in stone but is a liquid document that will change with time. The component list, their related costs and their related useful life expectancies will change with time as a history of actual expenses is developed, Boards goals change, statutory requirement change and the component list changes (e.g. removal of a playground or inclusion of plumbing repair contingency).
Most communities will have two separate accounts established one being the operating / maintenance account and the other being the reserve account. They are described below:
- Operating / Maintenance Account: pays for ongoing maintenance expenses related to items such as insurance, utilities, maintenance of common area such (e.g. mowing the lawn & cleaning the pool). The operating account is often set up with the bank under a checking account as there is a lot of activity from this account and money is constantly moving in and out of it.
- Reserve Account: pays for common area expenses related to larger scale replacement and repair that are less frequent but tend to be more costly. This would include common area replacement expenses such as roofing replacement, exterior paint, pool resurfacing, etc. Associations often establish a savings account with the bank as the designated “reserve account” so as the account grows with time there is the advantage of collecting interest on the balance.
A reserve study is conducted to provide guidance to an Association regarding the amount and time frame for which a specific community should fund there Reserve Account. The study will consists of recommendation on how much the Association should allocate to the reserve account, measurements and quality of the common areas, current and projected costs related to the repair / replacement of the common area building and site components and a timeframe for which to expect these larger scale projects to be conducted. It is important to remember that for almost all States there is no legal requirement to fund or allocated specific amounts to the reserve account but there are general guidelines and other parties, such as Lenders, which have their own guidelines for reserve account allocation rates.
The Two Parts of a Reserve Study
A reserve study consists of two parts the Physical Analysis and the Financial Analysis. They are described below:
- Physical Analysis: During a site inspection of the building and grounds the reserve analyst will quantify the common area components, determine when components were placed in service, condition assessments, take lots of pictures and take a lot of notes. Board members and vendors will be interviewed for all related information regarding the common areas and the history of expenses related to repair / replacement of them. Additionally extensive research into the costs for replacement of the common area components is established utilizing these information from these interviews, bids, invoices, cost manuals, in-house costs databases, etc. It is the goal of the reserve analyst to determine realistic useful life expectancies of the common areas, remaining useful life of the common areas and costs for large scale replacement / refurbishment of these common areas.
After all this information is compiled and determined to be accurate and comprehensive the reserve analyst will move on the financial analysis which is directly based on the information collected during the physical analysis. If the component list, costs, useful life or remaining useful life are not accurate the recommendations in the financial analysis will not be as accurate or reliable for a community to base their funding goals on.
- Financial Analysis: Utilizing the research and information obtained during the physical analysis, statutory requirements, National Reserve Study Standards and the Associations goals’, the reserve analyst will develop numerous funding options for an Association to follow and adequately prepare them for the elated expenses over a long period of time (typically 30 years). Some of these funding scenarios will be based on statutory requirements, others on goals of the Association and at least one recommended funding scenario which will guide the Association on a fiscally responsible path.
Other than recommendations and funding plans the reserve analyst will also provide a “Percent Funded” calculation in the reserve study. This is a current rating of where the Association’s reserve account actually is versus how much they should ideally have in it.
Funding Plans in a Reserve Study
Most of the time Funding Plans are based on statutory requirements and the recommendations of the reserve analyst but some Associations will also have their own plans they would like to be incorporated into a reserve study. Below is a brief overview of some of the more common funding plans utilized:
- Full Funding Strategy - Given that the basis of funding for reserves is to distribute the costs of the replacements over the lives of the components in question, it follows that the ideal level of reserves would be proportionately related to those lives and costs. If an association has a component with an expected estimated useful life of ten years, it would set aside approximately one-tenth of the replacement cost each year (ignoring interest and inflation). At the end of three years, one would expect that three-tenths of the replacement cost to have accumulated, and if so, that component would be "fully-funded." This model is important in that it is a measure of the adequacy of an association's reserves at any one point of time, and is independent of any particular method which may have been used for past funding or may be under consideration for future funding. The formula is based on current replacement cost, and is a measure in time, independent of future inflationary or investment factors. When an association's total accumulated reserves for all components meet this criteria, its reserves are "fully-funded."
- Baseline Funding Strategy - The goal of this funding method is to keep the reserve cash balance above zero. This means that while each individual component may not be fully funded, the reserve balance overall does not drop below zero during the projected period. The Baseline Funding Model is required to be included in a reserve study for common interest communities in Washington State. It is considered a bare minimal approach to funding but carries a higher risk as in the years when the reserve balance falls to close to zero even a minor component failure could place the community in a position of having insufficient funds.
- Threshold Funding Strategy - Threshold funding is based on a predetermined dollar or percent funded amount by the Client or reserve analyst. An example of this would be the Client requesting to be fully funded within a 15 year period; the reserve study would have a funding scenario that guided the Association to a fully funded level at year 15.
- Statutory Funding Strategy - This method is based on local statutory requirement. Washington State Laws state all reserve studies must include a Baseline Funding Plan, a Reserve Analyst’s Recommended Funding Plan and a Funding Plan that results in a 100% funded reserve balance within a 30 year period.
Updates to a Reserve Study
As a community ages there will be more accurate and reliable actual costs and an actual timeline of expenses that develop which is typically more accurate than the projections in the initial reserve study. This is due to the reserve analysts using average costs and average useful life of component used in an initial reserve study as opposed to actual costs and useful life (unless provided). For this reason the reserve study will typically become more accurate with time and updates in subsequent years. An example of this is a roof which lasted 25 years instead of the 20 years that was projected; an update to the reserve study would likely revise the useful life of the roof to 25 years if the same materials and craftsmanship are utilized.
Update requirements vary by jurisdiction but here in Washington State the reserve study must be updated annually with an actual site visit every 3rd year.
Levels of Reserve Study Service
- Level I Reserve Study: This is considered a “full” study with a site inspection, component analysis and financial analysis. This is the most comprehensive of the three levels of service and is for communities which have never had a reserve study completed or would like to start from scratch instead of utilizing past studies.
- Level II Reserve Study: This is an updated to the full study which would typically be completed every 3rd year (in Washington State) after the initial Level I was completed. There is a site inspection but the component list and measurements/quantities are taken from the prior study performed. This is typically less costly than a Level I as the reserve analysts will not be completing measurements on the date of the site inspection but only determining whether the components are deteriorating as expected or need adjustments.
- Level III Reserve Study: This is considered a financial update and no site inspection is performed. The component list, condition levels and information related to the useful life and remaining useful life are obtained from the prior study. Updates are made to the component estimated costs as well as the Associations financial and plans for items like special assessments and projects completed or out for bid.
Finding a Qualified Reserve Study Professional
There are two designations in the reserve study industry which are widely accepted as helping to elevate the industry standards and professionalism. The Community Associations Institute (CAI) has the Reserve Specialist (RS) designation and the Association of Professional Reserve Analysts (APRA) has the Professional Reserve Analysts (PRA) designation. A designation ensures the reserve analyst is following ethical and industry specific criteria in providing comprehensive and reliable reserve studies to common interest communities. Obtaining these designations require significant amount of work related experience, references and/or ongoing educational requirements to keep up on industry trends.
As with any industry there are some companies that have a history and reputation of providing great service and others that do not. Some companies will have lower fees but inferior or brief reports and other companies that may be more expensive but have more comprehensive reserve studies and provide superior service to Property Managers and Associations. Which type is the best fit for the Association you are working with may be dictated by their budget or Board views on the matter. In the end it will be a direct reflection of you as a property manager though so reserve studies that are comprehensive, accurate and on time, in our experience, put you in the best light to your customer.
Written by Joel L Tax - Professional Reserve Analyst - 06/01/2016