7 things you should know hoa reserve funds

1. Laws regarding Reserve Funding Levels, Reserve Studies and Reserve Contributions differ from state to state.

Reserve Study Laws and Reserve Funding Legislation vary by state. Click here for an interactive map and complete list of Reserve Study laws by state. In the absence of specific legislation regarding Reserve Funding, associations should refer to their governing documents (Covenants Conditions and Restrictions) with the help of a qualified attorney specializing in HOAs. The following resources provide additional information regarding basic fiduciary duties of boardmembers.

Council of Non-Profits “Board Roles and Responsibilities”

www.councilofnonprofits.org/tools-resources/board-roles-and-responsibilities

CAI Best Practices “Reserve Studies/Management”

http://www.cairf.org/research/bprs.pdf

Arizona Seller Disclosure Laws

http://www.re.state.az.us/Publicinfo/

2. Understanding the term “Fully Funded Balance” is one of the most important factors in understanding your Reserve Study.

This term is confusing to most homeowners and boardmembers. Providing the detailed mathematical formula tends to complicate things even worse!

In simple terms, the Fully Funded Balance represents the total accumulated depreciation for all Reserve Components. This still sounds complicated, so let’s use an example to explain: Association XYZ is only responsible to repaint a Metal View Fence. This View Fence is repainted every 5 years at a cost of $5,000. Here is a nice graphic to illustrate the Fully Funded Balance for this View Fence:

As you can see the Fully Funded Balance increases each year by the annual deterioration rate of $1,000 until year 5 at which time this component will be repainted and the Reserve Funds will be used and the FFB cycle starts over. This basic example is applied to all of the Reserve components at your association and the total is your FFB. Once you understand this basic concept, Reserve Studies become easy to understand and apply.

Note: Annual Depreciation is not the same as GAAP Depreciation. These are two separate calculations with separate purposes.

For all those nerds out there, here is an in-depth look at the FFB formulae and the effects on interest and inflation.

3. Underfunding Reserves is never a good idea.

Underfunded reserve levels always result in one of two outcomes; Emergency funding in the form of Loans and Special Assessments or Deferred maintenance resulting in lower property values.

The exact timing of future reserve expenses is unknown; however the need for future repair and replacement is a certainty. Failing to plan for the future with proper Reserve Contributions violates a boardmembers’ fiduciary duty and in some states is against the law.

4. A Professionally Prepared Reserve Study is an essential financial and strategic planning tool for boardmembers.

A responsible board member will contract with a qualified Reserve Professional to perform a Reserve Study to answer three basic questions:

1. What physical assets does the Association own that will require future monetary resources?

2. How much should we have in the Reserve Fund?

3. How much should we save per month or per year in order to avoid underfunding Reserves?

Accounting Tip of the Day: If you do not have a designated Reserve Fund Account, the IRS can view these funds as taxable income to the Association.

5.   Special Assessments and Loans are always more expensive than Proper Reserve Contributions.

Because Proper Reserve Contributions often result in the need to raise annual assessments, boardmembers will elect to “Save money” by cutting Reserve Contributions from the annual budget. This thinking is simply not true. The graph below compares the total cost to replace a Metal Fence in 20 Years at $150,000 with (3) Options: 1. Regular Reserve Contributions, 2. A Special Assessment 3. A 10 Year Loan at 5%. Regular Reserve Contributions benefit from the compound effects of interest earnings so the required funding is actually less than the cost to replace the fence of $150,000.

In addition to the financial benefits of making Regular Reserve Contributions as illustrated above, another reason for adequate Reserve Contributions is to accurately determine and set annual assessments which falls under the boardmembers responsibility.

Boardmembers who keep assessments low by ignoring the annual deterioration and funding requirements of common area components are not performing their “Fiduciary” duty. This scenario leaves future homeowners “holding the bag” and forced to raise emergency capital to replace the failed fence. To avoid the above situation, monthly assessments should accurately reflect the cost to maintain association owned assets now and in the future. This is best done with the help of a professionally prepared Reserve Study.

6. Reserve Studies protect and preserve property values.

A Reserve Study is a tool to be used by boardmembers to assist in the proper management and direction of the association’s present and future. If a professional Reserve Study which adheres to CAI standards and APRA is followed, funds will be available to maintain and replace common area components on time and therefore keep community assets in “good repair” translating into value for homeowners.

7. All Reserve Studies are not equal.

Despite one shared idea of “Prepare now for the future”, Reserve Studies differ in methodologies and calculations. For example, A Reserve Provider using the “Modified Cash-Flow” approach will produce a report yielding different results than a reserve provider using the older “Component Method” approach.  When looking to hire a Reserve Specialist, be sure understand the differences between these methodologies.  For more information on what to look for when hiring a Reserve Study Provider, read this article.