HOA Reserve Studies
Using a Reserve Study Effectively
When buying a home, what are the first things to think about? Some considerations may include: location, the quality of nearby schools, number of bathrooms and bedrooms in the home, etc. If a property is located in an HOA, then the considerations may include: what are the amenities and how high are the dues?
One important topic however is typically not addressed when buying a home within a HOA; is the replacement reserve account adequately funded?
Based on recent statistics of over 30,000 homeowner associations, the answer is most likely no. On average, about 40% of associations are in the ‘Fair’ range, meaning that there is a 10%-20% chance of risk of special assessment. Approximately 30% of associations are in the ‘Weak’ range where the risk of special assessment and deferred maintenance jumps to 30%-60%.
How can a savvy buyer know whether or not their association is at risk for special assessment and why should they care?
A special assessment is fee levied on current homeowners to cover expenses or projects. For example, if there is a 10 unit condominium with a $30,000 roof to replace and no money in their reserve account, then each owner must pay a $3,000 special assessment to cover the cost of replacement. The reason this is a problem is that this situation can be easily avoided if the prior board and owners had been putting money away for this predictable expense. If a potential buyer was not aware that the reserve account was not sufficiently funded for this expense, then once they move in, the new homeowner will have to cover the $3,000 bill!
A Reserve Study is the best way to establish whether or not an association is at risk for a special assessment or deferred maintenance as well as providing direction and recommendations to current owners on how to be proactive with their funding. Maintaining an adequate Reserve Fund is a bit like saving for retirement: a bit of self-denial now prevents a bigger problem later.
A Reserve Study helps boards explain how a sound plan for maintaining or replacing common area elements benefits all owners right away, as well as in the long run. As soon as their Association receives and begins to implement the Reserve Study report, current member-owners benefit in several ways:
- Reduced conflict. Assessments based on a Reserve Study are founded on hard facts and objective analysis. Owners may still disagree about how quickly to top off their Reserve Fund, but with the report in hand; discussion can proceed from a baseline of accepted facts.
- Predictable costs. Without a Reserve Study, owners never know when the next maintenance surprise will bring about a sudden Special Assessment. Once leaders start to act on the Reserve Plan, owners know what to expect, and develop confidence in their Manager and Board.
- Enhanced resale values. Savvy buyers take Association fees into account when they decide how much to offer for a unit. One of the most frequent objections selling agents hear from prospects is, “How do I know fees won’t go up after I buy?” A professionally-written Reserve Study is the best response to this concern, because it provides exactly the disclosure buyers are entitled to and the assurance they need.
In addition to the points above, the Reserve Study will also promote fairness among all owners, present and future. A Reserve Study must provide the following factors when providing funding recommendations:
- Adequate Reserves when Required
- Budget Stability
- Fair Distribution of Contributions
- Fiscal Responsibility
To elaborate, fundamentally the Reserve Funding Plan must provide adequate funds when they are expected to be required at a future point in time.
If $30,000 is needed in the year 2020 for a new roof, the Funding Plan should yield a Reserve Balance of at least $30,000 in that year. Because associations are corporations and their members expect and deserve the corporation to be run in a stable manner, it is important that the budget be designed for year to year stability. Large assessment changes from year to year indicate instability, and homeowners deserve a degree of stability in order to plan their own budgets.
To be fair to the owners and to stay away from accusations of “self-dealing”, it is important to offset inherently unstable periodic Reserve expenses with a stable Reserve income stream. It is fundamentally unfair (and potentially irresponsible) to burden one set of owners (think of the example of the new homeowner) with the cost of a replacing a Reserve component that deteriorated over a period of many years. This means that in addition to spreading the Reserve contributions fairly among the present unit owners, it is important to spread the Reserve contributions fairly among current and future owners. Since Board Members are “fiduciaries” (caring for the assets of others), they have to act in a fiscally responsible manner, making sound, business judgement decisions. Board Members must to act as corporate officers of multi-million dollar Real Estate corporations should act, making responsible, informed plans as they fulfill their job to “maintain, protect, and enhance” the assets of the corporation.
Rather than being in the dark about upcoming projects, current homeowners and savvy buyers should utilize the data provided in a Reserve Study to assess the current trajectory of an association’s reserve account. This data, provided by a credentialed professional, will bring insight and order to a distracted and cluttered housing environment and allow homeowners to make wise decisions about the care of their properties.
Bryan Farley
About the Author
Bryan Farley has completed over 1,500 Reserve Studies and earned the Community Associations Institute (CAI) designation of Reserve Specialist (RS #260). His experience includes all types of condominium and homeowners’ associations throughout the United States, ranging from international high-rises, historical monuments, and municipalities. Bryan is a frequent educator and author on the topic of Capital Reserve Planning.