Beyond the Basics and Maximizing HOA Reserve Funds
Don't overlook the importance of saving for the unexpected - especially when it comes to your HOA reserve funds. The classic saying "save for a rainy day" still holds true, especially when you consider the potential consequences of not being prepared. Without proper planning, a leaky roof or other unexpected expenses could result in a special assessment and additional financial strain on your community. So, be proactive and ensure your board and management company have adequately prepared for any rainy day that may come your way.
As a board member, your goal is to build a long-term budget that ensures the thriving of your community and maintains your property values. The key to achieving this is by operating on a structured budget with a solid reserve fund and reserve study. Working alongside your management partner and reserve specialist, you can ensure that your reserves are adequately funded, thereby avoiding the need for special assessments as much as possible. By going back to the basics and defining what a reserve fund and study entail, you can set your community up for success.
A reserve fund serves as a collective savings account for community associations to protect against future expenses that are both expected and unpredictable. This financial strategy ensures the stability of your association's finances in the long run and is funded through a percentage of your regular assessments. As a result, your reserve account can gradually increase and help offset unforeseen deterioration costs.
A reserve study assists with an association's long-term financial plan by considering the current status of the reserve fund and determining a regular funding contribution that will offset ongoing wear and tear. The reserve study comprises two things - a comprehensive physical analysis of the current condition of your community's assets and detailed financial analysis.
What Is Percent Funded and How Much Is Enough?
To avoid unexpected special assessments, it is crucial to establish consistent reserve funds. The question is, what amount is sufficient?
Robert Nordlund, the founder and CEO of Association Reserves, explained that determining a reserve fund percentage is "relative" to your specific association needs because it requires a comparison of the reserve fund size and the reserve requirements size. A ratio known as "percent funded" is used to find the reserve fund percentage by comparing how the current reserve fund balance matches up to the association's reserve needs (also known as the fully funded balance)1.
Percent Funded = Reserve Fund Balance (actual) / Fully Funded Balance (computed)
Maintaining healthy HOA reserve funds is essential for financial stability. Experts agree that if your percent funded is below 30%, your reserves are considered "low." Conversely, if you reach 70% or higher, you're in a "high" reserve position- precisely where you want to be. Keep your finances in check and secure the future of your business with this crucial piece of information.
For further explanation and an example, watch a quick video from Kirk Kowieski, vice president at FirstService Residential.
What are the Benefits of Having a Strong Reserve Fund?
Strategically allocating reserve funding is a significant duty held by both the board and management team. While experts suggest maintaining a reserve level of 70% or more, it's crucial to prioritize their use on projects that serve the community's best interests, both now and in the future. It's sound practice to manage these resources wisely for maximum impact. Here are three distinct benefits that residents and board members can expect:
- Peace of mind: A reserve fund gives association members greater confidence and comfort in knowing the money will be there when it is needed.
- Market value preservation: If your community has a strong reserve fund for support, the market value of shared assets and properties could be preserved (or potentially increase). Just like all the good things in life, the higher the value, the better chance at resell.
- Equitable cost participation: You can take pride in your neighborhood and know that you've contributed to the shared amenities that many generations to come will benefit from, including your children or family!
A strong reserve fund can go a long way in setting your association apart and attracting potential buyers to your community. When looking to purchase property within an association, potential homeowners often consider the financial stability and reserve funding of the property. By investing in a robust reserve fund, you can exceed basic maintenance needs and bolster your association's appeal to this audience. Ensure that your association is prepared to attract interested buyers by building a strong reserve fund.
How Can Incremental Assessment Increases Benefit Reserves?
Contributing to your reserves is not easy because it's an indefinite goal that often requires more funding each year. Naturally, most boards want to avoid being the "bad guys" that raise assessments. As a result, roughly 72% of associations have underfunded reserves,2 so many require special assessments when a last-minute project arises, or alternative options (like the one below) don't pan out.
"Associations run into the risk of miscalculating assets while trying to figure out their reserve fund budget. For example, if boards tried to save on reserve fund contributions by requiring every homeowner to manage their own garage door, sure, their monthly contributions will be less, but they have to pay out of their pocket for the door. Also, the association's property values will go down tremendously due to a few negligent homeowners or those who don't care to upkeep their garage door."
- Robert Nordlund, Founder and CEO of Association Reserves
So, what is the best way to increase assessments? Nordlund recommends that most associations follow the "$10 solution," which requires each homeowner to pay an additional $10 a month to the reserve contributions and increase it by $10 every year.
Maximizing your reserves' funding is an essential part of creating a successful and long-term financial plan for your community association. At FirstService Residential, we understand this process and offer sound guidance on how to establish, maintain, and make the most of your association's funding. With our expert support, your association can become empowered to make strategic decisions that ensure financial stability and sustainability. Trust us to guide your association to financial success.
Determining Maintenance Vs. Reserve Components
Determining whether common area components need maintenance, replacement, or both is crucial in deciding their placement in either the annual operating budget or reserve inventory. Proper classification of these components can be challenging, but it is necessary for effective reserve management. For instance, some elements like sidewalks and windows require regular maintenance such as pressure washing and cleaning, while others like roofs and mechanical equipment require replacement. Meanwhile, some parts, including pools and carpeting, need both maintenance and replacement. Generally, less expensive items go into the operating budget, while more expensive items are reserved so that they can be financed over an extended period.
As our communities age, infrastructure components such as roofs and asphalt should not be overlooked in our budget planning process. Though typically out-of-sight, these components have a long lifespan and are critical to the upkeep of our facilities. To ensure we are prepared for their eventual replacement, it is recommended that we add infrastructure items to our reserve components list. This proactive practice will help us efficiently allocate resources and keep our facilities running smoothly.
"Useful life" refers to the length of time that a component serves its original purpose. Every component has a useful life given to it by the manufacturer.
Although manufacturers provide an estimated lifespan for their components, there are numerous factors that can alter this projection, including environmental effects, wear and tear, changes in regulations, and obsolescence. Furthermore, inadequate maintenance can significantly shorten a component's useful life. This can result in the need for premature replacement, often before sufficient money has been reserved for such an expense. To ensure the longevity of components and avoid costly replacements, it is crucial to prioritize and implement proper maintenance practices.
Did you know? There are several ways to test the useful life of a component, including vibration analysis, thermal imaging, laser shaft alignment, trends analysis, and oil sampling and analysis. Work with your management company and engineer or maintenance team to explore these options and more.
Ultimately, your board should aim to budget appropriately for costs that you may not have anticipated to avoid the risk of imposing a special assessment or taking out a loan. If you need help determining whether an item should be included in your operating budget or reserve inventory, consult with your reserve study specialist or management company.
The Reserve Study: A Living, Breathing Component of Your Success
How will you determine which items to develop, upgrade or replace and their expected cost? A healthy, professionally conducted reserve study will point you in the right direction.
A reserve study specialist will assess the condition of common-area assets within your community (like clubhouses, lobbies, and pool areas), identify future replacement costs and recommend an annual contribution amount for your reserve fund. By partnering with a solid reserve study specialist and reviewing your study regularly, you'll have a strong foundation for your association.
It is essential to treat your reserve study as a living, breathing document that should be regularly reviewed and updated. While there are no specific legal requirements, FirstService Residential recommends reviewing your reserve study on an annual basis to include any new developments in your community. But remember, it only serves as a budgeting guide for current and future boards to use. Ultimately, your board has the power to adjust wherever you see fit.
Important! FirstService Residential recommends conducting regular reserve study reviews and on-site inspections with reserve and engineering specialists to ensure that you're not missing any new developments or crucial upgrades.
What is the biggest (and common) reserve blunder? Watch a quick video clip below to hear what Kirk Kowieski, vice president at FirstService Residential, said.
To Invest or Not to Invest Your HOA Reserve Funds?
Generally, it's a good idea to invest a portion of your savings and let it grow over time. A reserve fund is no different! If your reserve study predicts that you won't need any immediate big-ticket project within the next few years, short-term or long-term investments are great to keep your funds growing. As a rule of thumb, the IRS does not consider reserve funds and homeowner assessments as taxable income, as long as they are in a separate account from your operating funds.
While investment interest for reserve funds is not considered taxable in Arizona, we recommend consulting with your association's CPA for best practices and legal advice on this matter.
FirstService Financial can leverage its existing relationships with more than 30 banks to provide FirstService Residential clients with higher rates on money market accounts. On average, FirstService Residential clients earn rates that are 4 to 5 times higher than the national average.
For example, FirstService Financial partnered with a master-planned community in Peoria, Arizona to help increase their portfolio’s average interest earned by over $2,700 (29% increase) and assisted with laddering their investments.
Final Thoughts
Like an effective maintenance plan, a thorough reserve study and fully-funded HOA reserve funds can help maintain your community's or high-rise property values throughout board and staff changes and allow your residents to feel proud of their association. Life can be unpredictable (in good and bad ways), but your association's financial goals don't have to be.
Bibliography
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Nordlund, Robert. 2011. "What Exactly is Percent Funded?". Reservestudy.Com. https://www.reservestudy.com/resource/article/what-exactly-is-percent-funded/
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Nordlund, Robert. 2020. "How Much Should an HOA Have in Reserve?". Reservestudy.Com. https://www.reservestudy.com/resource/blog/how-much-should-an-hoa-have-in-reserve-2020/