Reserves: What Are They and Why Are They Important?
What is a Reserve Study?
A reserve study is an evaluation of a property’s physical components and an analysis of its reserve funds. Based on a thorough on-site inspection, a reserve study details anticipated replacements of repairs to common elements and recommended annual reserve funding to cover capital expenditures for the next 30 years. The goal is to provide recommended reserve contributions that provide enough funds to cover the major expenses while also avoiding overfunding.
A reserve study includes two basic components: physical analysis and financial analysis.
Reserve components are association maintained major property components with a determinate useful life. The analysis of the reserve components results in accurate and supportable annual reserve fund contributions.
What do we mean by “determinate useful life”? A property component has a determinate useful life when it has a finite expected service life based on normal wear and tear or obsolescence. An example of a component that does not have a determinate useful life would be the structural frame of a building.
What do we mean by “major” property component? A major property component is a capital (high dollar) expenditure. Major expenditures often occur within extended timeframes rather than daily, weekly, monthly or annually.
Reserve components are not homeowner components, minor expenditure components, general maintenance or regularly scheduled (daily, weekly, monthly, annually) activities. Homeowner components include those items where maintenance or replacement is the direct responsibility of the homeowner, and items that the association maintained items where the expense is billed back to the homeowners.
The Importance of Funding Reserves
As a board of a community association, your actions or inactions have an impact on yours and the members’ financial well-being now and in the future. The board has a fiduciary responsibility to maintain the common property of the association. The board’s focus should always be the SAFETY of the residents and visitors, the INTEGRITY of the buildings and grounds and the PRESERVATION of property value.
Properties that are well funded are going to be proactive and less likely to defer maintenance. Inadequate funding can lead to deferred maintenance, which compromises the safety, integrity and preservation of the community.
Budget for an Update Every Two- to Three-YearsIt’s important to remember that your reserve study is a snapshot in time. Your reserve study provider utilizes their experience and knowledge to forecast future replacements. Updates every two- to three-years allows your provider to re-evaluate your property and their recommendations based on the following factors:
- Changes in inflation and interest: inflation and interest rates change over time, while we do our best to anticipate what the future holds, inflation and interest used are “educated assumptions” that should be updated regularly
- Changes in condition: an on-site evaluation at the time of the update allows your provider to make adjustments to the anticipated replacement timing based on the current condition (have the individual components fared as expected, better than expected, worse than expected?)
- Updated replacement costs: material and labor costs change regularly and timely updates allow you to stay on top of those costs
- Changes in responsibility: sometimes declarations are amended or an action is taken that alters the responsibility of a particular element; an example we often see is responsibility changes for decks
- Unforeseen events: weather is unpredictable and an event like a hailstorm may result in premature roof replacement funded through insurance, this impacts the reserve study
- Actual implementation (or non-implementation) of the prior study: what actions did the Board take following the last study?
Using your Reserve Study
Beyond the reserve funding recommendations, your reserve study can also help you prioritize projects and can save the association money.
Often times, especially in an older property, multiple components reach the end of their useful life around the same time. It’s usually not feasible, either from a financial or a project management standpoint, to conduct all the work at once. Your reserve study should provide guidance to help the board make a decision on which project(s) to prioritize.
There are several ways your reserve study can help the Association save money:
- Maximizing useful lives: conducting maintenance in a timely fashion and in the correct manner will help maximize the useful life of your property components. Look to your reserve study for maintenance guidance.
- Proactive maintenance: by having a reserve study and being aware of maintenance requirements, the association can implement a proactive maintenance plan. Proactive maintenance is planned and systematic, and often under contract. This saves the association money. Alternately, reactive maintenance is marked with frequent emergency repairs at a high cost.
- Alternate materials and methods: look to your reserve study for suggestions on possible alternate replacement materials or methods that could save you money. Also, look to your reserve study for guidance when deciding whether to continue repairing an element versus replace it.
- Drafting requests for proposal: your reserve study should provide guidance on maintenance methods, replacement materials and replacement methods. Use this information when bidding out the projects to obtain “apples to apples” bids.
- Negotiating tool: your reserve study provides a benchmark for project costs. If bids come in too high, use the information in your study to negotiate a lower cost.