Maintenance, Capital Improvements, Useful Life: Is Your HOA Prepared?
“How do you decide which components to fix and which to replace?”
“Is it possible to extend a component’s useful life?”
“When do maintenance jobs turn into capital improvements?”
If these questions sound familiar, you’re not alone. As a board member, you expect your Nevada homeowners association management company to keep your community’s components operating smoothly and your common areas aesthetically pleasing. However, your community won’t be as well-run and attractive as you might like if the HOA property management company doesn’t have the expertise to help you plan for future capital improvements and isn’t offering adequate guidance on how to budget for maintenance and capital improvements. To find out your management company’s maintenance style, read our article, “Does Your HOA React, Outsource, or Prevent? Find Your Maintenance Style.”
What’s the Real Difference Between Maintenance and Capital Improvements?
To get a deeper understanding of these important topics, it helps to start with a refresher course. Maintenance refers to routine or frequent tasks that are needed to keep your property running smoothly. These activities are meant to minimize further deterioration of your components and to restore them to their original condition. Your operating budget should include a line item called “Repairs & Maintenance” (R&M) to fund this type of work.
Your HOA property management company should be keeping up with your association’s maintenance requirements and facilitating ongoing maintenance to ensure that components reach their expected useful life. Activities like patching your roof, cleaning your pool regularly, replacing burnt out lightbulbs and minor repairs to your irrigation systems are some examples of work that is considered to be maintenance.
To define capital improvements, we can take a look at two projects that a large active-adult community in Henderson undertook. The HOA partnered with their management company and facilities manager to retrofit all of the common-area lighting with LED lights. Then, it replaced the heating, ventilation and air conditioning (HVAC) systems with high-efficiency models. Both of these major projects were classified as capital improvements because of how they positively impacted the components’ market value. Unlike a maintenance job, which only restores components to their original value, these projects increased components’ market value beyond the current or original state.
The purpose of a capital improvement project is generally to reduce future operational costs or enhance service quality for residents. In the case of the Henderson community, the savings in operational costs over a 10-year period were expected to total $428,342. The new lighting provided safer outdoor common areas for residents, and the new HVAC system made indoor common areas more comfortable.
To fund projects like these, you need to accumulate a sufficient amount of money in your reserves over a number of years. It is neither practical nor appropriate to use your annual operational budget to fund costly capital improvements. How much is enough money? A reserve study will help you know:
Which components will need replacing
What upgrades could provide the greatest return on investment
The remaining useful life of components
Replacement cost of components
The amount of money you need to budget annually to pay for the improvement
The accuracy of your reserve study depends on who conducts it. Be sure to partner with a qualified reserve study specialist.
What Is “Useful Life” Referring To?
The useful life of a component refers to the amount of time that a component will serve its original purpose. According to Rodney Riepenhoff, FirstService Residential reserve study specialist and corporate engineer, “Every component has a useful life given to it by the manufacturer.”
Manufacturers make certain assumptions to estimate a component’s useful life. Factors such as obsolescence, regulatory changes, environmental conditions or added wear and tear can affect whether a component actually meets these estimates.
How Can We Extend “Useful Life”?
One of the biggest factors affecting useful life is how well your HOA follows the maintenance schedule recommended by the manufacturer. This step should be facilitated by your management company. As Riepenhoff explains, “Many communities do not do all the required maintenance, often because of the cost.”
Unfortunately, this can actually cost the association more in the long run. Neglecting maintenance also reduces the component’s useful life, which means that it needs to be replaced or undergo a major repair sooner. Since the HOA budgeted for the project based on an assumption that the component would last longer, it probably does not yet have all the needed funds to fully pay for it yet.
Often, HOAs don’t realize that their preventative maintenance is inadequate because they haven’t updated their reserve study in a long time, if ever. “Or the HOA hires a third-party vendor that is not doing the necessary work, and they have no checks and balances in place,” said Riepenhoff. In contrast, a component that has undergone maintenance above and beyond the manufacturer’s recommendation could actually end up having a longer useful life. This can happen, for example, if you use higher-quality materials or replace parts with higher-efficiency ones.
Riepenhoff recommends that you look at the cost effectiveness of the maintenance you are performing on a component to determine if it might be more cost effective to replace it. “When the yearly cost outweighs the replacement cost,” he said, “it’s time to replace it.”
Can a Maintenance Job Become a Capital Improvement?
You might find out that an issue you thought could be addressed as a relatively minor maintenance repair turns out to be a bigger problem. For example, roofers who are called in to repair leaks in your roof might uncover a more widespread problem that requires a full roof replacement. In that case, the maintenance job (funded from your operational budget) has become a capital improvement (funded from your reserves).
How Do We Identify Whether It’s Maintenance or a Capital Improvement?
It’s important to know when to categorize something as a maintenance job and when to categorize it as a capital improvement so that you know from which account to pay for it. Your management company should have the resources and knowledge to determine this on a case-by-case basis, considering many factors, including:
The scope of the work
The reason you are undertaking the work
The value of the component
The outcome of the work
The impact of the project on the component’s value, depreciation and equity return
By understanding how maintenance and capital improvements differ and how they work together, you’ll be better able to budget the work around your community more effectively. Tackling maintenance and capital improvements properly can only serve to benefit your association. It can have a positive impact on property values, and it contributes to residents’ enjoyment, safety and comfort.