What are the main components of an HOA reserve study?

An HOA reserve study has two main components. The physical analysis contains information about HOA components including their quantity, average useful life, remaining life, and estimated cost of replacement. The funding analysis analyzes the financial status of the HOA to determine a funding plan for the reserve contributions.

Reserve Study Archives - HOA Management Software

What Are HOA Reserve Funds? When Are They Used?

admin on June 30, 2022

In a lot of ways, homeowners associations are just like corporations. They operate with a budget, are headed by a set of board members, and manage a reserve fund. But, what are HOA reserve funds anyway?

What Are HOA Reserve Funds?

Simply put, a reserve fund is a savings account. It contains funds that the homeowners association will use to pay for the cost of future repairs and replacements. Homeowners association reserve funds differ from operating funds in terms of use. While both are funded by the homeowners, the operating fund covers the association’s regular expenses, whereas the reserve fund covers major repairs and replacements.

For homeowners associations, having a reserve fund is essential. Without a reserve fund, an HOA would have no way of paying for expensive repairs and replacements in the future. Every asset and structure has a useful life. Once that reaches the end of its useful life, it needs to be replaced or repaired. Otherwise, it could pose a threat to the safety of residents.

In some scenarios, an HOA will turn to the homeowners for immediate funding. If, for example, a particular building needs urgent foundational repairs, the association will resort to levying hefty special assessments to cover the cost. Neither scenario is ideal, as they can put homeowners in a financial bind or place them in imminent danger. With a properly funded reserve account, HOAs can avoid all of this.

What Can HOA Reserve Funds Be Used For?

In general, reserve funds are used to cover the cost of major repairs and replacements in the future. The exact specifics of this will depend on the bylaws or CC&Rs of the community. Some associations allow the board to use the reserves to pay for unexpected costs, i.e. those that do not occur on a regular basis. Others use it exclusively for any assets that require large repairs or replacements. And then there are also associations that set aside reserves to pay for construction projects.

Determining Adequate Reserve Funding for HOA

When talking about an HOA’s reserves, one question that always seems to pop up is exactly how much to put in the fund.

But, reserve fund accounting for HOA communities is not as easy as simply offering a dollar amount. Homeowners associations have different needs, and even the type of association can influence the possible repairs and replacements it will require in the future. For example, a condo community may need to replace or repair its elevators in the future, but not all single-family communities have elevators.

To know the adequate level of funding for your reserves, it is important to hire a professional to conduct a reserve study. A reserve study will determine the estimated remaining useful life of each asset in your HOA and how much it will cost to repair/replace them. This will give the HOA board an idea of how much the HOA will need to save and how long it has to do so.

Now, a lot of things can change after the completion of a reserve study. This is why it is a good idea to update the study once every few years. Some states even require associations to perform reserve studies, such as California, Virginia, and Colorado. And then there are also a few states that require HOAs to maintain a reserve fund but don’t require reserve studies. Massachusetts and Minnesota are two that come to mind.

Ideally, every homeowners association should have a fully funded reserve account. That means the HOA can cover 100% of the cost of future repairs and replacements. Unfortunately, this is not the reality for most associations. A good rule of thumb, though, is to reach at least 70% of the association’s requiring reserve funding.

Who Pays for the HOA Reserve Fund?

The money used to maintain an association’s reserve fund comes from the homeowners themselves. Reserve contributions are included in the calculations for the upcoming year’s dues. While the HOA board is in charge of this responsibility, board members are not exempt from the contributions. Both board members and regular homeowners have to pay their dues and contribute to the reserves equally.

Borrowing HOA Reserves: Is It Legal?

Generally, an HOA board should not spend the reserve fund for anything other than its intended purpose. But, there are times when an association will find itself in dire need of money to pay for operating expenses. In this case, the board may be able to make an exemption based on state laws and the governing documents.

For instance, California Civil Code Section 5515(a) allows HOA boards to authorize the temporary transfer of funds from the reserve account to the operating account without membership approval. This is only done, though, to meet short-term cash flow needs. However, the board must include notice of intent to transfer funds in a notice of the board meeting. The board must also restore any borrowed funds from the reserve account within one (1) year.

Investing Your HOA Reserve Funds

Because the money in an HOA’s reserve account tends to sit untouched for long periods of time, many boards consider the possibility of investing the funds. The board generally has the authority to do this, though it is still worth checking state laws and the association’s governing documents.

When considering potential investments, an HOA should go for a plan that offers no risk at all. Keep in mind that the money in the reserves does not belong to the board. As such, it is important to be prudent with the money.

In addition to risk, boards should also take liquidity into account. An HOA should be able to withdraw money from its reserves at a moment’s notice. Thus, it is best not to go for investments that have a lock-in period. The only downside to a risk-free investment plan is that it does not offer high yields. Sometimes, though, a savings account is enough to keep the money safe, at the ready, and still earning interest.

The Need for Professional Help

It is essential for homeowners and condo associations to maintain HOA reserve funds. But, you can’t truly know how much you need in the account if you don’t perform a reserve study. Reserve studies can’t be done by the board alone. They require the assistance of certified professionals, such as accountants and engineers. It also helps to have good HOA management software to keep track of your reserve study and level of funding.

Condo Manager is an all-around HOA management software that both homeowners associations and HOA management companies use. Call us today at (800) 626-1267 or contact us online for a free demo.

RELATED ARTICLES:

What Is A HOA Reserve Study And Does Your HOA Need It?

admin on April 2, 2016

Why do you need a homeowners association reserve study? A reserve study is a budget planning tool that can prepare HOAs for large capital expenditures. With an HOA reserve study, you can ensure the long-term financial health of your community.

Importance of an HOA Reserve Study

What is a reserve study and why does your HOA need it? Here’s what you need to know.

HOA Reserve Study Definition

An HOA reserve study analyzes the major components of an association. It will look at the current condition of HOA assets and determine how much life it has left. The reserve study also estimates how much it will cost to replace an HOA asset once it reaches the end of its useful life.

For each HOA asset, the estimated replacement cost is divided by the number of years left in service. Then, the numerical quotient for each asset is added. Thus, the result of the reserve study determines how much you need in your association reserves.

The total reserve amount is equally divided among the homeowners. Depending on your HOA, the amount can be covered by annual fees or it could be collected as a separate reserves contribution.

Benefits of an HOA Reserve Study

An HOA reserve study helps associations prepare for capital improvement projects. Unlike regular maintenance projects, capital improvements have larger scales and larger costs. For example, a roof replacement can cost anywhere from $5,000 to $50,000, depending on the size. The reserve study will determine how much time is left before the roof needs to be replaced. Thus, it provides HOAs with a timeline for saving money.

Given the results of the HOA reserve study, the board can come up with an accurate annual budget — which includes HOA reserve fund requirements. If the estimated revenue is not enough to cover operating expenses and reserve contributions, the board can determine early on if there is a need to increase HOA dues or levy a special assessment.

However, the main purpose of an HOA reserve study is to ensure that these two scenarios do not happen. With proper planning and an up-to-date reserve study, HOAs can protect the financial wellbeing of the community. The earlier you plan for capital improvements, the smaller the financial burden on homeowners.

Essential Components of a Reserve Study

An HOA reserve study has two main components: the physical analysis and the financial analysis.

Physical Analysis

This section of the reserve study contains information about the physical condition of HOA assets. You’ll find a detailed inventory of components with the following:

Quantity of Components: The reserve study should have an accurate count of HOA components. Some components may require additional details such as type, exact measurements, square footage, description of materials, and so on.
Average Useful Life: Each component has an average useful life, or how many years it is expected to serve its exact purpose — given that the component is regularly and properly maintained.
Remaining Life: The reserve study will consider a component’s age, physical condition, and maintenance history to determine how many years are left until it must be replaced.
Estimated Cost of Replacement: A reserve specialist will draw on his/her experience, as well as a detailed survey of current market prices, to determine how much it will cost to replace each component. Estimated costs are relatively stable but it’s still important to account for your local market trends and inflation rates.
Maintenance Assumptions: The reserve study also makes certain assumptions based on the maintenance history of each component. Was the asset properly maintained? Improper maintenance can have an effect on replacement schedules and cost estimates.

Financial Analysis

The second portion of the reserve study analyzes the current financial status of an HOA Your reserve specialist will look at income, expenses, and current reserves.

Based on these figures, the reserve study will recommend a funding plan for your reserve contributions.

There are three potential funding models: fully funded, threshold funded, and baseline funded.

Fully Funded: The reserve study will recommend a funding plan that will have your reserves at or near 100%.
Threshold Funded: With this funding plan, the goal is to have your reserve cash balance meet a certain threshold — typically at 70%.
Baseline Funded: The goal is to have the reserves at or above $0. This is not recommended for most HOAs. However, if your reserves are severely underfunded, this funding plan can serve as a temporary strategy that will guide the HOA to a more stable position.

Each funding plan has its own pros and cons. It will depend on financial goals and the types of components that an association has. For instance, if your major components are “life-critical,” such as elevators, fire alarms, and security systems, a fully-funded reserve is a must.

For many HOAs, threshold funding provides adequate financial security. In case a component fails ahead of time, you won’t have to raise as much money as compared to if you had minimally funded reserves.

Additional Reserve Study Guidelines

An HOA’s governing documents contain guidelines and requirements for the reserve study. There are also different reserve requirements by state. For instance, reserve studies are required in places like California, Virginia, and Utah. Most other states have legal requirements for reserves but not reserve studies while certain states have no requirements at all. Nevertheless, here are some general HOA reserve study guidelines to consider.

How Often Should an HOA Do a Reserve Study?

Regardless if they are legally mandated by your state or not, HOAs must conduct reserve studies. A good rule of thumb would be to have a formal reserve study every 3 to 5 years.

A professional reserve study specialist will come in to assess your major assets. HOAs must also update their current reserve study every year to ensure that the annual budget and reserves are likewise up-to-date.

However, a reserve study should be conducted after a major construction project or if there was a recent natural disaster as these two scenarios could have an effect on the current condition of HOA assets, as well as the financial capabilities of the association.

How Much Does an HOA Reserve Study Cost?

There’s no specific amount for an HOA reserve study. A formal reserve study with an on-site visit may cost around $1,500 while annual updates may cost around $300 to $600.

The cost will also depend on the size of your association and the number of shared assets. The cost of a reserve study for an HOA with basic amenities (swimming pool, park, basketball court) will be much lower than an HOA with private roads and golf courses.

Even though HOAs want to keep expenses low, don’t skimp on your reserve study. A CAI-certified reserve specialist will have the experience and expertise needed to conduct a reserve study. They also have software and resources to properly calculate the useful life of each HOA asset. The more comprehensive the report, the better you can budget for your reserves.

An HOA Reserve Study Is a Must for Your Financial Security

Without knowing the importance of an HOA reserve study, board members might think that it is just an unnecessary expense. However, a reserve study is essential for the financial health of your association.

Board members will have a better picture of the HOA’s assets, which will guide them as they create the annual budget, collect assessment dues, and contribute to the reserves. A reserve study ensures that your community can handle major expenditures — without putting most of the burden on the homeowners.

Want to get the best out of your HOA reserve study? Reach out to the Condo Manager team today! Call us at (800) 626-1267, email us at sales@condomanagerusa.com, or contact us online to learn more about our HOA financial management software.

RELATED ARTICLES: