By Will Simons, RS / Published December 2016
Editor’s Note: Part I was published in the March 2016 issue Part II in the June 2016 issue and Part III in the August 2016 issue.
This article represents the final in a series of four parts, modeled after a popular group of e-books originally published by Association Reserves over the last several years. The series is intended to adapt these e-books specifically to the needs of Florida community associations, summarizing and explaining the key information relevant to board members and property managers in the Sunshine State. The series has covered the following subjects, progressing from basic principles to more advanced concepts: “Component Lists,” “Reserve Fund Strength,” and “Funding Plans and Principles,” and concludes by answering the question, “Why Reserve Studies?”
If you haven’t read the first three articles, I might suggest a more detailed review of those subjects to gain a better fundamental understanding of the ground we’ve covered thus far, but we can briefly summarize the key points again here. First, each and every association must begin with an accurate, comprehensive list of components that it will be funding over the long term. Each component on the list will have specific estimates for its overall useful life, its remaining useful life as of the time of the analysis, and its replacement cost. Once this list is compiled, the values for life expectancy and replacement cost are then used to determine how much money an association should ideally have on hand at a given point in time to be adequately prepared for its future needs. The last step is to design a funding plan that will make sure the association is putting enough money in the account going forward to minimize the risk of special assessments or costly bank loans, which frequently occur when an association doesn’t have enough money on hand at the time expensive projects become necessary. This also ensures that each owner is paying his or her fair share of the costs of these common expenses, which can have large implications on property values and the resulting appeal to potential buyers down the road. This last installment will discuss how a reserve study can be a useful tool utilized by an association to ensure it is managing this process effectively. But first, let’s review how they came to be.
The condominium model as a form of housing began to spread in various locations around the United States beginning in the mid-20th century. As a state, Florida was one of the early hotbeds for this type of ownership, which appealed in particular to residents of the northeast United States looking for a warm-weather destination and the chance to own property with relatively low maintenance and upkeep requirements. As these first generations of buildings began to age and deteriorate, condominium board members were left wondering how to address the costs of looming expenditures for longer-lived components such as roofs and elevators. Reserve studies emerged in the 1980s as a tool to help reliably forecast these costs and provide recommendations so that an association could budget accordingly, thereby minimizing the chances of getting caught by surprise when components failed.
As time went on, more providers of these studies began to operate in various regions of the country, and an entire industry began to take shape. Today, reserve studies have become a fairly commonplace practice for thousands of associations across the country and are even required by statutes in many states. As discussed in part one of this series, the National Reserve Study Standards (NRSS) were eventually established in 1998 by the Community Associations Institute (CAI) in order to provide an agreed-upon set of definitions, terminology, and other requirements that professional reserve study providers could use to ensure higher quality and consistency in the work being done across the country. These days, most reserve studies are prepared by professionals coming from backgrounds such as engineering, architecture, construction management, and other related fields who provide insights about the various physical components that make up a community association property. Ongoing training and experience working with a wide variety of unique associations also effectively provides continuing education and facilitates the accumulation of a wealth of knowledge that can be leveraged across large numbers of diverse clients.
At this point, you might have questioned why an association board couldn’t just do all of this for themselves. It’s a fair question, and there are certainly cases where association board members have done a great job in managing their reserve planning for many years at a time with no major setbacks. Yet, there are still many good reasons to use a professional, some of which we’ll discuss here. For starters, engaging a professional reserve study provider is much like working with a CPA for managing association finances, or hiring an attorney for legal advice, in that it results in educated and unbiased guidance from a third party with no interest in the community except for providing reliable information. Using an outside professional removes any conflict of interest (whether perceived or real) that may exist when board members are compiling this information for themselves. Because board members are also residents of the association, they are subject to the financial outcomes that will result from reserve budgeting. Unfortunately, this can sometimes lead to a temptation to “fudge the numbers” to help keep assessments low, masking the reality of the financial situation.
Even if we assume that all board members are acting with the best of intentions, there are still some serious potential pitfalls that can develop. Usually, this manifests in some form of “not knowing what you don’t know.” As we have seen, the only way to create a reliable reserve plan is to create an accurate component list. Having worked with thousands of association clients over the years, we’ve seen a wide range of reserve schedules prepared by boards of directors containing significant flaws, effectively dooming any conclusions made from those schedules to be inaccurate and misleading.
For one example, we can return to the requirement in Florida statutes that we discussed in Part One dictating that condominiums must be budgeting reserve funds for roofing, painting, pavement resurfacing, and anything else with a replacement cost over $10,000. This last criterion is the one that often leads to errors of omission, as boards simply aren’t aware of what some things will cost. This might be because they are living in a fairly new development with no significant history of large repair or replacement projects. In that case, it’s easy to unintentionally ignore components that haven’t required replacement yet, such as domestic water pump systems, major HVAC components, fire alarm systems, and so on. Often, we’ve found that a reserve study is an eye-opener for many board members who were totally unaware of the various systems and equipment working around the clock to keep their buildings habitable and comfortable.
Another major category that we see overlooked pertains to common interiors and amenity areas. A large percentage of high-rise condominiums, for instance, seem to forget to fund for replacing hallway carpeting and repainting interiors, which can add up to large sums very quickly. Another mistake is to leave out things like pool deck furniture. Sure, one or two lounge chairs may only be a few hundred dollars to replace, but what if you have dozens of them? Those assets can easily reach the $10,000 threshold, even for smaller buildings.
Another common mistake is to ignore the effects of inflation and other market factors. For example, if a building is painted at one time for $75,000, it would be tempting to use that figure as a good cost estimate for the next time around. However, as years go by, inflationary effects will typically cause that amount to increase significantly. In one recent case, a client had documented that their building was last painted in 2009, and was assuming that the same cost paid at that time could be used in calculating their 2016 reserve funding requirements. Not so fast. Think back for a minute—what was happening in 2009? The economy was in the tank, and many contractors were scrambling for work to stay busy in the aftermath of the housing bust, meaning costs for many services came down. In conducting the reserve study, we were provided with new estimates the association had obtained, ranging from 25 to 50 percent more than the prior project. If the association had continued to assume the same amount would be realistic, they would have been significantly underfunded the next time the building required painting.
These are only a few brief examples of the difficulties that can arise when an association board has taken on too much responsibility, unknowingly exposing their association to unnecessary risk that could have been avoided by seeking out sound advice. We (along with most property managers, accountants, and other industry professionals) strongly suggest that every community association consider a reserve study as part of its annual budgeting process. A competent, up-to-date reserve study is a powerful tool that will help ensure that all board members are properly embracing their fiduciary duty to competently represent their neighbors and fellow owners.
Will Simons, RS
President of the Florida regional office for Association Reserves
Will Simons, RS, is the President of the Florida regional office for Association Reserves, one of the oldest and largest reserve study providers in the country. Since 1986, the company has prepared over 40,000 reserve studies for community associations throughout the United States and abroad. Highly regarded for its excellent customer service, attention to detail and user-friendly reports, the company has been recognized as a multiple-time Readers’ Choice Award winner by the Florida Community Association Journal. For more information about the company, you can visit www.ReserveStudy.com.