By Anastasia Kolodzik, PRA, RSS, CAM / Published August 2022
Board members are responsible for maintaining the fiduciary responsibility of the association that they represent. Often that is difficult because it means having to make decisions that result in higher monthly assessments for the owners—many of whom are friends. This can make the board member unpopular with some of the residents but is necessary to maintain the financial integrity of the association. Two of the items that are essential to keeping an association on the proper financial track, especially in an inflationary trend, are maintaining a proper reserve budget and making sure all the association’s assets are correctly insured to replacement value.
The new laws bring new challenges and requirements for reserve funding. We are still in an extremely high inflation period. Reserve studies, engineering reports, replacement cost valuations, and budgets are the topic of everyone’s conversation.
These reports and information can make or break an association. Reserve studies are guidelines for financial planning. An association benefits by having a complete inventory of its components, useful/remaining life estimates, current costs, projected future costs, and a suggested contribution amount to be on track when the item needs to be replaced.
Engineering studies work hand in hand with reserve studies but are a completely different report. An engineering study addresses the condition of the structure of the buildings. Frequently an engineering study is invasive where a reserve study is not. This information is vital, especially for older buildings, buildings that are showing signs of damage, or ones with previous structural damage. A reserve study addresses the components or amenities the association is responsible for from a financial rather than a structural point of view. Therefore, components like paint, roofs, pavement, HVAC units, pool equipment, tennis courts, and elevators are not included in an engineering study. Both reports are imperative to manage an association’s finances.
Reserve studies are of the utmost importance in today’s roller coaster economy, with inevitable construction cost increases and labor cost fluctuations. A properly prepared reserve study will give a clear view of where an association’s finances stand currently and a recommended contribution amount for the report year and projection for future years. Whether the association follows the threshold or component method of funding, a reserve study will determine their recommended contribution to keep them in a healthy state if followed as directed. Reserve studies should be prepared prior to the next fiscal year. For example, if the association’s fiscal year begins on January 1, a reserve study should be in place before December 1 of the previous year. Many associations seem to wait until the next year’s budget is set before authorizing a reserve study to be completed. This throws the association’s contribution off for that year and often requires a revised budget in order to be compliant. A reserve study is designed to assist the board in preparing for the budget; therefore, a study after that year’s budget is in place is of little use.
There are two types of funding allowed in the State of Florida: component funding, which is better known as straight line; and threshold funding, which is better known as pooled [since all reserve funds are available for all listed projects when needed]. Component funding has a goal of full funding and is often the more expensive, having a higher risk for special assessments. Threshold funding has a goal of accumulation of funds when needed and is the more conservative of the two methods.
Recent events have prompted the industry to suggest new procedures to assist the association in planning for and reducing the risk of financial disasters. One such suggestion is to include a series of entries in reserve studies for insurance deductibles, debris cleanup, and professional fees (including attorney and engineering studies). These entries are tailored to the association based on their historical values. For example, an association may have had a special assessment for legal fees and building restoration in the previous year. This figure can now be included in the study and accumulated over a specified period to reduce the need for a future special assessment. Funding these items will assist the board in their fiduciary duty of maintaining the building and all its components and keep the board on track to have these services performed on a timely basis.
Proper planning will assist in reducing the risk of special assessments, maintain property values, and open the doors for new mortgages. As of late, many mortgage writers such as Freddie Mac and Fannie Mae have required a current reserve study to complete the mortgage process. In addition, some are requiring full funding with a contribution of at least 10 percent of the total monthly assessments going to reserves. These requirements are fast becoming the norm in the procedures for purchasing units in an association. In the new law, a passage reads “not funding reserves are a breach of officer’s and director’s duty” and can have some detrimental repercussions. In another section of the new law, it states “associations can no longer vote to waive reserves,” which has been the basis for so many associations becoming underfunded in the past.
Fully funded has always been somewhat of a challenge in associations, particularly with inexperienced condominium owners and boards. Generally, unit owners want to “get by” as inexpensively as possible and will often vote to keep contributions the same or waive them all together. This practice has become extinct with new regulations and requirements set forth not only on a state level but a national one.
Reserve accounts have many variables, including interest and insurance claim payments. These should be taken into consideration as assets in the reserve study report. Many times these forms of income are overlooked. Your reserve budget should identify all association responsibility items and all income to the reserve account. This offers several of the following benefits:
So, how often should an association have a reserve study? Level I reserve studies with a full site visit are recommended to be done every three years, with Level III updates without a site visit performed in between. Only a material change in the property will warrant a Level II reserve update. This schedule, much like the replacement cost valuation schedule, will keep the current costs in front of the board on an annual basis. Construction costs are at an all-time high, coupled with inflation and lack of availability. What costs $100 today may cost $500 next year. When funding your reserves, this can be a major issue if the association does not have current costs and complete component schedules reflected in the reserve study.
A major issue that associations have in an inflationary economy, like the one that we are currently experiencing, is being underinsured. In Florida, construction costs (labor & materials) have been averaging an increase of three to five percent per year over the last decade. However, 2021 saw increases of 10–12 percent alone (depending on the location in the state).
Many people do not realize that it is the insured’s responsibility, not the insurance company’s responsibility, to set the correct replacement amount. In fact, it says in the insurance policy under the “insure to value” clause that the insured is acknowledging that he or she is insuring the property to its full replacement value.
Over the last few months some insurance carriers are requiring associations to have annual insurance appraisals done to make sure that they have the correct amount of coverage. The carriers recognize that with the current surge in construction costs many, if not most, associations are now underinsured.
M. Anastasia Kolodzik
Vice President, Expert Reserve Services Inc.
Anastasia Kolodzik is the vice president and oversees the reserve study department of Expert Reserve Services, which is a Florida-based, family-owned and -operated company serving all 67 counties. Anastasia works closely with board members and association managers and recognizes this as the key ingredient to preparing a proper reserve study. She has been certified by the State of Florida to teach reserve studies continuing education to community association managers. For more information, call (386) 677-8886, email email@example.com, or visit www.expertreserveservices.com.