By Sundeep Jay / Published January 2019
Reserves are very important in the overall budgeting of the association’s assets. If you are a new board member, it will be to your benefit to investigate how your association has been calculating reserve contributions. Some associations use the services of a professional reserve study company, while others may have board members who create their own reserve analysis/budgets.
What is a reserve study? A reserve study is a budget prepared for the future replacement of the association’s assets. Assets are fixed items that are owned by the association which typically require a replacement time greater than one year. In our experience, most items on a reserve study typically have a minimum replacement time of five to ten years and extend out as far as 60 years. A reserve study will provide an estimated replacement cost, an asset’s useful and remaining life, an annual contribution needed for the future replacement of the asset(s), a current reserve requirement, and a funding analysis to calculate possible deficit amounts for the annual contribution. A reserve study is a roadmap the board can use to help fund the association’s assets. It is also important to note that a reserve study is not a perfect report and does require updates—typically every two to three years. A reserve study can never be perfect because most items will not break when expected, and all contractors will have their own prices for replacement. The purpose of reserves is to have as much money available as possible to avoid special assessments to unit owners/homeowners. Reserving for future assets is also the fairest way for each unit owner or homeowner to pay for their share of the assets while living in a condominium and or a homeowners association. It is important to note that an association is a business, not a personal residence.
Unlike the operating budget which has a documented history of annual recurring costs, reserves are assets that the association must reserve for future replacements where not only the time of replacement can vary but also the cost. Most assets rarely break according to a manufacturer’s warranty time, and replacement cost estimates can vary greatly. We explain to our clients that the only controllable item on the reserve study is painting, which should and can be completed according to a set schedule to help protect the building structure. Whether the board knows the exact time and/or the cost of asset replacements, reasonable assumptions/estimates must be made to create a forecast of the monies to be collected by the association for reserve purposes. We have found that most unit owners do not like special assessments, hence the board’s goal should be in reducing the likelihood of special assessments in any given year.
Typically, board members and managers have a very difficult job when it comes to calculating the correct reserve contributions for their association. The State of Florida states that condominiums must fully fund their reserves each year unless there is a majority vote to partially fund the reserves. When a board analyzes a reserve study, they will have to review the annual contribution number stated on a reserve study versus their current and historic contribution figure. Though the right thing might be to fully fund reserves, a large increase can create additional problems for unit owners. The board should consider whether existing owners are on a budget which will greatly impact their ability to continue living in a building they purchased 10 to 30 years ago. In buyer-savvy markets, real-tors are assisting buyers in evaluating annual reserve contributions when making comparisons with other condominiums, and this may deter a potential buyer, which can effectively have a direct impact on a condominium’s market value. These and possibly other factors should be considered when figuring out the correct reserve annual contribution for your association.
We urge new board members to be cautious in completing their own reserve forecast. Experience in preparing budgets, knowing what assets to reserve for, and creating reasonable timelines and cost estimates are all very important components when completing your own reserve analysis. Being a contractor does not provide enough of the skills needed to prepare a reserve schedule. More importantly, board members must stay unbiased when preparing their own reserve schedule. They must remain fair even though the numbers that are derived may be much greater than what the association has been collecting in the past. This is a fiduciary duty of the board, and the board can be held liable by its members for intentionally creating a forecast that does not create a fully funding reserve contribution.
The best choice in any given year might be to partially fund reserves. Some of the reasons an association might need to partially fund is that the members have just incurred a large assessment that was not foreseen or budgeted. Another reason might be that the association has never reserved in the past, and the initial shock might not be possible with unit owners who are on a budget. In any case, we believe that full disclosure is vital in avoiding future problems and lawsuits. If partial funding is chosen, it is important to disclose (in writing) that the risk of special assessments in any given year is going to be much higher than if the association elects to fully fund reserves.
Experience is important when preparing a reserve study. Most reserve companies will have conducted numerous reserve studies for condominiums and homeowner associations. Comparison of cost and replacement time with other associations in your area is a vital skill and knowledge a reserve analyst brings into a reserve study. A reserve analyst will be able to differentiate between how a coastal property depreciates versus a property located miles inland. A good reserve analyst will also be able to guide an association towards helping resolve asset replacement issues that might have been experienced in another similar community.
To summarize, it is important that board members learn how their existing reserve contributions have been calculated. Board members and managers should review the reserve contribution and reserve balances on an annual basis. Experience and unbiased assumptions and calculations are key to a good reserve budget. Though special assessments may be inevitable over the life of the association, it is important to reduce the likelihood and amounts for special assessments. Lastly, a reserve study is a roadmap to help guide the board towards a financially healthy association.
J. R. Frazer Inc.