Reserve Studies and Funding: Critical Elements to the Success of your HOA

How does a reserve fund work?

A reserve fund is separated into its own bank or investment account and uses a very different budgeting strategy from an HOA’s operating expenses. When adequately funded, reserves can help cover the costs of large-scale repairs or replacements as they’re needed.

Here are the top 3 reasons your HOA should build up its reserve fund:

1. All things will eventually need to be repaired or replaced. HOAs can’t ignore it. New things become old—some, faster than others. Individual buildings and common area elements eventually need repair or replacement. Among these could be roofs, siding, and pool surfaces.
2. It’s your responsibility as an HOA board member. Without proper reserve funds to cover large expenses, HOAs have to turn to other means of getting funds, such as taking a loan, asking for more dues from members—or both. These scenarios cost more in the long run. In fact, saving in advance will likely lower your net cost. Statistics show that over time, compound interest gains from the reserve account offset the increased costs from inflation. Without enough in reserves, the only other option to financing or asking for special dues from members, is to defer the needed repairs. That can lead to the third reason for building up a reserve fund...
3. Reserve funding impacts HOA property values. Real estate agents call it “curb appeal.” Without it, buyers in a community shop elsewhere. Even with well-maintained appearances, a smart buyer researches the HOA’s reserve funding before signing the purchase agreement. Underfunded reserves depreciate the real estate market value of the house or condo. The buyer has greater risk of substantial costs in the future. In some cases, such as with FHA loans, qualifying for a mortgage may also be difficult because of poorly funded reserves.

So how do HOAs build a reserve fund?
If you don’t already have one, start with a reserve study. A great way to do this is to hire a Reserve Specialist. A certified Reserve Specialist can accurately inventory HOA components, determine their useable lifespan, and establish budgets for repairs and replacements. Based on this information, the financial analysis begins. Other professional advisors may be needed as well, such as legal counsel, structural engineers, or construction managers. In many states, HOAs are required to complete and maintain reserve studies that include both a physical and financial analysis.

How much should you have in your reserve fund?
This varies by state, as each state has different requirements for how much an HOA has to have in reserve funding. Your HOA documents may also have a criteria. A reserve specialist can help determine the best method for individual HOA needs. To give you some guidance, here are the 3 common funding goals:

• Full Funding – Save enough in your reserve fund to cover the estimated full replacement costs of different component’s lifespan. You can do this by equally dividing the total items cost amount among the years of useful lifespan and saving that amount. For example, if something will cost $50,000 to replace after 10 years, you would save $5,000 annually.
• Baseline Funding – Sometimes you need to make smaller repairs rather than full replacements. In those cases, you want to have funds to cover these smaller expenses. Because costs and timelines vary among components, this strategy is more like averaging. The reserve account is only funded enough to service items over a specific period of time. The desired result is that the reserve funds never reach zero.
• Threshold Funding – This strategy is a more secure version of Baseline Funding, allowing for shortened component lifespans. Sometimes components fail sooner than expected. With a minimum threshold established above zero, an HOA can anticipate the unanticipated.

Reserve funding is often expressed as a percentage, so to find out if your HOA’s reserve funding is enough, take a look at the National Reserve Study Standards (PDF). This will help give you insight into what would be the ideal percentage for your HOA.