Roughly 26.6 $billion was collected for reserve funds from U.S. association members in 2021, reports the Foundation for Community Association Research. That money was used for the repair, replacement, and enhancement of common property such as roofs, streets, swimming pool elevators, and other energy-saving features. It sounds like a lot, but reserve funds require more savings than people may realize.
The importance of reserve funds
Condos and HOAs must set aside enough money each year so that they can replace certain components or make large repairs without having to levy special assessments or borrow money from a lender.
Corporations/associations should aim to have a 70% funded reserve, although the closer the community can get to 100%, the better.
Many states have enacted legislation for community association reserves and operating funds to protect owners from financial problems and hardship. But after the Surfside condominium collapse, Florida and a handful of other states are mandating additional requirements.
For example, Florida condos over 3 stories tall will need to have a Structural Integrity Reserve Study performed by the end of 2024. Additional studies must be performed every 10 years, and associations cannot refuse to fund, or knowingly underfund the reserves for items required to be included in the Study.
The new legislation could help prevent another massive disaster from occurring, but it may also create financial strain on communities that are already struggling with finances. Below are some strategies that condo and HOA communities may use to strengthen their reserve funds.
Start with a reserve study
Reserve studies are formal studies conducted by an engineer or other professional. They are performed with the goal of determining how much money a condo/HOA needs in its reserve fund.
The study provides replacement cost projections based on a 20 to 30-year trajectory. This gives the community plenty of time to plan for long-term expenses.
As a best practice, a reserve study should be completed every 3 to 5 years. That’s because material and labor costs change almost annually, and with recent inflation prices, the costs for services or goods may have increased by 30%, 40%, or more. The reserve study will take into account estimated annual inflation and interest income, but older studies won’t have accounted for the drastic 2022 price increases.
Calculating long-term costs requires ongoing financial monitoring and regular inspections. Yes, reserve studies do cost money, and can range anywhere from $1,000 to 10,000. But communities that regularly invest in reserve studies set themselves up for future financial success.
Finally, reserve studies from qualified experts will provide owners with a quantitative explanation as to why the corporation/association needs to raise fees or dues. While no one is happy about higher fees, it’s much easier for an owner to contribute $20 more every month than contribute $2000 for a one-time special assessment.
Use the findings from the reserve study
It sounds obvious, but boards and property managers must ensure that they actually apply the findings from the reserve study. That often means adjusting short-term and long-term budgets.
Be transparent with owners
Owners are the ones funding the reserve, and they have a right to know where their money is going. As such, the board and management should always be transparent with the owners regarding the status of the reserve fund. Whether it is underfunded or adequately funded, members should have a clear understanding of the community’s financial health and what funds are being used for. Ignorance is not bliss when it comes to reserve funds.
Prepare to make changes often
Condos and HOAs will find that they need to make incremental adjustments to the budget. This is okay. Financial plans can and do change as external factors and unexpected incidents impact communities. Just make sure the changes are being accounted for early on, and the reserve fund doesn’t get too low.
Never take money out for day-to-day expenses
Reserve funds are used to cover expenses that do not occur regularly. A community’s governing documents should specify when reserve funds may be used. Money from the reserve is commonly spent on:
Construction of a new asset
Replacing a roof, elevator, or other major components
Painting common areas
Repairing streets or fences
Unexpected pool repairs
Other major construction or repair projects
Reserve funds should not be used for regular operating costs, like paying staff, unless extraordinary circumstances allow for it. For example, if there is a hurricane and a majority of owners are unable to pay assessments, then communities may be able to tap into those funds for temporary financial relief.
Prioritize infrastructure over aesthetics
Gym renovations and clubhouse upgrades are more popular than an HVAC repair, but the latter is more important to the overall well-being of the community. Infrastructure projects take precedence over esthetic upgrades, even if owners aren’t excited about those types of projects.
Don’t be afraid to ask for help
Budgeting for a million dollar reserve fund or roof repair 10 years down the road is not something that comes easy to most people. Board members should not hesitate to ask their property management company or a professional for assistance. The stakes are too high to try and figure things out as you go. Hire someone who can help the board, and the community, succeed.
Paying for costs when there are insufficient reserve funds
There may be a time when a condo or HOA has just paid for a major replacement, and another costly repair is needed unexpectedly. If there isn’t enough in the reserve fund, then the condo/HOA will need to look at other options.
Communities can raise monthly fees – but there may be limits on how much a condo/HOA can raise fees each calendar year. For example, an HOA may not be able to increase assessments by more than 5% in one calendar year without first hosting a vote and gaining approval from owners.
A special assessment is an unplanned payment or levy that the board imposes on owners when unexpected shortfalls or unexpected expenditures occur in the budget. There are very specific rules pertaining to the process of issuing a special assessment, and boards must ensure they follow each step.
While there are times when a special assessment cannot be avoided, owners will never be happy about it. Some special assessments can cost owners thousands of dollars on top of the fees they already pay.
Condos and HOAs may take out loans and pay the money back. Owners end up repaying these loans, and interest rates may be very high depending on the loan. However, communities may consider maintaining a line of credit with a low interest rate. Not only would this give them easier access to cash, but it would take less time and money for owners to repay the debt.
A healthy reserve fund is a critical component of a smooth operating condo or HOA. The amount a community requires in its reserve will depend on the development’s size, age and collection of facilities and equipment. Communities are encouraged to conduct a reserve study every 3 to 5 years so that the reserve budget reflects the community’s current financial situation.
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