What are reserve funds and what are they used for? Reserve funds are broken down into capital and non-capital expenses; capital would be replacing a roof; non-capital would be painting. These are IRS terms really, but for HOAs reserves are in general a savings account saving up to take care of long-term repairs and replacement — replacing the roof, paving the roads, resurfacing the pool, etc. It can get very detailed such as with club house furniture, storm water systems as well as any common area components that have long term repair/replacement costs. Reserve items are typically larger expenses the community will face in the future. Smaller and routine expenses should be funded through the annual operating budgets.
Every association should have a professional reserve fund assessment done. Let’s say a roof lasts 20 years; you take the cost of that roof and divide by 20, so in 20 years you have money in the bank to pay for replacement of the roof. The professional reserve fund assessment does this for each asset of an association, creating a 20-30-year cash flow with each homeowner paying his or her fair share.
What Reserve Balance Should Association's Keep?
What is the preferred amount/percentage of reserve funds? Conservatively speaking if you were reserving 75-80 percent, you’re in the top percentile of communities nationwide; if you do 100 percent you may have money in there that never gets used. I did a reserve study on a cash flow basis and component basis, but in analyzing it and cash flowing it over 30 years using the component funding basis, it never would have fallen below 1 million dollars; as long as there’s adequate cash flow funding, the homeowners can keep money in their own personal account as not all reserve components come up at one time.
Reserve funds are amassed as part of each homeowner’s property assessment whether paying annually, quarterly or monthly. For a community association and how it manages reserve funds, it should have segregated reserves from operating activities on the financial statements and have its own bank and investment account(s). Now, there is not a law in NC that requires that, but the governing documents of many communities do require it and it is best practice.
The Dangers of Inadequate Reserves
What can happen if a community has inadequate reserve funds? HOAs are limited insofar as things they can do about this. They can raise assessments, special assess the members, take out a loan, or a combination of these things. If an asset expires, you get into a push me pull me because the association is required to maintain and replace certain parts of the building and common areas, but if the association doesn’t have enough money to keep repairing or replace the roof, etc., its ultimately going to result in further damage to the roof and eventually to the interior of the home. Therefore, if there are inadequate reserves, one of the options above will need to be utilized – the roof has to be repaired or replaced.
HOAs should update their reserve study every 3-5 years. Material and labor cost change every year; fuel, energy prices, lumber prices, labor cost, etc. are what have impacts on the replacement cost. Therefore, they need to be checked and updated and kept on track because the study will assess replacement cost, remaining life of the asset for 5-10-15 years, and current reserve funds on hand at the time of the study. The reserve study also takes into account estimated annual inflation and interest income from reserve fund interest and investment income.
What rights do homeowners have with regard to oversight of reserve funds? It’s generally the board of directors that has the ultimate responsibility to manage the reserves; indirectly homeowners can keep an eye on things through elections. Generally speaking, just keep an eye on budgets and financial statements; if your HOA is budgeting 100k/year are they meeting that?
Engaged homeowners who keep an eye on reserves and push for ongoing professionally prepared reserve studies are essential so that that current — and future — homeowners aren’t left scrambling to raise emergency capital when assets expire.
If your board has questions about your community's reserves or is interesting in learning more about reserve studies, reach out to the experts at CAMS via your owner portal or at 877.672.2267 for trusted guidance.