Equipment and major components (like the roofs) must be replaced from time to time, regardless of whether we plan for the expense. It’s preferred to plan and set the funds aside now in an equitable manner. Reserve funds aren’t an extra expense—they just spread out expenses more evenly. There are other important reasons association monies are put in reserves every month:
- Reserve funds meet legal, fiduciary, and professional requirements. A replacement fund (Reserves) is required by:
- The secondary mortgage market in which the association participates (e.g., Fannie Mae, Freddie Mac, FHA, VA).
- State statutes, regulations, or court decisions.
- The community’s governing documents.
- Reserve funds provide for major repairs and replacements that will be necessary at some point in time. Although a roof may be replaced when it is 25 years old, every owner who lives under or around it should share its replacement costs.
- Reserve funds minimize the need for special assessments or borrowing. For most association members, this is the most important reason.
- Reserve funds enhance resale values. Lenders and real estate agents are aware of the ramifications for new buyers if the reserves are inadequate. Associations are required to disclose the amounts in their reserve funds to prospective purchasers.
- The American Institute of Certified Public Accountants (AICPA) requires the community association to disclose its reserve funds in its financial statements.
Reserve Study – What is it?
Every community association is unique, varies in age, type of amenities, and maintenance obligations. Planning for future repairs and replacements is not only in the best physical and fiscal interests of the community association, it is required by law in California. Maintaining a reserve fund not only meets legal, fiduciary, and professional requirements, it also minimizes the need for special assessments and enhances resale values. Every community association requires a different amount of funds in reserves to complete repair or replacement projects on schedule without special assessments or loans. How does an association properly determine and compile adequate reserves to fund necessary repair and replacement costs? By conducting reserve studies.
A reserve study has a physical analysis and a financial analysis component. A reserve study prepare evaluates information regarding the physical status and repair/replacement cost of the association’s major common area components. The prepare conducts a component inventory, a condition assessment through a physical inspection, and life and valuation estimates. The financial analysis assesses the association’s reserve balance or fund status. This is measured in cash or as percent funded to determine a recommendation for an appropriate reserve contribution rate or funding plan.
There are various different categories of reserve studies. Three common categories are:
- Full
- Update, With-Site-Visit/On-Site Review
- Update, No-Site-Visit/Off-Site Review
What is in a Reserve Study?
A reserve study should include:
- A summary of the association, including the number of units, physical description, and the financial condition of the reserve fund.
- A projection of the reserve starting balance, recommended reserve contributions, projected reserve expenses, and the projected ending reserve fund balance.
- Listing of the component inventory, component quantity or identifying descriptions, useful life, remaining useful life, and current replacement cost.
- A description of the methods utilized in computing the fund status and in the development of the funding plan.
- Source(s) utilized to obtain component repair or replacement cost estimates.
- A description of the level of service by which the reserve study was prepared and the fiscal year for which the reserve study was prepared.
- Experts recommend the following disclosures items be included in a comprehensive reserve study:
- A statement disclosing other involvement(s) with the association that could result in actual or perceived conflicts of interest.
- A narrative description of the physical analysis that details how the on-site observations were performed.
- Credentials held by the preparer.
- A report on how the current work is reliant on the validity of prior reserve studies.
- Discussion of material issues.
- The actual or projected reserve balance total presented in the reserve study based upon information provided.
- Accurate reserve components as determined in the updates.
- A description of reserve projects which is considered reliable. Any on-site inspection should not be considered a project audit or quality inspection.
Contact Infinity Management for more information regarding reserve studies.