As the autumn quarter inches closer, budget planning season will be here soon. The backbone of budgetary decisions rests on the association’s reserve study, a legally mandated review of the association’s assets. A comprehensive reserve study equips board members with more information about where the association stands today in relationship to future HOA expenditures. However, if the reserve study fails to paint a complete picture, associations may end up with a serious budgetary shortfall.
We talked with Mike Graves, an experienced reserve analyst from SCT Reserve Consultants, who explains the basics of a reserve study – and what may be missing from yours.
What is a reserve study?
Your community’s reserve study is a detailed analysis of your association’s assets and includes an analysis of your community’s physical assets (common areas), as well as a financial analysis that outlines the association’s financial health (expenses, income, and reserve fund balance).
This report helps to ensure that the HOA is on solid financial footing to implement the board’s current and future decisions.
Essentially, your reserve study is a detailed road map outlining how your association plans to spend its funds over 30 years.
Under California law, reserve studies based on a “diligent visual site inspection” must be completed every third year, but your association’s board must review the study annually and make updates if necessary. The annual budget report to the HOA membership must include a summary of the reserve study based on the current year.
The physical inspection
Your reserve analyst and HOA manager will walk the premises of your association, examining common areas to assess current conditions and consider future maintenance or replacement needs. They will be evaluating physical features like:
- Common area pipes/electrical wiring
- Asphalt (streets)/concrete (sidewalks) coverage
- Gates, entry/exit areas
- Amenities (clubhouses, pools, BBQs, playgrounds, sports complexes, recreational areas)
- Common area offices
We recommend members of your HOA board, architectural committee, or interested homeowners participate in the inspection. Those with intimate familiarity of the community will make sure that the reserve study is thorough and more accurate.
The financial analysis
Your reserve analyst will evaluate multiple elements of your association’s historical, current, and anticipated expenses to determine the appropriate reserves for your community. Your HOA management company will assemble bank statements, contractor invoices, cost estimates, and other financial documents to help the analyst create a complete financial picture.
Areas your reserve study may overlook
Your reserve study aims to provide a comprehensive look at funding requirements for the next few decades. However, unless there are provisions for the “unexpected,” your association risks facing budgetary shortages.
Here are some of the issues that unexpectedly drain reserves:
Ancillary repair costs
Sometimes anticipated upgrades come with unanticipated repair requirements, such as replacing damaged wood before painting.
Surprise amenity-related expenses
Your association’s amenities may be in worse shape than they seem, a fact that can evade discovery until you undertake planned changes (example: weak pool plaster that requires full re-surfacing instead of patch repairs).
Roof problems may not be discovered until the damage is serious. Costs for repairs, replacement, or other upgrades can rise quickly.
Associations should make provisions in their reserve study to “expect the unexpected.” Your association should have sufficient reserves in place to address emergency repairs (example: faulty or failed water or sewage pipes).
Increases in raw materials costs
Your reserve study must account for price changes to raw materials (ex. lumber) that, in large volumes, can dramatically impact costs.
Know your association’s funding mechanism
As a board member, it’s important you understand the funding plan for your association’s reserves. What is the mechanism that will ensure your association is adequately funded to meet the reserves outlined by your reserve study? How will annual assessments need to change over time?
Ask your HOA management company or reserve analyst to share your existing “percentage funded” for community projects and maintenance, as well as any changes they anticipate over the next five years. This information will help you make more informed decisions today that will protect against significant assessment hikes or emergency special assessments to cover budget gaps.
A solid start to next year
Once your reserve study is complete, scrutinize your association’s balance sheet to determine where you should start next year. There is no magic formula for calculating this amount. Best practice is to add the remaining months of the association’s reserve allocation and subtract any known expenses. Your HOA management company will make your analyst aware of any unpaid vendor invoices still in the pipeline that will impact your true reserve balance.
Though its name makes it sound like an immutable record, your association’s reserve study is actually a flexible document designed to evolve in response to outside factors that will impact association spending. Work with your reserve analyst and HOA management company to ensure your study covers all your bases, so your association is well-funded for whatever the future may hold.
Have questions about your association’s reserves or how they’re funded? Our HOA management experts are here to help.