On more than one occasion an association will have to make difficult
decisions regarding funding of short term and long term property repairs. Too often I hear about
property improvements needing to be funded by means of a special assessment due
to lack of money in a separate capital improvement reserve account. If you are a board member of an association
imagine how much easier your job would be if there is a plan for both short
term and long term repairs/replacements.
For a board to properly plan for future property improvements a Reserve
Study is critical.
A reserve study provides an estimate of the costs of repairing and
replacing major common area components such as roofing and pavement over the
long term. We recommend the association hire a professional consultant with
proven experience in the preparation of reserve studies to conduct a reasonably
competent and diligent visual inspection of the accessible areas of the major
components that the association is obligated to repair, replace, restore, or
maintain. Typically, individual
homeowners are responsible for maintenance of the interior of their own units.
Generally this includes maintenance of the interior unit finishes such as the
carpeting, interior paint, etc. In addition, each unit owner may have explicit
maintenance responsibility for exclusive use common areas such as private
patios, balconies, etc., or for some exterior features of the unit such as
front doors and windows, etc. The
property components that are the individual unit owner’s responsibility may be
described in a reserve study but costs for maintenance and repair of these
items should not be included as they are not the association’s responsibility.
We
recommend a reserve study inspection be performed followed by a written report
at least once every five years. Ideally,
all major repair and replacement costs will be covered by funds set aside by
the association as reserves, so that funds are there when needed. This
requires:
- Examination of the association's repair and replacement obligations;
- Determination of costs and timing of replacement; and
- Determination of the availability of necessary reserve cash resources
Because
the board has a fiduciary duty to manage association funds and property, a
replacement reserve budget is very important. This information supplements the
annual operating budget in providing owners with financial information. The reserve study is also an important
management information tool as the association strives to balance and optimize
long-term property values and costs for the membership.
The
following paragraph is taken from the Illinois Condominium Act:
“All budgets adopted by a
board of managers on or after July 1, 1990 shall provide for reasonable
reserves for capital expenditures and deferred maintenance for repair or
replacement of the common elements. To determine the amount of reserves
appropriate for an association, the board of managers shall take into
consideration the following: (i) the repair and replacement cost, and the
estimated useful life, of the property which the association is obligated to
maintain, including but not limited to structural and mechanical components,
surfaces of the buildings and common elements, and energy systems and
equipment; (ii) the current and anticipated return on investment of association
funds; (iii) any independent professional reserve study which the association
may obtain; (iv) the financial impact on unit owners, and the market value of
the condominium units, of any assessment increase needed to fund reserves; and
(v) the ability of the association to obtain financing or refinancing.”
For
association members, reserve planning helps assure property values by
protecting against declining property values due to deferred maintenance and the
inability to keep up with the aging of components. A good reserve study shows a
more accurate and complete picture of the association's financial strength and
market value. The reserve study
should disclose the manner in which the board and outside management, if any,
is making provisions for non-annual maintenance requirements. Preparing a
reserve study calls for association decisions on how to provide for long-term
funding, and on the extent to which the association will set aside funds on a
regular basis for non-annual maintenance requirements. A good reserve study may
also function as a maintenance planning tool for the association.
Many associations have not developed funding plans nor had a
professional reserve study prepared. This is particularly true in smaller,
self-managed associations. A good reserve study
should at a minimum be a physical analysis that contains the following
information:
- A description of the property components that fall under the association's responsibility to maintain beyond the typical annual maintenance items
- Identification of total cash reserves currently set aside
- The estimated costs for replacement or repairs to rectify immediate needs. Issues which may be categorized as an immediate need may include replacement of the following property components:
- Items that have failed
- Items that are beyond their useful life
- Items that do not meet building code requirements
- Items that are a life safety hazard
- Items that do not meet ADA guidelines if applicable
- Items that do not meet FHAA guidelines if applicable
- The estimated useful life and estimated remaining life of the existing property components
- The estimated replacement cost of the property components (Note: This can be shown in current dollar values plus an agreed upon inflation factor may be added to project anticipated future costs).
Some
reserve studies may go beyond the above items by recommending funding
strategies. A product of the funding analysis process is the development of a
funding plan (cash flow forecast or projection) to estimate future reserve cash
receipts and disbursements. It is our professional opinion that the funding
analysis should be prepared with the assistance of the Association’s accounting
firm. The
association should decide how much should be raised through regular assessments
for the reserve account each year and how much should be raised by special
assessment, if any. In addition, the association should consider how much cash
will remain in the reserve account at the end of the planning period relative
to the projected balance needed at that date. It is important that
association members understand the difference between operations and
replacement reserve activities. Boards should establish policy to distinguish
between reserve expenses (funded from the replacement reserve account) and
operating expenses (funded through the non-reserve operating budget).
In a new
development many homeowners assume that their reserve requirements have been
adequately established because the developer prepared a reserve budget. We recommend a transition study, which is
similar to a reserve study, be performed by an independent consultant. The developer’s reserve budget often does not
identify all components to a level of detail that identifies future needs. Consequently,
a new association should conduct its own reserve study before the developed
property is more than a few years old.
Resolve
to Have a Reserve Study
Associations
will have to make difficult policy choices in determining their funding goal.
Many associations are currently underfunded in reserves. This is due to a lack
of attention to reserve budgets in the past and underestimation of replacement
costs either by the association or by an inexperienced consultant. An ideal
goal for an association is to eliminate this underfunded reserves deficit or
shortage. That is, to build up the reserve fund to a level
where the cash in the replacement reserve account is at least equal to the
estimated value of accumulated wear of all major components. The association board should pass a resolution that a
reserve study shall be performed periodically. Associations that have been
operating without a reserve study, or funding plan, should initiate this
process as soon as possible.
When considering
which professional consultant to hire it is helpful to talk with people who
have worked with any firm or consultant under consideration and to examine
samples of related work. A Board
member’s decision making responsibilities could be so much simpler if they have
a well written Reserve Study to use as a guide.
Failure to plan is planning to fail.
John Hershey, President of J.
Hershey Architecture and a Licensed Architect with over 30 years of experience,
specializes in residential design, consulting, and construction management. He is a member of ACTHA, CAI, the American
Institute of Architects and is a LEED Accredited Professional for energy
efficient design. Send your questions to
jmh@jhersheyarchitecture.com or visit www.jhersheyarchitecture.com