A Community Manager's Guide to Managing Your HOA's Reserve Funds

by Derek Eckert, RS, PRA

A well-funded reserve fund is essential for homeowners’ associations (HOAs) to ensure the long-term financial stability of their communities. Reserve studies help associations plan for common asset maintenance, repair, and replacement while providing a roadmap for adequate funding. However, not all managers understand how to manage reserve funds for the association’s long-term financial and physical health. In this article, we will discuss the concept of fully funded reserves, monthly assessments, reserve study review frequency, and the implications of borrowing from reserve funds.

FULLY FUNDED RESERVES: DEFINITION AND IMPORTANCE

A fully funded reserve means that an HOA has set aside 100% of the necessary funds to cover the estimated costs of maintaining, repairing, and replacing common assets over their expected useful life. Approximately one in 10 HOAs are fully funded. However, those not yet 100% funded should have a funding plan designed to get them there eventually.

Achieving a fully funded status is essential for several reasons:

Financial Stability

A fully funded reserve ensures that an association has the necessary funds to cover expenses, reducing the risk of special assessments or deferred maintenance. Special assessments are tough on communities, the members, and their community managers. Additionally, deferred maintenance is the most expensive way to pay for reserve projects, as it can cost as much as three times more when you finally get around to doing the task, which is possibly a life and safety hazard at that point.

Fairness

What do reserves have to do with being fair? By adequately funding reserves, the association ensures that each homeowner pays their fair share of costs during their period of ownership. Remember that fairness extends beyond the current owners and applies to future owners. No future owner wants to buy into a community association only to get hit with a special assessment months later.

Property Value Preservation

Properly maintained common assets contribute to higher property values, benefiting all homeowners in the community. For example, our firm did a survey and found that on a square-foot basis, condominium homes in an association with solid reserves (over 70%) sold for 13% more than homes in a community with weak funding levels (under 30%). Those are compelling numbers when you consider that most homes in California sell for hundreds of thousands, if not million, and most HOA assessments are only in the hundreds of dollars per month.

MONTHLY ASSESSMENTS: ALLOCATING FUNDS TO RESERVES

The portion of monthly assessments allocated to reserves varies depending on factors such as the age and condition of shared assets, the reserve study findings, and the association’s financial goals. However, the general recommendation is that a condominium association allocate between 15% and 40% of monthly assessments to reserves to maintain a healthy financial status. Annually reviewing and updating the reserve study will help the association determine the appropriate allocation based on its specific needs. For example, an HOA that is 103% funded can likely allocate less than 40% of assessments to maintain a healthy reserve fund. But a community that is 65% funded should contribute as much as its budgetary limits allow.

Reserve Study Review Frequency

In California, the Davis-Stirling Act requires an on-site reserve study every three years, with annual financial-only updates to meet reserve funding disclosure requirements. This yearly review helps the association:

• Adjust for changes in common asset conditions or estimated costs.

• Reevaluate the reserve funding plan based on actual expenditures and reserve contributions.

• Monitor the association’s progress towards achieving a fully funded reserve status.

• Provide the required disclosures to all owners and future purchasers of homes within the community.

BORROWING FROM RESERVES: RISKS AND CONSIDERATIONS

The Davis Stirling Act allows associations to borrow from reserves to meet short-term cash flow problems. While it may be tempting to borrow from reserve funds to cover unexpected expenses or budget shortfalls, this practice can have severe consequences for an association’s financial health. Borrowing from reserves can:

• Deplete the reserve fund, leaving the association unprepared for future common asset expenses.

• Create a reliance on reserve borrowing, masking underlying budget issues and delaying necessary financial adjustments.

• Result in special assessments or increased regular assessments to replenish the reserve fund, placing a financial burden on homeowners.

• Cause delays in significant repairs and replacements of components that could present a life and safety hazard, such as foundations, decks, and elevated walkways.

Before borrowing from reserves, an association should carefully weigh the risks and consider alternative funding options, such as implementing cost-saving measures, adjusting the budget, or levying a special assessment.

Additionally, before you borrow from reserves, you should contact your reserve specialist and financial manager to determine the immediate impact on the overall health of the reserve fund.

Summary Of The Tips For Managing Reserve Funds

Understanding the intricacies of reserve studies and their implications for an HOA’s financial health is crucial for longterm success. By striving for a fully funded reserve status, allocating an appropriate portion of monthly assessments to reserves, reviewing and updating reserve studies regularly, and cautiously approaching reserve borrowing, associations can avoid surprise expenses, make informed decisions, save money, avoid loans and special assessments, and protect property values. That makes proper management of the reserve fund a win for everyone.

Derek Eckert, RS, PRA, is the President of the Association Reserves’ Northern California division.