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New Reserve Study Standards
By Scott Clements & Les Weinberg
The Reserve Study Standards published by the Community Associations Institute were updated in 2023. Before then, the standards hadn’t been updated since 1998. Changes were long overdue to reflect current practices and several statutory requirements in the U.S.
Other motivating factors were the 2021 Champlain Towers tragedy in Surfside, Florida, and the 2015 balcony collapse in Berkeley, California.
Community managers, reserve analysts and politicians across the country embraced the need to place a greater emphasis on reserve funding and ongoing maintenance of community associations.
In this article we will highlight the most significant changes impacting the community management industry.
The Reserve Study Explained
A reserve study is a budget-planning tool that determines an association’s current financial status (percent funded) and provides a stable and equitable funding plan to offset the anticipated future major common area expenditures. It consists of two parts:
1) Physical analysis
This includes a visual inspection of the common area components, via an on-site visit, which determines the component inventory and details the assessed condition.
2) Financial analysis
This determines the contributions necessary to meet the financial obligations over a 30-year period based on the current fund balance, future anticipated expenditures, inflation, and interest earned.
The reserve study is not an engineering report, architectural review, pest control report, or home inspection, and is not intended to be technically exhaustive.
Consequences of Underfunding Reserves
Underfunded reserves can lead to catastrophic failures, such as was the case at Champlain Towers. There are many reasons to avoid underfunding reserves, including the potential for significant special assessments or higher than market-rate regular assessments, which may reduce resale value or result in higher insurance premiums. Deferred maintenance can result in poor curb appeal and dissatisfaction among the membership. Coupled with the Federal Housing Association (FHA) and other mortgage providers placing more requirements and scrutiny on the financial stability of associations, it is critical for associations to demonstrate they are acting in a fiscally responsible manner.
Significant Changes
1) The definition of a component was revised to include a 3-part test, versus the old 4-part test, which combined the “need and schedule for a project” into a single item versus each individually.
2) Emphasis was placed on supplemental reports, such as engineering evaluations, preventative maintenance schedules, and ongoing reviews of major structural components (such as elevated elements inspections per California Civil Code §5551).
3) A new level of service was added: Level IV, preliminary, community not yet constructed. It calls for the creation of a funding plan for new communities, which is not addressed in the California Department of Real Estate (DRE) initial funding estimates, specifically the DRE623 form.
4) A funding adequacy definition entails reliable and timely execution of major repair and replacement projects without reliance on additional supplemental funding (e.g., loans or special assessments), versus the long-established “pay as you go” principle. This eliminates the incurrence of the entire cost of a component that deteriorates over an extended period simply because ownership existed when the expenditure occurred.
Funds Not Limited to Physical Items
Reserve funds can be used for these purposes:
1) Professional inspections, evaluations, or related building services qualify for the use of reserve funds if they meet the definition of a component (e.g., the previously mentioned exterior elevated elements inspections).
2) Important services and documentation of the properties’ needs, such as creating a maintenance matrix that identifies the items to be maintained and the responsible party: the HOA or the individual unit owner.
3) Creating or updating a community maintenance manual that identifies the common area components and the regular schedule of services needed to properly maintain the property.
4) Updating or revising the Covenants, Conditions, and Restrictions (CC&Rs), which are important to identify or clarify the responsible parties for the repair, restoration, replacement, or maintenance of the components within the community.
Long-life Components
The updated standards recognize the need to include components with an anticipated service life beyond 30 years (i.e., infrastructure), provided it is reasonably predictable. This may include such items as potable plumbing supply (copper piping), waterproofing elements, electrical service panels, and exterior cladding. For example, if the potable water copper piping servicing a property has an expected service life of 40 years, the recommended reporting would include a useful life (UL) of 40 and a remaining life (RL) of 39 for a new property.
If the component has an indeterminate life expectancy at the time of reporting, such as natural gas piping, the recommendation is to include the component in the inventory and note the useful remaining life as 30+, without funding, to serve as a placeholder for the eventual inclusion. This also discloses the fact that the component exists, but is not included in the funding calculations, as the remaining life exceeds the 30-year requirement for inclusion. It is still at the discretion of the preparer as to the inclusion or omission of such items, but this change places a greater emphasis on inclusion.
Tips for Managers Facing Resistance to Proper Funding
1) Document discussions in the minutes and note opinions and/or objections.
2) Provide detailed information on the process involved in producing the recommendations.
3) Encourage members to review the information and consult with service providers and other experts.
4) Invite industry partners to address the membership directly, including the reserve analyst, CPA, legal counsel, engineers, and others with knowledge of the circumstances.
Bottom Line
The new reserve study standards will significantly impact homeowners’ associations and the community management industry. It would be prudent for managers to help their associations implement them sooner versus later.
