The Benefits of Having a Reserve Study
As budget season approaches, many associations are focusing on their reserve studies for two reasons only; one, it is required, either by state statutes or governing documents, and two, to make sure that the reserve assessment fits within the desired overall budget of the association.
Those are definitely important, but represent only the short term benefits of a reserve study. The long range benefits include many more items.For many associations, maintenance of common areas is the largest single cost of the association.It is not often considered as such because it typically is broken into several different cost categories within the association budget, such as painting, pool maintenance, landscape maintenance, roofing repairs, paving, fencing, and other categories.When considered together as maintenance activities, these are often the largest single cost.
The reserve study is one factor that helps to identify, quantify, and attempt to control such costs.Another major factor is the association’s maintenance plan.Many people have taken the position that the association’s maintenance plan IS the reserve study, or is defined by the reserve study.We believe that cannot be true, as a comprehensive maintenance plan must also include operating maintenance activities.And, those operating maintenance activities often determine the resulting reserve maintenance activities applicable to the same common area components.Therefore, the reserve study should be a reflection OF the maintenance plan, not the creation of the maintenance plan.
Most associations have not yet developed internal procedures to the point that they have established formal maintenance plans or formal reserve policies. These should be viewed as the planning process from which the reserve study is ultimately derived. Because this advance planning does not exist in many cases, most reserve studies today are used for more purposes than would be considered normal in the above-described setting.
The reserve study will always be used to fulfill the legal / fiduciary responsibility of the board and the association. It is also used to establish an appropriate capital reserve budget. Performed regularly, and assuming that adequate initial funding exists, the reserve study report includes a future funding projection, normally for a 30-year period, that can be used to achieve stable and predictable assessments and avoid special assessments. In addition, many associations attempt to assure a “fair” reserve contribution by all owners. This is usually referred to as “full funding” or “100 percent funding.” The concept behind this funding model is that as the useful life of components is “used up” or “depreciated,” those members receiving the benefit of that useful life are also contributing an equal amount to the planned replacement of the “used up” or “fully depreciated” components. Other associations opt for less than full funding under the theory that as long as you never go below zero in the reserve account, you have adequately funded reserves.
The reserve study depends upon a comprehensive component inventory of the major components of the association. Creating this inventory is another benefit of the reserve study. The identification and evaluation of common area components can also result in the improvement of maintenance procedures, or an improvement in energy use practices. Where no formal maintenance plan exists, the reserve study also allows the association to identify and plan for major repairs or replacements.
The reserve study can play a big part in properly maintaining association common areas. This directly affects property values. A good plan will preserve and / or enhance property values. A poor or nonexistent plan will have the opposite effect. Given budget pressures, and particularly in today’s depressed property value market, many associations are not increasing their reserve assessments annually. However, inflation IS affecting your future maintenance obligations annually, and the longer that adequate reserve funding is ignored, the greater is the gap between funds on hand compared to maintenance obligations. During a 20+ year career of preparing reserve studies, we have seen the effect of inadequate funding, which is either significant special assessments, or deferral of necessary maintenance projects. The short term thinking of keeping reserve assessments low can cause ultimate repair / replacement costs to dramatically increase. We have seen the failure to increase monthly reserve assessments by as little as $2 per month per owner and performing necessary maintenance result in costs increasing by tens of thousands of dollars. The cost benefit relationship or proper maintenance is well established. Attempting to save “pennies” in budgets can result in large decreases in property values due to inadequate maintenance.
The reserve study is also a useful tool for prospective buyers. While too few buyers are educated as to the values of a reserve study, or even understand it, educated buyers, and there are more of them every day, will want to see a reserve study before they buy so that they can evaluate the funding status of the association’s reserves. Although FHA has relaxed its reserve study requirements, more lenders are becoming savvy to the value of a reserve study and are requiring reserve studies before they will lend. We believe we will see an increasing trend of lenders requiring reserve studies. Another benefit of the reserve study is that it may help protect the association against litigation. While this is a development that we hope does not represent a trend, we have seen litigation, and have testified as experts, in situations where litigation against associations has resulted from inadequate reserve studies or failure to perform a reserve study.
While the above describes the various benefits of a reserve study, it still boils down to the fact that it is just common sense to have a reserve study prepared. Not having a reserve study is like starting a trip with no destination in mind and no plan. You may end up in a nice place, or you may not. It’s better to have an idea where you’re going. It’s better to know how you intend to get there. It’s better to plan.
Gary Porter, FMP, RS, CPA
Facilities Advisors International