Part 1: Six things to know about reserve studies for small HOAs

Reserve studies are among the topics that intimidate our small HOAs the most. It’s understandable! They can be daunting…page after page of maintenance schedules, actuarial tables, funding percentages, variable contributions, and inflation rates. Plus hard to read charts and actuarial tables galore!

Then there’s the money. Funds start adding up over the years, and board volunteers with fiduciary duties to the HOA can be intimidated. How can they be confident that they’re protecting and spending funds responsibly?

Getting a grip on reserve studies can be tough, but they're crucial for ensuring the financial health and stability of a homeowners association…even a small one.

1. The basics: What is a reserve study?

A reserve study is essentially a well planned maintenance schedule with a clear savings plan, for obligations you share with other owners. The reserve study’s purpose is:

An assessment of maintenance needs for an HOA’s common property

A financial plan for the association to fund that maintenance

A report on the community’s status on that funding

2. Does my HOA need a reserve study?

This is an important starting place for small HOAs. The requirement of a reserve study is determined by the state you live in, and whether the HOA has any shared or common property, elements, or area.

In some states, reserve studies and updates are required by law. California, Delaware, Hawaii, Nevada, Oregon, Utah, Virginia, Washington, Ohio, Illinois, and Nevada have requirements, although some make exceptions for very small HOAs. Similar legislation is pending in other states. More on your state’s legal requirements here.

If your HOA has no shared or common property whatsoever, a reserve study may not be required. Your shared obligations are outlined in your HOA declaration or CC&Rs. Some very small HOAs have no common obligations whatsoever. However, your documents may be outdated, or not thorough, and your community may decide that planning for reserves is in the best interest of protecting property values.

3. How does a reserve study relate to our HOA budget?

There are two parts to your annual budget: the operating fund and reserve fund. The operating fund is for the HOA’s day-to-day expenses. The operating fund may include things like the monthly utilities, management, and regular maintenance.

The reserve fund is the second part of the budget that sets aside income for future obligations. A portion of the homeowner assessment is a reserve contribution which goes straight to the reserve account.

The annual budget determines the amount that needs to be contributed annually to fund future projects. The funding is divided into owner contributions in the form of monthly or regular fees.

4. When do we need a reserve study?

For existing HOAs, this depends upon the laws of your state and the requirements of your bylaws. For a small HOA with just a few components, an update every 3 to 5 years can keep up with responsible planning but some states require them more frequently, or require a review rather than a full update. The current published Best Practice of the national Community Associations Institute is to update your Reserve Study on the basis of a diligent visual inspection at least every third year.

It’s important to update because things change. For example, the condition of common elements such as exterior painting might be necessary sooner than projected. The financial analysis, like replacement costs, interest rates, and the balance of the fund will need to be reviewed routinely to keep up with changes.

For every new condominium under construction, an initial reserve study needs to be conducted. The initial study is commissioned by the developerbased on the project’s declaration to determine the reserve contribution for buyers.

5. Elements of the reserve study

A reserve study is made up of two parts, the physical analysis and the financial analysis.

The physical analysis includes the component inventory, condition assessment, and life(remaining useful life) and valuation estimates. Components are things like roofs, fences, driveways, and community mailboxes. The component inventory is primarily determined by the community’s declaration or covenants, although some communities add additional components. The condition of the component and the ‘remaining useful life’ of that component are evaluated to determine when they need replacement or repair. The valuation is an estimate of the cost of the replacement.

Image from Reserve Study and Reserve Management Best Practices, Community Association Institute

The financial analysis is the status of current reserve fund and a recommendation for an appropriate reserve contribution rate (a funding plan).

6. Who does the reserve study?

A reserve study is not a DIY project. Unless you are actuary, you’re probably going to need professional help to determine how the reserves are funded. Get professional help.

Reserve study providers are professionals who will develop your component list, determine replacement costs, and know the standards of useful life on your components. They will do a projection of funding and an estimate of current ability to meet projections. Unless you are experienced with accounting necessary to project inflation rates, compounding funds, and distribution of funding over time and between units, this is a job for a professional.

But don’t overspend. Depending upon the status of your reserve study, it doesn’t need to cost hundreds of dollars for a small HOA reserve study update. More complete studies with site visits and revised estimating will be more expensive.

That’s five basics of reserve studies for small HOAs.

Part 2 of ‘Reserve Studies for Small HOAs’ covers the reasons for reserve studies and why they’re important to the HOA and the individual homeowners.

Small HOA basics: Reserve studies