In the world of HOA finances, there are two principal accounts: the operating fund and the reserve fund. Operating funds pay for daily expenses and ongoing maintenance of the assets of the association. They represent the majority of the transactions in an HOA. Reserve funds, on the other hand, are like the community’s savings account. The reserve fund acts like a cushion, both protecting the association against unplanned expenses and essential upgrades over time. Going without a reserve fund puts your association at a significant risk.
Why Do You Need Reserve Funds?
HOAs set aside money for reserves according to the community bylaws to pay for the unanticipated major costs, or capital projects. Large scale projects like the repair and replacement of HOA property come from reserve funds. The criteria that govern such reserve funds come from the by-laws, regulations and rules, and accountability of the community.
It is easier to visualize these costs by considering some real world examples. This fund could cover renovation or construction, significant landscaping projects, roof replacement, fencing replacement, and repairs to aged buildings. Such reserves are never intended to add new features to the community. Sometimes, a community will be forced to levy a special assessment in order to cover the costs of such major projects.
Governing Documents and Reserve Funds
Why would an HOA mandate having money in this reserve fund? The governing documents spell this out. They usually require the HOA to repair, operate, maintain, and replace the development’s common areas. The common areas of the property cover such real estate that the homeowners jointly possess. Each home owner enjoys the rights to utilize these areas. Some examples of common areas include parks, pools, and clubhouses. They might also cover spas, entrance gates, and fountains in some developments.
These documents that govern the HOA will usually provide the association with the rights to assess periodically from all homeowners so that they can cover the continuous operation, maintenance, replacement, and repair costs of all of the common areas. Ascertaining the amount of money required to be collected is a function of the HOA deciding on and approving a yearly budget.
Determining how much continuous maintenance will be required comes down to a few factors. These include the number of amenities the property offers and the numbers of common areas located in the community. This will comprise more than simply daily operating and maintenance costs. The yearly budget will also mandate a part of the collected assessments to be placed into the special reserve fund. It is up to the HOA itself to decide the amount that is appropriate to collect in this reserve fund. They generally arrive at this figure by conducting a reserve study.
Using Reserve Studies
Reserve studies come up with the longer-term schedule of potential repairs and costs for a community. An independent professional like a reserve analyst usually conducts these. He or she will estimate the necessity, timing, and cost of replacement and repairs to all common areas that will have to be addressed in the coming 20 to 30 years in the future.
The schedule of the study appropriately spreads out all estimated repair costs throughout the determined time period. It will then advise the HOA on the right amount of money to collect through its periodic assessments so that the HOA can put away enough cash to pay for the estimated upcoming association needs.
The Practicalities of HOA Reserves
It is the unfortunate reality that countless HOAs possess reserves that are chronically underfunded. This means that they did not allocate a sufficient amount of money in order to pay the estimated future costs. All of the states have their own requirements regarding reserve studies.
Not all of them require them. Despite this, all HOAs should perform reserve studies minimally every several years. These studies will evaluate all of the amenities and assets’ conditions, determine approximately when they will have to be replaced or repaired, and what this will cost. The amount can change over several years, which is why the studies should be performed fairly frequently.
The optimal goal for an HOA is to completely fund its reserves. This would provide it with the estimated amount of money it needs to cover the anticipated expenses. In reality, having funded minimally 70 percent is a good starting point.
For HOAs that have under 70 percent funding, they play a dangerous game of not having enough money to cover their expenses. This would require that they assess special collections or increase association fees instead. It can create undue burdens on homeowners who do not have the money handy but have to front it with little notice according to the community rules and regulations.
Things To Remember When Considering HOA Reserve Funds
It is critical that HOAs pay the cost to engage a professional to do the reserve study. These professionals are aware of what to look for so they can appropriately steer the HOA to the right amount of money to save for the reserve fund. If the funds being saved are not enough, it is necessary to adjust the budget in order to allocate a larger percentage of all association fees into the reserve fund. This usually requires allocating from 25 percent to 40 percent of all incoming fees to the reserve fund.
It is advisable to be honest with the homeowners on the reserve fund’s status as well as the means for boosting funds. It might be better to increase dues now then to surprise them with a large lump sum assessment later. Staying atop today’s preventative maintenance will help to keep the property and assets working well to extend their useful life. It is unavoidable that there will be replacements and repairs along the way, yet effective ongoing maintenance can reduce the instances of unanticipated failures or damage. Part of this process involves watching the amenities and assets’ individual wear and tear so that the HOA can better gauge replacements and repairs to pre-plan for them as necessary.
Get a Helping Hand
Our management at Clark Simson Miller is experienced and fully capable of helping your HOA to make better decisions on managing your HOA Reserve Fund. For more information contact us online or by phone at 865.315.7505