What is a Reserve Study?
A Reserve Study is the art and science of anticipating and preparing for major common area repair and replacement expenses. A Reserve Study allows the Board and Management of Association-governed communities to offset the ongoing deterioration of the common area components with Reserve Funds to ensure their timely repair or replacement. A well-crafted Reserve Funding plan will ensure that irregular Reserve expenses are offset by ongoing, regular Reserve contributions, avoiding the need for Special Assessments.
What is a Special Assessment and why should they be avoided?
Special Assessment is a term used to describe a temporary, unplanned tax levied upon the members of an Association on the basis of a membership vote. A special assessment can be a single lump sum demand by the Association, or collected in multiple payments.
Sometimes the need for a special assessment comes about due to misfortune (to meet a large insurance deductible or a non-insured loss), but most of the time Special Assessments are levied to compensate for poor financial planning (i.e., failing to set aside sufficient funds in advance for predictable reserve expenses). Funding reserves through special assessments should be avoided because they unfairly penalize one unlucky set of Association members at a particular point in time.
Why does our Association need a Reserve Study?
The Governing Documents of most Association-governed communities require the Board of Directors to set aside an “appropriate” amount of money on a regular basis to offset the ongoing deterioration of the common areas. All physical assets deteriorate with time and most of the “major” components which an Association is responsible to maintain will require repair or replacement in a predictable manner. A credible, current Reserve Study makes it possible to prepare well in advance for these inevitable expenses, spreading out the reserve contributions evenly over time, rather than funding reserves through special assessments or loans.
What are National Reserve Study Standards?
National Reserve Study Standards were established in 1998 by the Community Associations Institute (CAI) to provide consistent terminology, standardize the levels of Reserve Study services, create a common set of disclosures within the Reserve Study, and establish a Reserve Specialist (RS) credential program.
What is a Reserve Specialist?
Reserve Specialist (RS) is a certification created by the Community Associations Institute to improve the quality of Reserve Studies. The RS designation is achieved through an application process that involves a 5 part review of each applicant’s:
- Background (demonstrating minimum educational criteria)
- Experience (demonstrating minimum Reserve Study experience)
- Sample Work Product (demonstrating minimum reporting requirements)
- References (minimum of 5 clients)
What will our Reserve Study tell us?
Every Reserve Study provides three key pieces of information, useful for both annual budget planning and disclosure purposes. The results are part of National Reserve Study Standards:
- What you are reserving for (also known as the Component List),
- Strength of the Reserve Fund (also known as Percent Funded)
- Recommended Funding Plan
What time of year should we do our Reserve Study?
Since a Reserve Study is a budget planning tool, most Associations start the process by soliciting a Reserve Study proposal six months in advance of their Fiscal Year (FY) End. This gives the Board of Directors a month or two to select a Reserve Specialist, a month or two to get the Reserve Study done, a month to review the completed report, and sufficient time to incorporate the funding recommendations into the budget for the upcoming Fiscal Year.
How Much Does a Reserve Study Cost?
There are five factors that determine the cost of a Reserve Study:
- Association size (# of units)
- Property age (years since constructed)
- Scope of common area assets
- Property location (for site inspection- based Reserve Studies)
- Time of Year (in-season or off-season)*
* Reserve Studies are prepared in advance of the Fiscal Year. Since most Associations operate on a Dec 31 Fiscal Year End, “in season” for Reserve Specialists means Jun thru Nov and “off season” means Dec thru May.
Which Components Belong in the Reserve Study?
The Reserve Component List forms the foundation of any Reserve Study. There is a four-part test, now part of National Reserve Study Standards, to determine if a component is appropriate to designate for reserve funding. To be funded, a component must pass all four of the tests.
- The component must be a common area maintenance responsibility, as defined in the Association’s governing documents or a well-established Association precedent
- The component must have a limited Useful Life (UL)
- The component must have a predictable Remaining Useful Life (RUL)
- The component’s Replacement Cost ($) must be above a minimum threshold amount
What is Percent % Funded?
A Reserve Fund balance that is adequate for one Association is not necessarily adequate for another. But when an Association’s actual Reserves on hand are compared to its computed Reserve requirements, a relative measuring scale called “Percent Funded” is established. This relative Reserve Fund strength measurement is now part of National Reserve Study Standards and independent of the funding (i.e., cash flow, straight line, etc.) method.
% Funded = Reserve Fund Balance (actual)/Fully Funded Balance (computed)
The Fully Funded Balance (FFB) is computed by multiplying the current replacement cost of each component by its fraction of life “used up” and summing them all together
% Funded = 100 (ideal) when the Reserve Fund Balance (actual) is equal to the Fully Funded Balance (computed)
See Are Your Reserves Adequate? for a more thorough explanation.