How to Read a Reserve Study | Association Reserves

Robert Nordlund:

Well, thank you, Jenn, and welcome, everyone. It’s a pleasure to be here today to help you with this very important topic.

Our goal today is to help you understand what a reserve study is, how to review your reserve study, where to find the key information within it, and most importantly, how to apply that information for the benefit of your association.

We prepare thousands of reserve studies every year, and many of our regular clients already know what to look for. But we want everyone to have a positive experience understanding the document they’re working with. Whether you’re using another reserve study provider, you’ve recently received a reserve study from Association Reserves, or you’re about to receive one and begin your association’s budgeting process, this program was designed with you in mind.

I’d like to begin by setting the stage with a challenge.

Living in a community association is a unique form of homeownership. Everyone lives together, but ownership is divided into two distinct categories. Some things belong to the association—the common areas—and other things belong to the individual homeowners, their private spaces.

The important point is that the board has been delegated the responsibility of maintaining the common areas on behalf of all the owners.

While they’re doing that, however, every one of those common area components is continuously deteriorating.

Deterioration is predictable.

It’s expensive.

And it never stops.

Mother Nature and Father Time simply do what they do, and they don’t negotiate.

So the board has an ongoing challenge. How do we prepare for this deterioration? How do we keep up with it? How do we make sure these common area assets continue serving the community?

It’s important to understand right from the beginning that deterioration—not the board and not state law—is what ultimately defines the cost of reserve planning.

Mother Nature and Father Time continually move every component closer to the point where it needs to be repaired or replaced.

The board’s responsibility is to establish a budget that keeps pace with that deterioration.

That’s the balancing act.

Mother Nature and Father Time continue driving expenses upward, while the board works to create a budget that keeps the association financially prepared.

I always enjoy showing a particular cartoon during this discussion. It illustrates a board meeting where everyone is reacting to conversations about future projects like roofing, asphalt, and stucco repairs. One gentleman says something we hear quite often:

“Why should I contribute to reserves at my age? I don’t even buy green bananas.”

He’s basically saying he doesn’t care about projects that won’t happen until sometime in the future.

That’s a fundamental misconception.

Reserves are not about paying for the future.

Reserves are an ongoing usage fee for the common areas.

Think back to the illustration of continuous deterioration. Every day, every week, every month, your common area assets are gradually wearing out.

Reserve contributions simply offset that ongoing deterioration.

They’re the bill for using those common areas.

As deterioration occurs, the association collects reserve contributions little by little so that when the roof eventually needs replacement—or the asphalt needs resurfacing, or the paint needs to be renewed—the money has already been accumulated.

That’s really the challenge.

The board is responsible for the common areas, while Mother Nature and Father Time are constantly working against them.

The moment a component is restored to like-new condition, deterioration begins again.

Reserve planning is simply the process of keeping pace with that reality.

So let’s talk about the reserve study itself.

One of the first things to understand is that volunteer board members aren’t expected to be experts.

As a board member, you’ve accepted responsibility for managing the association on behalf of the homeowners. Legally, your decisions are generally evaluated under what’s known as the Business Judgment Rule.

The Business Judgment Rule is essentially a three-part test.

First is the duty of care.

Did you genuinely look after the needs of the association? Did you take your responsibilities seriously?

Second is the duty of loyalty.

As an elected director of the corporation, did you place the interests of the association ahead of your own personal interests?

Did you make the difficult decisions when necessary?

Did you approve the assessment increase the association truly needed?

Did you answer the emails?

Return the phone calls?

Do the work even when you were tired or didn’t particularly feel like doing it?

And finally, there’s the duty of inquiry.

This is especially important.

When you don’t know something, you’re expected to seek expert advice.

You’re expected to reach out and gather the information necessary to make informed decisions that benefit the entire association.

Why is that so important?

Because you don’t want to receive advice from someone who isn’t qualified to give it.

I like using the example of the stereotypical used car salesman.

If you’re buying a car from someone who’s only interested in making a sale, you’re probably not expecting completely objective information. You’re expecting to hear how wonderful the car is.

That’s not what you want from a reserve study.

A reserve study should provide confidence because it was prepared independently by someone with no conflicting interests.

It should be prepared by someone with the expertise to evaluate the property accurately.

And because conditions continually change, it should also be current.

Ideally, your reserve study should be:

• Independent
• Reliable
• Recently prepared

Why is that so important?

Because reserve funding is often one of the single largest line items in an association’s entire budget.

Typically, reserve contributions represent roughly twenty-five percent of an association’s total budget, although the range we commonly see is somewhere between fifteen and forty percent.

That’s far too significant a budget item to base on guesswork.

You want expert guidance.

When we talk about independence, we’re really talking about avoiding conflicts of interest.

For example, a management company representative may genuinely want to help, but they also have an ongoing business relationship with the board. They may naturally want to avoid creating conflict or recommending unpopular assessment increases.

Similarly, a board member or homeowner shouldn’t prepare the reserve study.

After all, homeowners have a personal financial interest in keeping assessments low.

That creates an unavoidable conflict.

A reserve study should be prepared by someone whose only objective is accurately evaluating the condition of the property and recommending what’s best for the association.

Reliability is equally important.

One thing I always recommend is looking at the name on the cover of the reserve study.

Do you see the designation RS or PRA after the preparer’s name?

Those stand for Reserve Specialist and Professional Reserve Analyst.

Those professional credentials demonstrate that the preparer has the experience to evaluate physical components, estimate remaining useful life, determine replacement costs, perform the financial analysis, and clearly communicate the results in a written report.

Finally, the study needs to be current.

The National Reserve Study Standards recommend updating reserve studies at least every thirty-six months, and Fannie Mae and Freddie Mac have adopted that same standard.

Your individual state may have different legal requirements. Some states require updates every five years. Others have different timelines.

But reserve studies become outdated much more quickly than many people realize.

Every year, component conditions change.

Project costs change.

Reserve balances change.

That’s why national best practices recommend updating the study every three years.

Robert Nordlund:

Now that we’ve talked about the importance of having an independent, reliable, and current reserve study, let’s talk about what you’re actually looking at when you open one.

A reserve study is designed to answer three fundamental questions.

The first question is: What are we responsible to repair and replace?

The second question is: Do we have enough cash today to meet those future obligations, or are we already behind?

And finally, the third question is: What should we do now?

The first two are findings. They’re an evaluation of your association’s current situation. The third is a recommendation—a multi-year funding plan designed to ensure you have enough money when it’s needed, with every owner contributing their fair share over time.

Remember the concept we discussed earlier. Reserve contributions are simply offsetting deterioration. They’re that ongoing usage fee for the common areas.

Another way I like to think about reserve studies is to compare them to a perishable item—maybe a banana or an avocado. A reserve study has a shelf life.

Why?

Because every year, three important things change.

First, the condition of your components changes. Unless you’re performing preventive maintenance, everything is getting older.

Second, project costs change. Inflation affects the cost of labor and materials, so future replacement costs continue to increase.

Third, your reserve balance changes. You’re making deposits throughout the year, you’re spending money on reserve projects, and your reserve account is earning interest.

Because all three of those things are constantly changing, the reserve study itself is constantly becoming outdated.

The board still has the responsibility to make annual budget decisions that properly sustain the association’s assets, despite the fact that conditions continue to change.

That’s why you rely on an updated reserve study.

At this point, I’d like to turn things over to Chip Munday, who will walk through those three questions in greater detail.

Chip, welcome to the program.

Chip Munday:

Thanks, Robert. I appreciate it, and I’m excited to be speaking with everyone today, especially those joining one of our webinars for the first time.

Let’s take a closer look at how the information contained in a reserve study answers those three fundamental questions, particularly during budget planning season.

Those questions are:

• What are we reserving for?
• Do we have enough cash?
• What should we do now?

Everything begins with the component list.

The component list is really the foundation of every reserve study because it answers the first question:

What are we reserving for?

Each component listed in the reserve study contains several important pieces of information.

You’ll see a description of the repair or replacement project.

You’ll see the Useful Life, often abbreviated as UL, which estimates how long the component is expected to last under normal conditions.

You’ll also see the Remaining Useful Life, or RUL, which estimates how much service life remains before the project should be performed.

Finally, you’ll see the estimated replacement cost expressed in today’s dollars.

Using that information, the reserve study calculates the current value of deterioration, commonly called the Fully Funded Balance.

Here’s a simple example.

Suppose you’re reviewing the reserve study while preparing next year’s budget.

You notice that the pool furniture has a remaining useful life of zero years.

That means the furniture has fully deteriorated from a reserve planning perspective, and the entire replacement cost should already exist within the reserve fund.

If replacing the furniture will cost $4,600, then ideally there should already be $4,600 reserved for that project.

Now consider another example.

Suppose pool resurfacing is expected to cost $10,000 and the surface is halfway through its useful life.

Since fifty percent of the deterioration has already occurred, the reserve fund should contain approximately fifty percent of the replacement cost, or about $5,000.

The reserve study performs this calculation for every component within the association and combines those values to determine the Fully Funded Balance.

That naturally raises another important question.

How does something get included on the component list in the first place?

The Community Associations Institute, or CAI, has established National Reserve Study Standards that define a three-part test for determining whether a component belongs in the reserve study.

The first question is whether the association is responsible for maintaining or replacing that component.

Typically, that responsibility is defined by your CC&Rs, governing documents, recorded plats, maintenance agreements, or even agreements with local municipalities.

The second question is whether the repair or replacement project can be reasonably anticipated.

In other words, is this something we know will eventually require repair or replacement?

And finally, is the project significant enough financially that it should be funded through reserves?

When determining the cost of a project, we don’t just look at the contractor’s invoice.

We include all associated costs, such as installation, shipping, taxes, permits, engineering, and any other direct or indirect expenses necessary to complete the work.

Once we’ve identified every qualifying reserve component, we’re ready to answer the second question:

Do we have enough cash?

Now that we know the current value of deterioration, we compare that figure to the amount of money currently sitting in the reserve account.

Typically, you’ll find that reserve balance listed under assets on the association’s balance sheet.

The question becomes simple.

Does the available cash adequately cover the accumulated deterioration?

That comparison tells us whether the reserve fund is in good condition, fair condition, or poor condition.

We often describe this using a measurement called Percent Funded.

For example, suppose the Fully Funded Balance is $100,000, but the reserve account currently contains only $75,000.

The association would be seventy-five percent funded.

That’s much more meaningful than simply knowing the bank account balance because Percent Funded tells us something much more important:

It tells us the association’s level of risk.

As Percent Funded decreases, the likelihood of special assessments increases.

Associations with very weak reserve funds face a much greater risk of unexpected assessments because they simply don’t have enough money available when major projects become necessary.

Conversely, associations with reserve funds above approximately seventy percent funded generally experience much lower special assessment risk because they have enough financial flexibility to absorb normal reserve projects—and even a few unexpected surprises.

Having additional reserve strength provides valuable financial margin.

Chip Munday:

Now that we’ve identified the reserve components and evaluated the strength of the reserve fund, we’re ready to answer the third question:

What do we do now?

The answer is found in the reserve funding plan.

Sometimes people look at the balance in the reserve account and think, “We have plenty of money.” It might seem like a large amount sitting in the bank.

But then you start thinking about the actual projects.

Roofs are expensive.

Asphalt is expensive.

Elevators are expensive.

Building exteriors are expensive.

The list goes on.

The key to minimizing reserve funding challenges is preparing for those expenses over time by spreading the cost across many years.

That’s exactly what the funding plan is designed to accomplish.

If you were looking at the reserve funding graph in your report, you’d see projected reserve expenses over the next thirty years.

The funding plan is designed so the reserve balance remains above those projected expenses throughout the entire planning period.

Maintaining that balance ensures the association has enough money available when projects occur at their expected cost.

Of course, life doesn’t always follow the plan perfectly.

Components don’t always last as long as expected.

In many cases, products simply aren’t built the way they used to be.

Costs can also change unexpectedly.

We’ve seen examples of that recently with inflation, tariffs, labor shortages, and material cost increases.

Sometimes a component experiences much heavier use than originally anticipated, shortening its useful life.

A strong reserve fund provides a cushion that allows the association to absorb those unexpected changes without immediately resorting to special assessments or delaying necessary repairs.

That’s why reserve funding shouldn’t simply plan for predictable expenses.

It should also provide a reasonable margin for surprises.

When you look at a healthy reserve funding plan, you’ll notice that the reserve balance rises and falls gradually over time.

That’s intentional.

The reserve balance should fluctuate as projects are completed, but it shouldn’t experience dramatic swings.

Maintaining a comfortable reserve balance creates a smoother, more equitable funding pattern and significantly reduces the risk of unexpected special assessments.

The funding plan really becomes the board’s roadmap for budgeting.

To put all of this into perspective, we generally find that reserve contributions average about twenty-five percent of an association’s total budget.

Some communities need more.

Some need less.

But if your reserve contributions are significantly below that level, there’s a good chance the association is gradually underfunding reserves.

Over time, that weakens the reserve fund and makes it increasingly difficult to keep up with the community’s deterioration.

So what should boards actually do with the reserve study?

Speaking from my experience as a professional community association manager, I can honestly say that a current reserve study is one of the most valuable tools available when preparing the annual budget.

I always recommend developing the reserve budget first, completely separate from the operating budget.

That approach keeps the board focused not only on next year’s operating expenses, but also on the long-term care of the community.

Use the reserve study as your guide.

Review the component list and identify the projects scheduled for the coming fiscal year.

Look at your projected reserve balance.

Review the projected reserve strength at the beginning of the next budget year.

Most importantly, pay attention to the recommended reserve contribution.

That recommendation is specifically designed to keep pace with ongoing deterioration while maintaining a reserve fund that’s strong enough to meet future obligations.

Remember, a reserve study is a predictive planning tool.

It’s based on the best information available today.

But we also know that conditions change.

That’s why reserve studies should be reviewed every year, ideally before budget planning begins.

If circumstances have changed, don’t hesitate to contact your reserve study provider.

Reserve professionals can update the study to reflect current conditions and adjust recommendations accordingly.

One thing I’d strongly encourage boards to avoid is the temptation to postpone projects or intentionally underfund reserves.

Deferred maintenance almost always costs more than performing the work on schedule.

Trying to save money by delaying necessary repairs is often a very slippery slope.

Boards have a responsibility to address ongoing deterioration.

The funding plan exists to guide those decisions and provide the funding necessary to preserve, protect, and enhance the community.

Hope and wishful thinking are not financial strategies.

Underfunding reserves or postponing maintenance rarely produces good long-term outcomes.

A reserve study also provides tremendous value for homeowners.

It helps everyone understand the true cost of living in the community.

That’s why it’s important to communicate reserve study information openly with homeowners.

Help them understand what they’re looking at.

Explain why the board is making certain financial decisions.

Show them that the reserve study provides objective evidence supporting those decisions.

When homeowners understand that the board is acting based on professional recommendations and in the best interests of the entire community, those conversations become much easier.

Robert Nordlund:

Thank you, Chip.

There were a lot of great concepts in there.

One thing I really want to reinforce is that every reserve study essentially provides three primary results.

First, it tells you what you’re responsible for repairing and replacing.

Second, it tells you the current financial condition of your reserve fund.

And third, it provides a funding recommendation for the future.

As board members and managers, we want you to understand those three concepts thoroughly because they form the foundation for communicating with homeowners.

When someone is brand new to reserve studies, one of the first questions they’re likely to ask is:

“What projects are coming up soon?”

The answer is found in the component list.

Look for projects with two characteristics.

First, they have a large replacement cost.

Second, they have a very short remaining useful life.

Those are the projects you should pay attention to first because you have very little time left to prepare for them.

If you’re reviewing a printed reserve study, I’d actually encourage you to highlight those projects.

Those are the items your board should already be discussing.

Next, compare the reserve balance shown in the reserve study with the reserve balance you’ve been seeing in your monthly financial statements.

Those numbers should generally agree.

For example, if your monthly financial reports consistently show reserve balances somewhere between $250,000 and $300,000, then your reserve study should begin with approximately that same amount.

If the reserve study shows a beginning balance that’s dramatically different—perhaps $100,000 or $500,000—that’s something you’ll want to investigate before moving forward.

Consistency matters.

Finally, look at the funding recommendation.

Reserve studies typically include a funding plan extending twenty or thirty years into the future.

While that long-term outlook is valuable, the most important recommendation for budgeting purposes is the contribution being recommended for your next fiscal year.

Take that recommendation and compare it to your current reserve contribution.

Is the reserve study recommending a significant increase?

A modest adjustment?

Or roughly the same contribution you’re already making?

Understanding that comparison will help guide your discussions with homeowners as you explain the upcoming budget.

Robert Nordlund:

Once you’ve compared the reserve study’s funding recommendation to your current reserve contribution, you’ll have a much better understanding of how to communicate the budget to homeowners.

Another helpful question to answer is, “What percentage of our total budget is going toward reserves?”

We’ve shared throughout today’s discussion that it’s common for associations to contribute approximately twenty-five percent of their total budget toward reserves.

So, if you perform the calculation and discover your association is contributing twenty-one percent, and homeowners tell you that’s excessive, you can explain that the national average is actually closer to twenty-five percent. In other words, your association is still within a reasonable range.

On the other hand, if your reserve contribution is twenty-eight or even thirty-two percent of the budget, you can explain why.

Perhaps your community has extensive wood siding that requires regular maintenance.

Maybe there are numerous wood decks, large parking areas, extensive asphalt, or significant recreational amenities.

Those features provide value to the community, but they also increase long-term maintenance costs.

Every association is different, and those differences should be part of your conversations with homeowners.

Ultimately, our goal is to help you apply the reserve study—not simply read it.

At its core, reserve planning comes down to budgeting to pay your bills.

You don’t negotiate with Mother Nature.

You don’t negotiate with Father Time.

The deterioration bills are coming whether you’re prepared or not.

When your association is financially prepared to pay those bills, you dramatically reduce the likelihood of special assessments because the necessary funds are already available.

When projects are completed on time, you also avoid deferred maintenance and the much higher costs that often accompany it.

There’s a significant difference between repainting a building at the appropriate time and rebuilding portions of that same building after years of deterioration.

Preventive action is almost always less expensive than reactive action.

Another benefit is homeowner enjoyment.

People simply enjoy living in attractive, well-maintained communities.

The curb appeal is real.

Beautifully maintained common areas enhance the ownership experience every single day.

And ultimately, that investment comes back to homeowners through stronger property values.

Reserve contributions aren’t money that’s simply spent and gone forever.

In many ways, you’re transferring dollars from your pocket into the long-term value of your home.

That’s an investment.

Now, depending on your association’s current reserve strength, it may take several years to fully reach your funding goals.

That’s perfectly okay.

It’s a journey.

The important thing is that you’re moving in the right direction, and your reserve study serves as the roadmap for getting there.

As we’ve discussed today, every reserve study consistently provides the same fundamental information.

It identifies the components your association is responsible for repairing and replacing.

It estimates when those projects are expected to occur.

It estimates how much they’ll cost.

It evaluates the current strength of your reserve fund.

And finally, it recommends an appropriate funding plan moving forward.

Those are the key pieces of information you should become comfortable reading and discussing.

Whether your reserve study was prepared by Association Reserves or another qualified reserve study provider, those are the fundamental concepts you should expect to find.

That concludes our prepared presentation for today.

If you’d like to continue learning, we have a wide variety of educational resources available.

Here at Association Reserves, we’ve now completed more than 100,000 reserve studies, and we’ve tried to share the lessons we’ve learned through those decades of experience.

You’ll find articles, educational resources, and additional information on our website at www.reservestudy.com.

As Jenn mentioned earlier, this webinar has been recorded, and within about a week you’ll also be able to find it on our YouTube channel, along with our library of previous webinars and educational videos.

Simply search for Association Reserves or Reserve Studies on YouTube, and there’s a very good chance you’ll find the material you’re looking for.

If you enjoy listening to podcasts, I’d also encourage you to check out our weekly podcast, HOA Insights: Common Sense for Common Areas.

Each episode is about thirty minutes long and is designed specifically to encourage and equip volunteer board members as they navigate the challenges of leading their communities.

You can find the podcast on all major podcast platforms, on YouTube, or by visiting hoainsights.org.

And if you prefer having a reference book on your desk, our book Understanding Reserves is available through Amazon. It covers many of the same concepts we’ve discussed today and serves as an excellent resource whenever reserve planning questions come up.

With that, I’ll turn things back over to Jenn, who will coordinate our question-and-answer session.