By Robert M. Nordlund, PE, RS
Association Reserves, Inc.
I recently read an article critical of using “% Funded” to measure the financial strength of an Association’s Reserve Fund. The author argued that since an error in the Component List would make the “% Funded” computation misleading, “% Funded” results should always be ignored. I was initially bothered by this sideswipe at an established National Reserve Study Standard (NRSS) measurement of Reserve Fund Strength, but then realized some truth in the accusation. While I am in the majority believing that “% Funded” reliably reports Reserve Fund strength, the truth is that when the Component List is wrong, everything else in the Reserve Study is equally suspect.
A NRSS-compliant Reserve Study provides three key results:
- Component List (detailing the scope & schedule of reserve projects)
- Reserve Fund Strength (% Funded)
- Funding Plan (Reserve Contribution)
The Component List is foundational because the second two results are computed based on the first! Therefore if the Reserve Component List is “inaccurate” with respect to the scope & schedule of the anticipated repairs & replacements, the Reserve Fund Strength and Funding Plan calculations will also be inaccurate. Thus… get the Reserve Component list “wrong”, and you’ve wasted your time.
Fortunately, National Reserve Study Standards dictate a four-part test to help ensure that the Component List is complete. To qualify as a valid component, a project needs to pass all of the following four tests:
Test #1. Is it a common area maintenance responsibility?
Test #2. Is it life-limited?
Test #3. Does it have a predictable Remaining Useful Life?
Test #4. Is its repair/replacement above a minimum threshold cost of significance?
While there is still a great deal of skill and judgment involved in compiling all elements of the Component List (Useful Life and Remaining Useful Life to determine the schedule of the project and Current Replacement Cost to determine the scope), the NRSS four-part test means we have sound guidance on which items to include.
Let me make two observations at this point:
- If the Association’s Reserve Specialist, Manager, and Board of Directors are all being guided by the NRSS four-part test to establish the Component List, the list should remain reasonably accurate and stable through the years.
- There will always be some changes and surprises. For example, if your old landscaping company trimmed the trees on an ongoing basis, but your new landscaping company’s contract excludes tree trimming, you’ll need to add “Tree Trimming” to your Component List. There is also a chance that a common area item everyone reasonably predicted would “last forever” (failing part #2 of the 4-part test) suddenly fails. In that case, you would have a new component to add to the Component List.
The bottom line is that “% Funded” or a Reserve Funding Plan shouldn’t be tossed aside as unreliable concepts just because of the potential for problems with the underlying Component List. So place the proper attention on assembling an accurate and stable Reserve Component List, because everything else in the Reserve Study stands on that foundation.