Does Your Community Need a Reserve Study? Part I
An HOA reserve study is essential in examining and maintaining the financial health of your association. Yet, many boards need to be made aware of the importance of these studies and choose to forgo them altogether. But what is a reserve fund study, and how will it help your community?
What's an HOA Reserve Study?
What is an HOA reserve fund? Reserve funds are funds that homeowners associations set aside for future financial obligations such as major repairs, replacements, and maintenance. To understand reserve studies, you must first know a reserve fund.
How much money should an HOA have in reserve? Calculating HOA reserve funds differs from association to association based on many factors, such as community size and the nature of the HOA's common elements.
Typically, reserves are considered fully funded if they cover 100 percent of future financial obligations. Meeting this HOA reserve funding percentage is usually tricky for many associations, though, and a respectable level of funding is 70 percent at the least.
What is a reserve study for an HOA? A reserve study is simply an assessment of your association's assets done to keep your reserve fund at an optimal level. It typically involves an on-site inspection to calculate the estimated remaining life of common elements and the estimated cost of repairing or replacing them.
Reserve studies consist of two parts, namely:
Financial Analysis examines the association's income and expenses, such as its financials. It also takes the current reserve fund into account.
Physical Analysis examines the association's common elements' physical condition and the estimated cost of repairing or replacing them.
The Difference Between Reserve Funds and Operating Funds
Homeowners associations usually set up and maintain two types of funds. These are the operating fund and the reserve fund. The operating fund covers routine expenses such as management fees, vendor fees, utility costs, and insurance premiums.
Physical assets will deteriorate over time, and your HOA will need to replace or repair them down the road. On the other hand, the reserve fund covers the cost of significant replacements or repairs that will eventually come up. The reserves act as your association's savings account from which you can withdraw money to pay for these future costs.
Unlike your operating fund, set aside your reserve fund for investment opportunities. When investing your reserve funds, capital preservation is imperative. You must guarantee the safety and liquidity of your reserves and consider yield last.
Types of Reserve Studies
There are four general types of reserve studies — a preliminary study, a study with no site visit, an on-site visit, and a complete reserve study. The one you choose should directly address the present needs of your association.
A Preliminary Study
A preliminary study usually takes place before the construction of a community and includes an inventory of the components, life estimates, a funding plan, and valuation estimates. One uses these for budget estimates based on engineering and architectural projects.
No Site Visit
This study doesn't involve an on-site review of the association's common elements. Generally, it only uses observations and discussions with the board, staff, and vendors to determine information. Therefore, it's the most affordable type of HOA reserve study.
With Site Visit
This study involves an on-site review of the association's common elements. It will update the fund status, the funding plan, and life and valuation estimates. This process costs more than a study with no site visit but less than a complete reserve study.
Full Reserve Study
A complete reserve study involves component inventories and condition assessments. It's the most expensive and time-consuming because it involves a full site inspection. This study usually takes place only once (at the beginning) or twice if the association wants a second opinion.
Please read Part II for more information. (Coming soon!)
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