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WHY A RESERVE STUDY?

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A Reserve Study is a budget planning tool that identifies the current status of the Reserve Fund and a stable and equitable Funding Plan to offset the anticipated future costs associated with major common area expenditures that will affect a community association. The Reserve Study consists of two parts: the PhysicalAnalysis and the Financial Analysis. Reserve Studies are often prepared by an outside, independent consultant, which benefits the administrators of a property with multiple owners such as a condominium or homeowners’ association (HOA), and contain an assessment of the state of the commonly owned property components as determined by the particular Association’s bylaws.

Reserve Studies are, in essence, planning tools designed to:

 

·         Help the Board anticipate, and prepare for, the property’s major repair and replacement projects.

·         Give those overseeing the maintenance of the property a better idea of what major expenses to expect.

·         Provide an educated estimate of when these expenses will occur.

·         Allow the Association to create a budget so members contribute their “fair share.”

·         Prevent a large output of monies at once and help space out expenditures more evenly each year.

·         Provide important annual disclosures to Association members (and prospective buyers) about the condition of common area components.

·         Show the level of preparedness (strength) of the Reserve Fund (typically measured in terms of PercentFunded).

How does an Association properly determine and compile adequate reserves to fund necessary repairs, replacement costs, and unplanned costs such as natural disasters or failed systems?   By conducting Reserve Studies.

Community Associations

The term “community association” is used generically to describe a residential development (freestanding home, townhome, condominium, etc.) whereby each owner is governed by a set of documents that require compliance with rules and the payment of fees. Most commonly they are referred to as Homeowners’Associations or Condo Associations. Membership in the “Association” is automatic when a unit is purchased, and the fees collected are used for the operation of the Association. 

At the end of 2012, there were over 320,000 of these Associations in the U.S., with approximately 25.9 million units, housing over 63 million people. Size, demographics, amenities provided, and upkeep requirements vary greatly.

As a member in a leadership role of these Associations or cooperatives, you have fiduciary responsibilities that require you to make decisions that can have a profound financial and social impact on your community. The role and scope of authority can vary depending on the Association’s governing documents and the law. Some run with the same authority as a corporation, and others precisely state the powers of the board. In both cases, board members have the responsibility to fulfill their fiduciary duties to the community and exercise discretion ethically and in the best interest of the community. Receiving professional and accurate advice or guidance on reserves can make the difference between prosperity and distress; a Reserve Study is an example of this.

Community Fees

All community Associations have fees that must be paid to the Association. The fees may cover costs such as landscaping and maintenance of common areas, snow removal, garbage collection, street lighting, amenities, police patrol, insurance, and reserves for the eventual replacement of common elements.

A legal report, the annual budget is usually approved at the annual meeting of the Association. The annual budget is not a reserve study. The Reserve Study is only for the major repair or replacement of the common elements that are the Association’s responsibility. A reserve fund is intended to cover non-annual maintenance, repairs, and capital improvement costs. In all cases the cost of ongoing (annual) maintenance should also be budgeted for separately, as this is not included within the Reserve Study. If the proper maintenance is not performed, it can result in a significant loss of useful life for the reserve components. This will result in their replacement occurring sooner than anticipated, when adequate funds have not yet been accumulated.   

If the community Association has hired a manager, their responsibility is to implement the decisions of the board of directors. The property manager is not responsible for determining the condition or planning for repair or replacement of the common elements. 

Future Repairs and Replacements

Careful planning for future repairs and replacements is not only in the best physical and fiscal interests of the community association but is required by law in some states. Defining the assessments that dictate why and when replacements and repairs are necessary is also a crucial part of the process. Maintaining a reserve fund not only meets legal, fiduciary, and professional requirements but also minimizes the need for special assessments and enhances resale values.

 

Professional advisors, including attorneys, accountants, reserve study consultants, engineers, architects, insurance brokers and community association management consultants are among the paid advisors who may be engaged to advise on either a narrow issue or more broadly to help directors understand and comply with their legal standard of care.

-Jeffrey A. Barnett, ACP, specializing in legal representation of common-interest developments

 

Every community Association requires a different amount of cash in reserve to complete repairs or replacement projects on schedule without special assessments or loans. This is one aspect that makes a Reserve Study imperative.

Definition of Reserve Studies

As previously mentioned, there are two components of a Reserve Study: a physical analysis and a financial analysis. During the physical analysis, the reserve provider evaluates information regarding the physical status and repair/replacement costs of the Association’s major common area components. To do so, the provider conducts a component inventory, a condition assessment, and life and valuation estimates. A financial analysis assesses only the Association’s reserve balance or fund status (measured in cash or as percent funded) to determine a recommendation for an appropriate reserve contribution rate (funding plan).

Types of Reserve Studies

Once the Full Reserve Study has been conducted, there are two options for updates: an Update With Site Visit/On-site Review or an Update No Site Visit/Off-site Review.

  • The Full Reserve Study includes a component inventory, a condition assessment (based upon on-site visual observations), and life and valuation estimates to determine both a fund status and a funding plan.
  • In an Update With Site Visit/On-site Review, the reserve provider conducts a component inventory (verification only, not quantification), a condition assessment (based on on-site visual observations), and life and valuation estimates to determine both a fund status and a funding plan.
  • In an Update No Site Visit/Off-site Review, the reserve provider conducts life and valuation estimates to determine a fund status and a funding plan.

The Full Reserve Study consists of four elements: Component Inventory, Condition Assessment/Valuation, Fund Status, and Funding Plan.      

It is rare that the current funding status exactly meets the needs of the Association. Often, the Association is underfunded as a result of insufficient contributions, unexpected costs, or a variety of other factors. On occasion, an Association may be overfunded, indicating that more of the Association members’ money than necessary is tied up in the Capital Reserve fund. The purpose of the Funding Plan is to recommend to the Association several options for achieving the desired funding levels.

Criterium Peters Engineers’ Funding Plan is based on the following assumptions: the Association wishes to achieve a Baseline Funding level wherein the objective is to keep the reserve cash balance above zero. The balance in the fund at the end of the reserve analysis period (20 years) is approximately equal to the average annual funding requirements over that period (unless significant repairs are expected just beyond that period).

The Capital Reserve may be funded by monthly fees, special assessments, or both. Monthly fees may remain stable throughout the period or may increase or decrease at varying rates.

Criterium Peters Engineers develops three alternatives to achieve the funding levels as described above. Once the Association has had a chance to review these funding strategies, Criterium Peters Engineers may make adjustments or modifications, as requested, to the chosen strategy.         

In preparing the Reserve Study, the replacement costs that are used are based on both industry estimating standards and the actual costs of similar projects that have been performed. The replacement costs are typically based on current dollars and are not based on the preparation of specifications and bidding of the work to actual contractors. They are intended to be used as a budget-planning tool. Actual costs at the time work is done are influenced by many variables such as material prices, contractor workload, weather, and problems that may arise.  In order to keep the replacement costs as well as the anticipated useful life values current, the Reserve Study should be updated (including a site visit) a minimum of every three years.  Some states require updates more frequently.

Reserve Specialists

To help ensure that you have the expert guidance you need to manage your community’s assets most effectively, look for professionals with the designations and certifications needed to fulfill your responsibilities.

Community associations rely on qualified Reserve Specialists (RS) to assist them in extensive reserve planning to keep their communities running smoothly. The RS designation is awarded to experienced, qualified reserve specialists who, through years of specialized experience, can help ensure that your community association prepares its reserve budget as accurately as possible. RS designees must meet comprehensive requirements including: (1) Prepared at least 30 reserve studies; (2) Received a bachelor’s degree in construction management, architecture, or engineering (or equivalent experience and education); and (3) Complied with strict rules of conduct outlined by the Professional Reserve Specialist Code of Ethics.

A Reserve Specialist can help ensure your Association is planning for future needs to reduce the chances of levying special assessments to pay for unexpected expenses.

RS+PE

Reserve Specialists who are also licensed Professional Engineers (PEs) (or Architects) specializing in the practice of building inspection engineering adds an even higher level of education and experience. 

The most important element of a credible reserve study is valid component data. Inaccurate cost information, improper assessment of the condition of each component, and failure to examine ways of maintaining components to prolong their useful life can lead to underfunding or, almost as problematic, overfunding of the reserve account. When you hire a Reserve Study consultant, you are paying for a professional opinion of the condition of each component. The value of that opinion is directly related to the knowledge and expertise of the person rendering it.

A significant portion of the Reserve Study is based on a physical analysis of the individual components (such as the roofs and the roads) included within the study. The physical analysis is important because it determines the existing condition and actual expected life of the common elements. Someone with extensive field evaluation experience should be responsible for the evaluation of the components. 

In many instances the original component that is being replaced either is no longer available or has become outdated since it was first installed. By making recommendations for alternatives to the initial installation, the Association may be able to install a replacement component or system with a significantly longer life, such as a new type of roofing system, or a component or system that is much more energy-efficient, such as a new HVAC system. 

Companies have developed databases for estimating the useful life of most major components. Databases, however, only work for typical systems and components, not actual ones. Nothing can replace an actual inspection of the component in place. Furthermore, a competent consultant will not only be able to make a more accurate assessment of the remaining useful life, but he or she can also exercise judgment. That means that if maintenance can prolong the useful life, it may be more cost-effective. If staging the replacement or repairs can minimize expenses, then that should be part of the recommendation. Anyone can look up numbers in a table. Only experienced professionals can apply judgment.

A Reserve Study also includes an evaluation of defective components and systems in need of immediate repair. Such information is not found in tables. This is another reason to hire someone who knows how components and systems operate in the real world.

By reviewing the anticipated replacements in the coming year on a regular basis, the Association can plan to have the required work performed before actual conditions deteriorate to the point that remedial work will be required as part of the replacement, which can result in a significant increase in the actual cost of doing the work. A common example of this occurs with pavement seal coating and overlays. If the application of the seal coating is not performed on the recommended schedule, even if the pavement looks good, it can result in additional deterioration of the pavement, which must be corrected prior to the application of the overlay. This can reduce the anticipated time period before the overlay is needed and also increase the cost of the work when it is done.

Additional common replacements with a “shelf life” include siding, roofing, and deck maintenance.

If defects are found or needed repairs are identified, the next step will usually be to develop a plan of repair, assemble a bid package, and seek estimates. The consultant performing the Reserve Study should be able to help the Association with this important work. Although it would be a conflict of interest for the consultant to actually perform the repair, it is very useful for the consultant to be available to oversee the repair to make sure it is done properly.

A key to evaluating this qualification is to have this portion of the work performed under the direction of a licensed PE, as the license confirms that this person has been trained and educated in performing this type of evaluation.

Federal Housing Authority (FHA) Mortgage Guidelines and Selling the Property to New Homeowners

On September 13, 2012, the US Department of Housing and Urban Development (HUD) issued Mortgagee Letter 2012-18, related to all FHA-approved loans for condominium sales and projects. The new guidelines reflect enhanced risk management standards being enforced in all FHA program areas. It addresses how much space can be commercial and how much is nonresident-owned and includes rules regarding delinquent homeowners and insurance requirements. Of importance is the fact that in order for a borrower to qualify for an FHA-insured mortgage, the Association must be listed with HUD, and listing involves an application process that, while not specifically requiring a Reserve Study, does require demonstration of adequate reserves. In the best interest of the community Association and its owners, the prudent step would be to have a Reserve Study. Otherwise, there is the risk of potential purchasers being turned down for financing.

Much of this information was compiled from the resources available from the Community Association Institute (CAI). For more information, visit www.caionline.com.

Criterium Peters Engineers

Criterium Peters Engineers is part of a nationwide firm with over 55 years of experience specializing in real estate engineering services including reserve studies. The company maintains the largest number of locally based offices in the industry. When you hire Criterium Peters Engineers, you are hiring a local engineer with knowledge of your area, conventions, and system performance. You also get the personal attention of a small business owner who has the support and backup of a national company. Work is performed by and under the direction of a licensed Professional Engineer with many years of experience in building systems and Reserve Study consulting. Our software was developed for our exclusive use by KPMG Peat Marwick, one of the largest and most prestigious accounting firms in the country. Learn more at www.Criterium-Peters.com

 

CLICK HERE TO DOWNLOAD AND PRINT THIS ARTICLE to share with other property managers and/or your board.