Reserves
Your Reserve Study...Needs HELP <CLICK TO EXPAND>
Mister Rogers taught us long ago about what’s real and what’s pretend. Most reserve studies pretend to be accurate and homeowners pay the price. Expand this section and click through to read Reserve Judgment.
Special assessments to fund failing infrastructure offer a reality check, but why do associations ignore obvious errors for decades at a time? Reserve Judgment from CIC Info Byes Issue #64 highlights one reason reserve studies aren’t accurate and The Myth of “Full Funding” includes 10 more.
Below is a snapshot of a reserve study for a condominium in Seattle, WA.
2021 data are as presented by the reserve study firm. 2023 data updated by a brief SMAARTE Group reserve study tune-up.
Replacing the fire control system will cost $330,000: over 300% more than the reserve study’s prior estimate of $107,000
The reserve study excludes 10.5% sales tax
The study woefully underestimates the cost of elevator modernization
The study under-counts the total glazing (doors and windows) by about 90% and underestimates the replacement cost by 100% to 200% ($ millions)
The study excludes the cost of a building-wide re-pipe
Reserve funding, reserve studies and property infrastructure go hand-in-hand.
A Reserve Study amortizes funding expenses over time so that current owners are not unfairly burdened with the responsibility to pay for the maintenance, repair and replacement of components (regardless of cost) that have a useful life beyond one year. Why debate the fairness factor? If component XYZ needs to be maintained, repaired and/or replaced every 2 years to 100 years, plan for it in your reserve study to amortize costs over the presumptive useful life of every component.
WHAT belongs in a reserve study?
Start with your state statutes, but remember that there are certain guiding principles (see above) that make sense for every community. Three out of four four Washington State CIC statutes dictate that reserve studies should or must (!) include components with a cost exceeding 1% of the association's annual budget:
A reserve component list, including any reserve component, the replacement cost of which exceeds one percent (1%) of the annual budget of the association, excluding contributions to the reserves for that reserve component. If one of these reserve components is not included in the reserve study, the study should/must explain the basis for its exclusion. The study must also include quantities and estimates for the useful life of each reserve component, the remaining useful life of each reserve component, and current major replacement costs for each reserve component ... AND MORE
In preparing a reserve study, the association shall estimate the anticipated major maintenance, repair, and replacement costs, whose infrequent and significant nature make them impractical to be included in an annual budget.
DEFINED: WHAT are reserve expenses?
1. The expense is for inspection / review, maintenance, repair or replacement of one or more components that already exist AND are substantially the same. Capital improvements are NOT reserve expenses.
2. The expense does not occur annually, but is expected to occur at least once or more within the expected useful life of the property as a whole. Annually recurring expenses are NOT reserve expenses.
N.B. The expense does not have to be "predictable." For example, generators and common piping are often omitted from reserve studies. The fact that there is a lack of consensus about when or if these items will reliably require inspection, maintenance, repair and/or replacement does not obviate them from being included in a reserve study. Failure to include common piping has resulted in many multi-million dollar special assessments.
N.B. The expense does not have to be "significant" or more than 1% of your annual operating budget. "Significant" and "material" and other such words are meaningless as they are not defined by statute, nor your governing documents. Quarrels have been had over less. 20 items that are 0.5% of your operating budget add up to 10%. 10x $3,000 items = $30,000. Oh, and is that 1% in current dollar terms or inflated 20 years from now? Oh and what if your estimate of the replacement cost is off by 1,000%? Don't be fooled by excluding components you'll have difficulty tracking over time! Put every expense that does not occur annually in your reserve study. This is the ONLY way to ensure: 1) tracking and 2) equity of reserving for costs over time.
3. The expense is some form of common expense.
Common expenses are defined by statute and your declaration / CC&Rs and generally benefit more than one unit.
TLDR: Several reserve study vendors are still not meeting the minimum requirements of RCW 64.90.525 that applies to ALL Washington State common interest communities (CICs) since July 2018. Over half the reserve studies analyzed by a Seattle law firm in 2021 were found to be substantially non-compliant with the statute. This deficiency jeopardizes your annual budget ratification process.
Have you transformed your reserve study into a living document?
Transform your reserve study into a living document by integrating information sourced from routine maintenance, repair and replacement including: WHO provided service, WHEN it happened, WHAT was addressed, and HOW much it cost.
WHY? Value-added contextual data facilitates reserve study updates and more accurate data related to estimated useful life and component costs. Your association will also evaluate the data more frequently than might otherwise be the case.
READ: The Prevention Plan
Over 10 States REQUIRE Reserve Studies and/or Reserve Funding
The lack of a law requiring due diligence and appropriate funding should not be construed as a best practice. Don't put your faith in imperfect laws! Follow the lead of community associations that have successfully navigated decades of maintenance, repair and replacement.
Maryland (Md. Code, Real. Prop. § 11-109) and Florida (718.112(f) require minimum reserve funding levels
Washington (RCW 64.34.380 & 64.90.545), Florida (720.303(6)) and six other states have statutory reserve study and reserve fund requirements. View a list of reserve study and funding requirements by state.
$$$ How can your CIC spend your reserve funds? $$$
Start with your state statutes. Three different Washington State CIC statutes provide the language below. Reserve funds are intended to be expended specifically for maintenance, repair and replacement activities, NOT for capital improvements (BUT you can often borrow from your reserve funds with a specified repayment schedule). Reserve studies do not contemplate capital improvements as part of their over-time funding and expense algorithms.
WA: RCW 64.34.384 + RCW 64.90.540
An association may withdraw funds from the association's reserve account to pay for unforeseen or unbudgeted costs that are unrelated to replacement costs of the reserve components. Any such withdrawal must be recorded in the minute books of the association. The board must give notice of any such withdrawal to each unit owner and adopt a repayment schedule not to exceed twenty-four months unless the board determines that repayment within twenty-four months would impose an unreasonable burden on the unit owners.
The board must provide to unit owners along with the annual budget adopted in accordance with RCW 64.90.525 (a) notice of any such withdrawal, (b) a statement of the current deficiency in reserve funding expressed on a per unit basis, and (c) the repayment plan.
Payment for major maintenance, repair, or replacement of the reserve components out of cycle with the reserve study projections or not included in the reserve study may be made from the reserve account without meeting the notification or repayment requirements under this section.
The board may withdraw funds from the reserve account without satisfying the notification of repayment requirements under this section to pay for replacement costs of reserve components not included in the reserve study.
Florida Condominium Act - 718.112(2)(f)(3)
Reserve funds and any interest accruing thereon shall remain in the reserve account or accounts, and may be used only for authorized reserve expenditures unless their use for other purposes is approved in advance by a majority vote at a duly called meeting of the association...
Why would an association use reserve funds for items not contemplated in the reserve study?
to pay for sizeable capital improvements that will be depreciated over a period of several years
amortizing large expenses reduces the immediate cost burden
if a new asset is going to last 10, 20 or 30 years, it might make sense to pay for it over time
to fill a gap in operating funds (!)
to pay for maintenance, repair or replacement of a component that will be added to the reserve study
Do you have volunteers involved in your reserve study update process?
Volunteer participation is absolutely essential! In Washington State, reserve study vendors are statutorily indemnified from being held accountable for providing inaccurate information. CICs with volunteer involvement have consistently expressed more confidence in the information their reserve studies contain. 40% of CICs have volunteers who dedicate time annually to their reserve study updates. View the 2021 CIC Reserve Questionnaire.
Many nonsensical comments over the years contend that"reserve studies are just tools" as a way to justify woefully inaccurate data related to cost and useful life. Having to complete a project 5 years early or at 10% to over 1,000% more cost is material in many cases.
If your CIC's major component replacement costs $5MM instead of $3MM (or if you've excluded that component from your reserve calculations) most organizations don't have the additional $2MM capital available to make it work. Special assessments can be avoided by applying proper planning and additional effort from reasonable people looking at the data. It does not require a certification or degree or expertise in any specific field to make a measurable difference in your reserve study. View the difference below from 2013 to 2021.
VIEW Decision-Making 101
Impact of Volunteer Involvement on a Reserve Study
Predicting the future isn't easy, but this reserve calculator with industry-standard calculations does most of the hard work for you!
CRITICAL QUESTIONS FOR EVERY RESERVE STUDY:
Are all your existing components identified and included? This requires understanding what your annual operating budget will resolve.
Are components with useful lives of 40 to 50+ years correctly calculated as part of the fully funded balance?
Are components properly categorized as CE vs. RLCE vs. CLCE, etc. as required by your governing documents?
Does every component reflect the correct useful life and remaining useful life?
Does every component reflect an accurate cost to maintain, repair or replace?
Have you applied sales tax to the cost of every component?
Are assumptions about component inflation costs and annual interest realistic?
N.B. This reserve calculator is not a replacement for hiring a reserve study vendor. | File > Save As > Download a Copy | Requires Excel 2016+
>>> If you're interested in a more robust reserve tool, please check out UPlanIt by Association Reserves. <<<
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