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
WHAT is a reserve study?
A Reserve Study amortizes funding expenses over time so that current owners are not unfairly burdened with the responsibility to pay for the inspection, maintenance, repair and replacement of components (regardless of cost) that have a useful life beyond one year. Reserve funding, reserve studies and property infrastructure go hand-in-hand.
WHAT belongs in a reserve study?
There should be no debate: if a component requires inspection, maintenance, repair and/or replacement every 2 years to 100 years, plan for it in your reserve study to amortize costs over the presumptive useful life of every such component. READ: Reserve Funding Strategies
WHAT AREN'T RESERVE EXPENSES?
Capital improvements are NOT reserve expenses.
Annually recurring expenses are NOT reserve expenses. Expenses incurred every year belong in your operating budget.
WHAT ARE RESERVE EXPENSES?
Expenses for inspection, maintenance, repair or replacement of one or more components that already exist AND are substantially the same.
Expenses that do not occur annually, but are expected to occur at least once or more within the expected useful life of the property as a whole.
N.B. The expense does not have to be "predictable." For example, generators and common piping (plumbing) 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 become discretionary judgements unless they are clearly defined by statute or 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%?
How are you tracking the need to maintain, repair and replace something every 5 to 10 years if the component isn't listed in your reserve study? And how are future owners expected to budget for it?
For all the reasons above and more, put every less than annual expense to maintain, repair and replace components in your reserve study. This is the ONLY way to ensure: 1) continuity for reasonable, reliable, tracking and 2) equity of reserving for expenses over time.
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.
Several reserve study vendors are still not meeting the minimum requirements of RCW 64.90.525 that applies to ALL Washington State community associations 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
Multiple 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.
Minimum reserve funding required: Delaware § 81-205, Illinois 765 ILCS 605/9, Maryland § 11-109, Michigan Administrative Code 559.511 (pursuant to 559.205), Minnesota 515B.3-1141, Nevada 116.3115, Ohio 5311.081 and 5312.06, Wisconsin 703.163 and Florida 718.112(f)
View our State Statute Details Matrix to learn which states have statutory reserve study and reserve fund requirements.
$$$ How can your association USE /SPEND reserve funds? $$$
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 inspection, maintenance, repair or replacement of a component that will be added to the reserve study
to fill a gap in operating funds (!) by BORROWING and repaying the reserve fund over time
to pay for capital improvements that will be depreciated over a period of several years with the borrowing repaid to the reserve fund over time
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
🏦💵 How can your association INVEST reserve funds? 🛟🦺
With the exception of 10-year Treasury Notes, principal-guaranteed securities such as money market funds, certificates of deposit (CDs) and US Treasuries (bills, notes and bonds) have NEGATIVE INFLATION-ADJUSTED RETURNS from the year 2000 to 2024.
Unlike retirement planning which is finite (humans have an expiration date), community association reserve funding needs are infinite ♾️!
Contrary to the common wisdom of most long-term investment planning (university endowments, pension plans, whole life insurance assets, etc.), community associations have been lead to believe that risk-adversity is key to storing their collective billions of reserve dollars in an eroding investment scheme as a best practice. Guaranteeing return of principal (moving to more conservative investments) a well-known concept employed by target-date funds, but as we've already stated, community association common assets are typically planned for inspection, maintenance, repair and replacement in perpetuity.
💡 Most associations with more than minimal common assets would benefit from rethinking their reserve investment plan to PRESERVE AND GROW capital on an inflation-adjusted basis INSTEAD of an absolute, fixed dollars-in, dollars-out concept. Prudent investors understand that purchasing power decreases over time.
❓Do you have homeowners involved in your reserve study 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 association's major component replacement cost is $5,000,000 instead of $3,000,000, AND/OR if your reserve study has excluded hundreds of thousands or millions of dollars of components from its component list (see common exclusions), most organizations lack the capital on hand to make up the difference.
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, degree or special expertise to make your reserve study accurate, comprehensive and precise. View the difference below from 2013 to 2021.
READ 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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