Association Reserve Funding Strategies: Ensuring Your Budget's Success
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A reserve fund is a community savings account that serves as a cushion — protecting your association’s finances from the burden of necessary future expenditures. By design, a reserve account grows over time through regular funding that comes from a percentage of your association’s dues.
A reserve study assists with an association’s long-term financial planning by taking into consideration the current status of the reserve fund, and determining a regular funding contribution that will offset ongoing wear and tear and/or achieve future community enhancements. The reserve study is comprised of two parts — a comprehensive physical analysis of the current condition of your community’s assets, and a detailed financial analysis.
Both the reserve fund and reserve study are critical components of the budgeting process that help ensure the long-term financial security of your community.
Association Reserve Funding Benefits
The key to protecting the fiscal health of your community is committing to the consistent funding of your reserve fund over time. By doing so, your association will realize three distinct benefits:
- Peace of mind - A reserve fund gives association members greater confidence and comfort in knowing money will be there when it is needed.
- Market value preservation – When reserves exist to support shared assets in a community, the market value of properties within that community are better maintained.
- Equitable cost participation – One of the main advantages of establishing and maintaining a reserve fund is that it ensures all residents who are using and enjoying community assets are contributing to their costs. Without reserves, a special assessment may be needed whereby only those residents who are living in your community at the time an asset needs to be replaced would be impacted. By funding reserves over time, you can ensure that generations of owners share in the costs of assets.
Your governing documents will detail if a reserve fund must be established for your community. In fact, some states require fully funded reserves. Those documents will also outline what procedures must be followed for contributing to your reserves. It can also tell d if funding can be postponed or sidestepped all together if the majority of your residents agree to it. A good property management company will offer sound guidance on establishing and maintaining funding of your reserves. At FirstService Residential, it is an essential component of the support we offer communities for successful, long-term financial planning.
The importance of a reserve study to your reserve funding strategy
It can be challenging for a board to identify all the items in its community that will eventually need the support of reserve funds, when those items will need to be developed, upgraded or replaced and how much it will cost in the future. That’s where the reserve study comes in.
By assessing the condition of common-area assets within your community (like club houses, lobbies and pool areas), identifying future replacement costs and recommending an annual contribution amount for the reserve fund, the study can better position your board for long-term financial success.
At FirstService Residential, we highly recommend that you enlist the services of a third-party professional such as a reserve specialist to conduct your reserve study. These pros will have a thorough understanding of all the assets in your community, their typical lifespan and replacement cost, and if/when they should be added to your reserve inventory.
They will also have intimate knowledge of your state’s requirements regarding reserve funds and studies. And most importantly, they will offer your board an unbiased and sometimes much needed voice to your budgeting process. Please reach out to FirstService Residential if you need help identifying a reserve specialist in your area. Our Illinois footprint is such that we can make these recommendations for communities of all sizes and types.
It is also important to treat your reserve study as a living, breathing document that should be regularly reviewed and updated. But remember, it’s a guide. You don’t have to hold fast to the recommended timeframes.
“For example, your reserve study may indicate that a roof should be replaced in 30 years. If you are 28 years in, it still looks great and you’ve done all the preventive maintenance, you can decide to get another five years out of it and adjust that component accordingly,” said Kevin Adam, chief financial officer with FirstService Residential.
It’s also strongly recommended to regularly update your reserve study. For newer communities, the suggested interval is every three years. After a decade of existence, communities should consider updates every other year and detailed reviews of the study should occur annually. Again, your state may dictate the schedule you must follow for reserve studies/updates. A good property management company will be able to provide this information to you.
Determining Maintenance vs. Reserve Components
Properly categorizing your community’s common area components is one of the challenges that comes with managing reserves. Some items will require regular maintenance such as pressure washing sidewalks and window cleaning, others will need to be replaced like roofs and mechanical equipment, and still others will require both such as pools and carpeting.
To ensure your community components will last until they are due to be replaced, you must budget for maintenance costs every year. If you don’t, you may end up having to replace them before the reserve study’s replacement due date and impose a special assessment or take out a loan.
At the same time, you must make a reserve contribution each year to be properly prepared for covering replacement costs when they are scheduled to occur.
Deciding whether items are maintenance vs. replacement (or both) will ultimately determine if they will be listed in your annual operating budget or as part of your reserve inventory. Usually, less expensive items are included in the operating budget, and costlier items are assigned as reserve components so their replacement costs can be financed over a longer time period. If you need help determining whether an item should be included in your operating budget or reserve inventory, consult with your auditor or property management company.
More and more associations, especially for communities that are decades old, are starting to address infrastructure components as part of their budget planning process as well. These are components that last a very long time, are generally out-of-sight and as such, are not often thought of — like sewers or risers. A good practice to follow is to add infrastructure items to your reserve components list when they reach the halfway mark of their expected life spans.
As your board takes on the responsibility of budgeting for your association, be sure to rely on your reserve fund and reserve study. They are both indispensable tools that can help keep your community’s long-term financial plan in check.
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