“Reserve Study.” The term is common HOA lexicon that just about everyone in our industry has heard. Managers know their associations need them. Board members know that they need them. But what are Reserve Studies, really, and why are they getting so much attention now? Well, it all comes down to – what else − money. Due to the number of unanticipated expenses that associations are now facing, (think: aging communities, increased insurance premiums, inflation), financial planning for communities has never been more important and Reserve Studies are the most effective financial planning tool associations have. Understanding what Reserve Studies are, how they operate and the role they should play in an association’s budget is no longer something that only experienced or senior community managers need to know; this is knowledge that all community managers must have in order to effectively guide an association.
What is a Reserve Study?
A Reserve Study is a comprehensive two-part report created by a Reserve Analyst for an association every three (3) years. The report contains a: 1) physical analysis and a 2) financial analysis. The physical analysis portion of the Reserve Study identifies the various components at a development for which the association is responsible for repair, replace, restore or maintain in the next thirty (30) years. For some developments, that means that the Reserve Study will only contain common area components. However, in other developments which contain “townhomes,” the Reserve Study will also include those components of the individual residential structures for which the association is responsible for repairing, such as the building roofs or exterior surfaces. Once all the components are identified, the Reserve Study then captures the current condition of each component with pictures and a written description, as well as a written projection of how well the component appears to be holding up over time. The Reserve Study identifies the average useful life for that physical component and the approximate remaining useful life for that component. Most importantly, the Reserve Study indicates the anticipated cost of replacement of the component at the end of its useful life. The Reserve Study also includes a reserve funding plan for the board to use when creating its annual budget. The reserve funding plan is intended to help the association prepare financially so it has the necessary money to perform the required repairs or replacement of components when the time comes.
Now that the basics of a Reserve Study have been reviewed, let’s take a deeper dive into what the above bolded terms actually mean.
Current Condition of Component
In order to know when a physical component needs to be replaced, an association needs to understand the current condition of the component. What does it look like? Is it showing signs of normal wear and tear? Does it appear to be in better or worse shape than an average component? The Reserve Analyst will often provide an opinion on the current condition of each component.
Useful Life
The “useful life” of a physical component is generally considered to be the length of time that a component will typically last before needing replacement. Not all components are ‘built to last’ as long as others, but the Reserve Analyst should know the approximate lifespan of any component at a development.
Remaining Useful Life
Although the average useful life of a component is based on industry standards and general knowledge of the physical components, themselves, the remaining useful life of a component is far more complicated to determine. First, the remaining useful life of an item depends on a number of different factors. Some components will age more quickly due to their amount of use, their directional exposure, or the quality of materials used in the component. Other components may fare better than expected because they don’t get used as often, are protected from the elements or the product quality is superior. Regardless of the reason why, the Reserve Analyst will approximate the remaining useful life for each component in the Reserve Study. This remaining useful life number will determine what year the component will be projected for replacement and, in turn, will determine how much money the association will need to save each year so it can perform the replacement project when the time comes.
Cost of Replacement
The cost of replacement for a physical component in a Reserve Study is another complicated issue. Fundamentally, this is just a projection by the Reserve Analyst of how much the association should anticipate spending to replace a specific item. The Reserve Analyst may use actual costs incurred by the association for a similar project, comparisons of similar projects the Reserve Analyst has estimated at other associations and national guidebooks on cost estimating to arrive at the replacement numbers. In addition to this, Reserve Analyst factor in something that affects all pricing: inflation.
Reserve Funding Plan
Depending on your perspective, the most important aspect of the entire Reserve Study is the Reserve Funding Plan. Keep in mind that although the Reserve Study identifies all the physical components, their condition, and what it will cost to replace them at the expiration of their useful life, the association’s ability to perform any of the repairs at any time depends entirely on how much money the association has in its Reserve Account. Although the Civil Code requires all associations to maintain a Reserve Account, the law does not explicitly require that associations actually fund the account or how much money associations must put into those accounts on an annual basis. As a result, the funding levels of Reserve Accounts differ greatly from one association to another. Some Reserve Accounts are either at or near ‘fully funded’, while others have a concerningly low amount of money saved for large scale repair and replacement projects. The Reserve Funding Plan contained within the Reserve Study should provide clear guidance about how a board should approach assessment values to attain full funding so that it has the money necessary to perform all the repairs needed when the time comes.
When You Fail to Plan, You Plan to Fail
A Reserve Study is the best and most comprehensive tool associations have to gauge not just the physical health of its property, but to also diagnose an association’s financial health. The components listed in the Reserve Study lay out all an association’s major repair and replacement projects on a long-term basis and attempt to forecast how much money an association will need to meet those obligations. In order for an association to be a desirable place to live, the development must be properly maintained and financially strong.