Seven Things You Must Know Before Conducting Your Next Reserve Study
One of the primary business responsibilities of a Homeowner Association or Condominium Development is maintaining and preserving property values of the Association’s Common Element or Common Area which results in protecting the value of the property of the owners that live there. To do this properly, Associations must develop funding plans for future repair, maintenance or replacement of Major Common Elements or Common Area components. A Reserve Study is a budget planning tool that identifies the current status of the reserve fund and establishes a stable and equitable funding plan to offset the anticipated future Major Common Elements or Common Area expenditures.
The Reserve Study consists of two parts: The Physical Analysis and the Financial Analysis.
There are many benefits to having a Reserve Study done. First, it meets legal, fiduciary and professional requirements. It provides for the planned replacement of major items that must, at some point in time, be replaced, as major items deteriorate during use. It minimizes the need for Special Assessments. And lastly, a replacement fund enhances resale values. Following are the things to keep in mind when planning your Reserve Study.
1. All Reserve Study Preparers are Not Equal
There are a number of ways to evaluate the qualifications of the person or firm, which you are going to retain to perform your Reserve Study. Key factors when making your decision should include the following: knowledge and experience of the provider, ability to understand the client’s needs, local expertise and availability, quality control and accountability, and professional education. It would also benefit the Association to have its Reserve Study prepared under the direction of someone who has received the Community Association Institutes (CAI) Reserve Specialist (RS) designation and the Association of Professional Reserve Analysts (APRA) Professional Reserve Analysts designation. By obtaining these designations, the individual has proven through a combination of education and experience that they are qualified to perform a Reserve Study in conformance with the National Reserve Study Standards of the Community Association Institute and the Association of Professional Reserve Analyst.
Since a significant portion of the Reserve Study is based on the condition of the individual components (such as roofs, siding and the roads) included within the Reserve Study, someone with extensive field evaluation experience should be responsible for the evaluation of the components. A key to evaluating this qualification is to have this portion of the work performed under the direction of a person with an educational background such as, Construction, Construction Management, or Engineering, as this education and experience confirms this person has been skilled, trained and educated in performing this type of work or evaluation.
At Reserve Studies by Reserve Funding, with over 35 years of expertise in residential community management and 4 offices on the West Coast, we are able to provide both experience and accessibility to meet all of our clients needs. All Reserve Studies are performed under the direction of a Reserve Specialist (RS) and a Professional Reserve Analyst (PRA) on staff who oversee and guide the entire process.
2. All Reserve Studies are Not Equal
Until just a few years ago, most Reserve Studies included a list of all of the components, their replacement cost, and remaining useful life in order to determine what the next years funding should be. After many years of discussion and development by the Reserve Study Committee of the Community Association Institute, it was agreed by the leading providers from across the United States that all Reserve Studies should include not only this “Financial Analysis” but also a comprehensive: Physical Analysis.” This is now the standard. The physical analysis is important because it determines the existing condition and actual expected life of the Common Elements or Common Areas. The financial analysis, which includes a cash flow projection of the Reserve Fund over a 30-years period, is important because it focuses on the planning and budgeting of replacing these Common Elements or Common Areas based on the specific needs of the Association. A Financial Analysis enables the Association to consider long term planning decisions, rather than focusing only on the next year’s replacement items. By providing this projection, the Association is better able to make an informed decision in regards to how much money should be set aside each year into the Reserve Fund and still feel comfortable that a Special Assessment will not be required over the life of the projection.
At Reserve Studies by Reserve Funding, all Reserve Studies are prepared in conformance with the National Reserve Study Standards of the Community Association Institute and the Association of Professional Analyst. Our financial model was prepared with the help of licensed CPAs and Advanced Reserves Management, Inc.
3. Full Funding of a Reserve Study may mean that you are over funded
Based upon the National Reserve Study Standards of the Community Association Institute and the Standards of the Association of Professional Reserve Analysts, there are a number of different “Funding Goals” which are recommended for use as the basis for your Association’s future reserve fund planning.
- “Baseline Funding” is when the cash flow projection reaches $0 at some time over the projection period.
- “Component Full Funding” is based on keeping every individual component within the Reserve Study 100% funded. In most instances, this will result in a significant amount of funds, which are never used during the cash flow projection period.
- “Threshold Funding” is when the amount in the fund during the cash flow projection period is based upon keeping a minimum balance within the fund. This is generally more than “Baseline Funding” and less than Full Funding.”
- “Statutory Funding" is based upon the establishment of the amount as dictated by the local State requirements, and finally, the most accurate method is called
- “Pooling Method. With Time Value of Money” with weighted average life (entering a specific contribution amount is also an available feature). First, the following data is accumulated for each real or personal item in the analysis: the date placed in service, the cost, and when maintenance or replacement is scheduled as of the analysis date. Based on this data the: “Weighted Average Life” of all the items, the “portfolio” is calculated.
This calculation considers the cost (weight) of the individual items and how many years and months (life) until long-term maintenance or replacement of the portfolio items will take place. This calculation can be made by using either the current cost or future cost of the reserve items, hence the current cost or future cost methods for calculating the Weighted Average Life (WAL). The clients also have the option of including inflation, yield on investments, loans/special assessments and deferred expenditures. Once all the data has been entered into the system and the financial options determined, the Client will be able to review the profile of the “reserves.”
Reserve being funds accumulated and the items requiring long-term maintenance or replacement, and when the two are properly correlated into an overall physical and financial plan, projected funds would be available when needed. This is determined by the beginning balance of the reserve funds, the timing and materiality of scheduled expenditures and the Weighted Average Life of the portfolio as reflected in the cash flows. The reserve study provider will be able to arrive at the optimum solution by utilizing the reserve profile adjustment factor, hence producing the most accurate and customized resource management report possible.
At Reserve Studies by Reserve Funding, we work with the client to establish the funding goal ahead of time and then concentrate on strategies to achieve that objective. We also present detailed projections so the client can immediately see the results of continuing the funding suggested and the 30-years financial plan.
4. The Replacement Costs
Included within a Reserve Study may consider replacement alternatives, not just replacement with the exact same component or system. In many instances the original component, which 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 Client may be able to install a replacement component or system with a significantly longer life, such as a new type roof, siding, or a component or system which is much more energy efficient such as a new HVAC system. In both cases, this will result in either a reduction in recommended contributions to the Reserve Fund or a reduction in the Client’s energy costs.
At Reserve Studies by Reserve Funding, all Reserve Studies are prepared under the direction of a designated Reserve Specialist and Professional Reserve Analyst and a licensed Engineer for costs and life cycles whose expertise are invaluable to the Client.
5. Cash Flow Analysis
The Reserve Study can be used for much more than just estimating the Association’s contributions to the Reserve Fund. The Reserve Study cash flow analysis can also be used as a tool for determining how the Association’s Reserve Funds can be invested. They give the Association the ability to plan for the actual replacements, therefore making it easier to negotiate more effectively with contractors. The cash flow analysis will show how much money will be in the Reserve Fund and over what period of time. By reviewing this information with the Association’s investment advisor, an investment plan can be established to maximize the return on these funds based upon when they will be needed.
In addition, by reviewing the anticipated replacements in the coming year on a regular basis, the Association can plan to have the required work performed before the actual conditions deteriorate to the point that remedial work will be required as part of the replacement, which can cause 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 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 seal coating or overlay. This can reduce the anticipated time period before the overlay is needed, but also increase the cost of the work when it is done.
At Reserve Studies by Reserve Funding, our expertise in both the analysis of existing conditions and the ability to answer technical questions specifically related to the conditions at your site or provide someone who can prevent this from occurring.
6. Annual Maintenance
The Reserve Study will not be the only funding the Association will need for the upkeep of the Common Elements or Common Area. The Reserve Study is only for the major repair or replacement of the Common Elements, Limited Common Elements, Common Areas or Limited Common Areas that are the Association’s responsibility. A reserve fund is intended to cover non-annual maintenance, repair and replacement 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 of the reserve component. This will result in their replacement occurring sooner than anticipated when adequate funds have not yet been accumulated.
At Reserve Studies by Reserve Funding, we can also provide the Association with a recommended annual maintenance schedule and budget (Not include in the cost to prepare the Reserve Study) to help prevent this situation from occurring. Of course, any such maintenance plan is ultimately dependant on effective implementation and management.
7. The Reserve Study is a Budgeting Tool
The actual cost of performing the replacement work when it occurs may vary from the costs included within the Reserve Study. In preparing the Reserve Study, the replacement costs which are used are based upon both industry estimating standards as well as the actual cost of similar projects which have been performed. The replacement costs are typically based upon current dollars and are not based upon the preparation of specifications and bidding of the work to actual contractors. It is intended to be used as a budget-planning tool. Actual costs at the time work is done are influenced by many variables such as, but not limited to, material prices, contractor workload, weather, location, etc. In order to keep the replacement costs as well as the anticipated useful life current, the Reserve Study should be updated (including a site visit) on a regular basis.
At Reserve Studies by Reserve Funding, we recognize the statutes under which each Association is regulated and will make an annual off-site update of each Reserve Study and an on-site visit every three years.