What is a reserve study? And why is it considered a litmus test for the financial health of an HOA? If you are new to the world of HOAs, it’s good to know the answers to these important questions. Here’s a helpful guide that will teach you everything you need to know about an HOA reserve study.
In this article:
HOA Reserve Study: What Are Reserve Funds?
Before we discuss reserve studies for HOAs, you will first need to know all about reserve funds and why they are important for an association.
Reserve funds are essentially a homeowners association’s version of a “rainy day fund.” An association will put money into their HOA reserve funds for the purpose of funding future projects. This includes large-scale maintenance projects, such as a new roof on the community center; construction of new amenities like a swimming pool or tennis court; and unexpected expenses caused by natural disasters.
All of these community projects are quite costly. Levying one-time fees can put a huge financial burden on homeowners. So instead, associations will save money in smaller increments but way ahead of the expected project completion. When homeowners pay their dues each month, the board will allocate a percentage of those fees to their HOA reserve funds.
Reserve funds should be highly liquid so that the HOA can cover the costs when it is time to repair or replace common area components. But, how much does your HOA need to have in its reserve funds? This is where a homeowner association reserve study comes in.
What Is an HOA Reserve Study?
An HOA reserve study determines how much an association should currently have in its reserves. It provides an estimate of the costs to repair and/or replace common area components over time. The results of the reserve study are also very important when planning for the annual budget.
How to Conduct an HOA Reserve Study
An HOA reserve study has two parts: physical analysis and financial analysis. The physical analysis portion will list down each common area component, its physical condition, total useful life, and remaining life, and the cost to repair and/or replace the component.
Meanwhile, financial analysis will assess the HOA’s reserve funds. This portion will determine the strength of your current reserve fund and then make a recommendation for the amount and rate of funding the reserves.
Who Should Conduct the Reserve Study for HOAs?
Since a reserve study will have a significant bearing on your association’s finances, you want it to be as detailed as possible. A board member or even an HOA manager won’t have the expertise needed to conduct a reserve study. They won’t know how to calculate the useful life of a component and the costs of replacing/repairing them.
It’s best to hire a reserve specialist to conduct your reserve study. These professionals will often have certifications from respected institutions like the Community Associations Institute and abide by a code of ethics.
Apart from expertise, they also have software and resources to accurately calculate the useful life of your components and determine your reserve funding rate. So, even though it might be the costlier option, the HOA will greatly benefit from a comprehensive reserve study.
When Should HOAs Conduct a Reserve Study?
In some states like California, reserve studies are mandated by law. Communities in these areas are required to conduct an HOA reserve study every year. The study should also be updated annually.
Meanwhile, in other states like Massachusetts, associations are required to have reserve funds but not reserve studies. As such, your association should check with state laws to determine how often they need to conduct a reserve study.
However, even if your state laws do not require them, it’s still the best practice for associations to have reserve studies. Why? Reserve studies provide an accurate picture of an HOA’s finances. The results can also ensure that your annual budget is strong and financially sound.
For board members, it is a matter of performing their fiduciary duty to the association. An HOA reserve study can help them make better financial decisions. It can also protect them from liability in cases where an association runs out of reserves. Homeowners won’t be able to accuse the board of mishandling reserve funds if they were diligent in conducting reserve studies in the first place.
HOA Reserve Study: A Litmus Test for Your Community’s Financial Health
You can determine the financial health of an HOA by calculating the strength of their funds through a reserve study. The reserve study can also tell you a lot about how the HOA is managing its finances.
Ideally, an association should fund its reserves as close to 100% as possible. Reserve funds that have reached 70% are in decent shape, but anything under 50% should be cause for alarm.
Why? Because if one of your projects comes up for completion and the reserve funds cannot cover the costs, then the homeowners will be slapped with potentially huge assessments. That is not something anyone wants to deal with.
While homebuyers might be attracted to join an HOA that charges low monthly fees, chances are they’re not going to be buffering their reserve funds. This is an indication of a faulty management strategy. If an HOA wants to keep the “status quo,” they won’t want to rock the boat and increase monthly fees. If a sudden capital improvement is needed, this approach will almost surely come back to haunt the HOA.
Inadequate reserve funds also affect an HOA’s ability to sell homes. The Federal Housing Authority (FHA) won’t offer loan assistance to a community that has low reserve funds. That’s going to stand in the way of a current owner hoping to sell their property.
So, good reserve planning is essential if an association wants to have financial stability as well as protect the community’s property values. If you have an accurate reserve study, you’ll have enough money to ensure that common assets will be properly maintained as they age.
The Importance of an HOA Reserve Study
By now, you have a better understanding of reserve studies and why they are important for the financial health of your association.
An HOA reserve study is not by any means a financial guarantee, but it provides a solid foundation for how the association should budget its finances. So, to help your community grow, make sure to hire the best reserve specialist and conduct reserve studies as mandated.
- How To Protect HOA Reserve Funds And Operating Funds
- Should The HOA Invest Reserve Funds?
- How Can HOA Financial Management Help Your Community’s Finances?