As we look ahead to our upcoming webinar on reserve studies in which Marc Markel leads a discussion featuring industry experts, we want to offer a preview of what you will hear during this special event. We sat down with Marc, Elon Goldman of Association Reserves and David Yancy of Criterium Yancy to discuss aspects of reserve studies all associations need to know.
What is a reserve study?
Elon Goldman: At its most basic form, it is a budget planning tool that identifies the current rated depreciation at an association, and then what we provide is a budget plan that is stable and equitable to offset that rated deterioration at the association. We always call it a roadmap for the association, because sometimes there’s a lot of chaos. And you know the reserve study will outline the things that are nearest on the radar and maybe need more attention. It will also outline things further out in the future, like a roof that might cost $2 million to replace that the board might be not thinking about today, but its significant cost should be on that map.
David Yancy: In the simplest terms, a reserve study is a budget planning tool to manage cash reserves for non-annual, expected, predictable expenses. Most reserve studies forecast these obligations 20 – 30 years into the future.
As an attorney with over 40 years of POA experience, what should a POA know about a reserve study before conducting one?
Marc Markel: They need to know what they are and what they aren’t. They are not an evaluation on the integrity of the components of their buildings (assets). They are a reasonable prediction on the future based on the assets in place. As an example, if a clubhouse has a roof with a 30-year life expectency, you should put away 1/30th of the cost to replace the roof every year so long as it doesn’t hinder other costs to continue the day-to-day operation of the association. Increased costs at the time of replacement as well as the interest earned on the reserve funds should be taken into account. For a condominium it is even more critical because of the different components that the association is responsible for that can affect the operation of the building/complex. A typical high-rise building has HVAC issues, lobbies that will need to be remodeled over time, painting in all common areas, parking lot resurfaces, window seal replacement and usually much more that the association will need to save for over time. The same approach as our clubhouse roof example should be taken for each item – how much does the association need to save and when will the item need to be replaced.
POA’s should also take note that the reserve study is of interest to the buyers and sellers of homes or a unit. In a condo, the buyer can use the reserve study to forecast the possibility of a potential for large special assessments in the future.
Why should an association consider a reserve study and what benefits does a reserve study provide to an association?
EG: There are numerous reasons why an association should consider a reserve study. Number one is to find out what that number is that is a fully funded balance, as we call it at Association Reserves, that deterioration that has happened up until this point. Whether it’s a 30-year-old community, a five-year-old community, or one that had just been built and turned over to the board that was developer managed, they need to determine what that fully funded balance is and that funding plan so they can offset the deterioration and reduce the risk of a special assessment, deferred maintenance and we always say declining property values. An association that is well funded and has the money to take care of those near-term future projects maintain, if not increase, their property values is an association that looks good.
I always say it’s a disclosure document. Once the Board is determining what those budgets, the reserve contribution operating budgets, are going to be for that next fiscal year, the reserve study helps to identify what that rate should be or that contribution rate on a monthly, annual, or quarterly basis or however that association handles those contributions. The reserve study needs to be updated throughout the years because that study technically expires for the fiscal year that it represents.
DY: The most fundamental results of a reserve study inform an association if it has adequate levels of funding to address repairs of the non-annual, expected and predictable expenses. These expenses typically relate to association-owned common elements. A reserve study is a beneficial tool intended to help the association manage future obligations and inform the community of future financial needs. They help the association stay fiscally responsible.
Is a reserve study required by Texas law?
MM: Reserve studies are currently not required by law, even though there have been attempts over the years. As Elon and David have pointed out, there are numerous reasons for associations to conduct a reserve study. Another reason I will offer is, if an annual audit is required for the association, if a reserve study has not been conducted you will receive a footnote in your audit pointing out this deficiency. You may also receive a footnote in your audit if you are not fully funded. These footnotes could potentially have a negative effect on the association down the road. Would a legislative requirement for reserve studies help associations? Yes, because it would highlight the levels of funding for associations to maintain its assets. However, funding a reserve can often be difficult (and unpopular), especially for those that have capped assessments or require a membership vote to increase assessments.
What are some common misconceptions about reserve studies?
EG: A common misconception is that a reserve study is for the future and not for the present. The reserve study is looking at the current rate of deterioration not the future duration, although our reports are 20 or 30-year reports, depending on the firm. Those assessments, those reserve contributions, that are being made pay for the daily, weekly and monthly deterioration, not the future deterioration. So, if I have a community member that says, “hey I’m not going to be living here in 20 or 30 years,” they are paying for the day-to-day deterioration, while they’re living in that building, so we always say everybody needs to pay their fair share and that’s one of the biggest misconceptions with reserve studies.
DY: A reserve study is not a capital improvement plan, nor is it a maintenance plan. The study is primarily recommendations on developing a funding plan for the community with the objective of limiting substantial cash excess while minimizing financial burdens that can result from significant cash inadequacies.
Is there a benefit from a legal perspective for POAs to conduct a reserve study?
MM: I believe any POA that has an asset (clubhouse, pool, etc.), would greatly benefit from a reserve study and will help them to prepare for future anticipated expenses. For a condominium association, a reserve study is highly recommended. The reserve study can show how much in funds are needed for the eventual failure of the roof, an elevator in a high-rise complex, or other items that effect the usefulness and property values. Reserves in my opinion should also consider costs for upgrades to meet new codes in the future.
What kind of qualifications should an association and its board look for when selecting a company to conduct a reserve study?
EG: At Association Reserves, we all hold the RS credential. It’s a reserve specialist credential offered through Community Associations Institute, and there are several chapters throughout the country and four here in Texas. So reserve study providers can also have a PRA, which is a Professional Reserve Analyst, and there’s also engineers. Engineers do reserve studies, but it’s the reserve specialists who really hold that credential. They’ve completed numerous reserve studies. They have a lot of references with those studies they’ve completed that they can show to CAI and get the RS credential and they’re reputable in the industry. Most reserve study providers with the RS are oftentimes active within CAI, and that’s good because it shows you are engaged with communities and boards within your region and you understand the demographic. You understand issues that they’re having in those areas and so I always think it’s great to look for that RS with CAI.
DY: A reserve study should be performed by a qualified professional that has been involved in evaluating buildings, evaluating facilities, construction or restoration experience, and/or maintenance planning. Credentials typically include, but are not limited to licenses in engineering, architecture, or construction management, and/or an individual with a Reserve Specialist designation from the Community Association Institute. Reports should be prepared in accordance with the Community Association Institute standards.
Why do you feel some associations might be hesitant to conduct a reserve study?
EG: Number one money. The reserve study cost varies from property to property depending on how long, how intensive it may take on site. We’re doing a physical analysis of the property and also a financial analysis of what we determine on site.
Another reason might be the recommendation we provide that says full funding, 100% funding over 30 years and a lot of boards might say, “hey this is too much money to kind of hold. We don’t want to do full funding. We want to do baseline funding and we’re not going to listen to what the reserve study provider says.”
In addition to the cost factor of a study, sometimes it’s ok if they don’t have the money to spend at this moment, because it wasn’t budgeted for. Oftentimes, associations go out for proposals and then budget for the cost of a study in their next fiscal year.
A lot of the smaller associations that are self-managed might do their own reserve studies, which isn’t recommended. It’s always best to seek outside counsel by a reputable provider that has the credentials we talked about. But it’s important to have at least one reserve study done so you know the basis of the funding. You know what that contribution rate that transfers from your operating account to the reserves should be.
DY: We find that most associations want to have an idea of the financial health of the association but are hesitant to engage qualified professionals to conduct the study. Reasons typically include:
a. The Association already has an engineer or financial advisor on the Board
b. The Board uses a “rule of thumb” to collect reserves – X percentage of the total annual assessment
c. The Board simply reserves the unspent amounts of the annual assessment to address future repairs unaware if the amount is adequate or not
What advice would you provide to an association that did receive negative feedback on its level of funding?
EG: It’s the board’s duty to maintain, to run the association, to be fiscally responsible. If the cost is each owner providing $5 to get their reserve study done, it is worth protecting one of their most valuable assets in their life, their home. Having a reserve study and receiving that recommended funding contribution and hopefully they adopt that contribution rate that we recommend, they’re protecting that asset. There are so many benefits to having a reserve study and having one updated consistently that puts the association on track to a sustainable, brighter financial future.
DY: We often find that associations are underfunded and/or not well-maintained. While the association may not be able to take steps immediately to rectify the conditions, it is important to address them head on and begin to take steps towards improving the financial and maintenance conditions of the community. It is important to remember, associations typically have a fiduciary duty to maintain the common elements, so we always work with the Board on taking the necessary steps to improve their health and condition.
What can attendees expect to learn from the upcoming webinar?
EG: We want to clear up some of the misconceptions in the industry. We want to discuss baseline, threshold and full funding, and what those mean. The different levels of service that reserve study providers provide, whether that’s full reserve studies, starting from scratch, or you’re doing a no site visit update. We want to address things people are asking themselves on a daily basis, such as why do we need to reserve study, what are the components of reserve study and what are the results. Sometimes boards find the results confusing, but we want to make everything clear and concise.
DY This webinar will inform the viewer of the benefits of a reserve study and why a reserve study should be performed routinely by qualified professionals.
MM: They’re going to learn do why do I need a study, as well as the benefits and burdens. They’re going to hear why managers and board members should go back to their board of directors and promote the use of reserve studies. It will be an opportunity for attendees to hear from the experts and ask those questions that they have so they to can understand the ins and outs of reserve studies and why they are so important. I hope everyone can make time to join us.
Join Marc, Elon and David for this special webinar on Reserve Studies on Wednesday, May 19 at 11:30 a.m. They will be going into detail on all aspects of reserve studies, including more details on the different funding levels for associations, case study examples on the outcomes of reserve studies for associations who have delayed conducting a reserve study and those who have conducted reserve studies regularly and much more. To RSVP for this event, please visit https://www.rmwbh.com/education/reserve-studies-what-you-need-to-know/.