Reserve Studies: Leave It To the Professionals
Some Community Associations believe that they can calculate their own Reserve Study without spending money for the services of a Professional Engineer. Board members often think, "Why should I pay someone else when I can do it for free?" These board members, property managers and Community Associations fail to realize the complexity and importance a Reserve Study.
What is a Reserve Study?
A Reserve Study is a budgetary tool that includes a Physical and Financial Analysis. It is an inventory of all the components or common elements that the Association is responsible for maintaining, repairing and replacing. The report includes an assessment of the physical condition of each common element as well as corresponding useful life estimates. Replacement costs are then researched for each line item and an annual budget is created. A Reserve Study also recommends what amount of money should be contributed to reserves each year so that when common elements need to be replaced, the funds are already in the reserve account. According to the National Reserve Study Standards of the Community Associations Institute (CAI), the cash-flow cost projections within the report should cover a 30-year time period.
Although the basic concept is simple, preparing an accurate and useful Reserve Study requires a wealth of technical expertise. Just reading through a community's documentation and identifying what is and is not the Association's responsibility can be arduous and complicated. There are common elements and limited common elements and many grey areas of which to be careful. Professional reserve providers have experience navigating through public offering statements and master deeds. They are familiar with the standards and know how to create a document that will meet all legal, fiduciary and statutory requirements, while minimizing the need for special assessments and enhancing property values.
The Physical Analysis
The Physical Analysis of a Reserve Study involves quantifying common elements, which is not as simple as it sounds. As a DIY Association, will you be able to accurately calculate the square footage of the Community's sidewalks and roadways? Will you be able to precisely gauge the surface area of all the roofs? Will you know what material the roofs are made of? What about light fixtures, carpeting, doors, tile and most importantly mechanical equipment? Can you read architectural drawings or will you hand measure the balconies and curbs?
With some time and effort, a DIY Association could identify and quantify their common elements for inclusion in the Physical Analysis portion of their Reserve Study. However, determining the useful life of each item is a skill that takes years of experience and construction expertise. For this reason, the CAI developed a Reserve Specialist designation for Professional Engineers who have proven their experience and expertise. Professional Reserve Specialists are able to accurately calculate how long an EPDM membrane roof will last and can inspect siding to determine how many years it will provide adequate protection for the Community Association's buildings. In addition, Reserve Specialists have prepared numerous reports and are familiar with the common pitfalls and overlooked problems Associations often run into in regards to maintenance issues and common verses limited common elements.
The Financial Analysis
Once the Physical Analysis is complete, the financial portion of the report is prepared. A replacement cost must be assigned to each common element. These approximations can be researched in construction cost estimate books or through contractor bids. Next, these future expenses are analyzed along with each item's assigned remaining useful life to determine how much money the Association needs to put aside each year to have the appropriate funds when needed. The seemingly simple multiplication and division becomes complex when dealing with hundreds of items throughout a Community. Another critical step is to calculate an annual contribution amount, factoring in monthly association fee changes as well as the type of funding plan chosen.
Professional Reserve Specialists are familiar with the pros and cons of the three types of funding plans detailed by the Community Association Institute's National Reserve Study Standards: full, threshold and baseline funding. Full funding, the most conservative budgeting plan, divides the replacement cost of a component by its estimated remaining life to determine the annual contribution for that component. Fully funded Associations often hold significant amounts of money in the bank for long periods of time. Threshold funding, the most commonly used funding plan, establishes a minimum amount of money for the Association to keep in its reserve account. This number varies according to the Community and not only minimizes the potential for a deficit but also prevents the Association from keeping excessive funds in the reserve account for long periods of time. Baseline funding, the most risky funding plan, reduces the annual contributions to the point where the reserve fund drops to zero periodically. If a component needs to be replaced a year sooner then expected or costs more than anticipated, a baseline funded Association will run into a deficit.
The Financial Analysis of a Reserve Study is a time consuming and detailed process of calculations, but it shows the Association its funding options and allows the board to choose the plan that works best for their Community's specific situation. Because the remaining useful life assigned to a particular item can drastically affect an Association's bottom line, the Financial Analysis of a Reserve Study must be carefully calculated. Likewise, if an estimated construction cost or annual contribution number is off, it can affect the entire projection. Because the financial plan of a Community Association is so delicate and important, it is best left to the professionals.
Fiduciary Responsibilities and Statutory Requirements
In addition to getting an accurate and useable report, having a professionally prepared Reserve Study also protects the board from liability. Association board members have a fiduciary responsibility to maintain the assets of the Community. For instance, in the state of Illinois, the Condominium Property Act directs Association board members to maintain "reasonable and adequate reserves." In defining this term, the Condominium Act directly suggests meeting this requirement with a professionally prepared Reserve Study. With a professional engineering report, no homeowner will be able to attack the board should the Association run into a deficit.
In some states, statutory regulations require that Community Associations have an updated Reserve Study to protect unit owners from fiscal problems and financial hardship. For instance, the Florida Condominium Act requires reserves for roads, roofs and sidewalks. Likewise, Virginia mandates Reserve Studies every five years. Many other states have laws or legislation pending that address reserve and operating fund requirements. While a DIY Association could work to meet the requirements of their state's law, having a professionally prepared Reserve Study will undoubtedly meet state legislations regarding reserve funding.
FHA Financing and Bank Loans
In many cases, a Reserve Study is required for Community Associations to receive Federal Housing Administration (FHA) financial aid. Although the FHA does not require Community Associations to have a professionally prepared Reserve Study, an "adequate" budget must be established. A comprehensive report of all the major common element components that will require maintenance and/or replacement, a Reserve Study clearly meets these FHA loan requirements. In fact, when an association's budget documents do not meet the FHA standards, the mortgagee can require an up-to-date Reserve Study to assess the financial stability of the project before approving any financial aid.
Similarly, many banks are now requiring financial status updates and/or Reserve Studies before offering Community Associations capital improvement loans. Although a DIY Association could illustrate its financial stability, a professionally prepared Reserve Study infallibly includes all the information needed for a Community to apply for a bank loan or FHA financing.
A Penny Wise and Dollar Foolish
Overall, the construction expertise necessary to prepare an accurate physical analysis, the complexity of creating a Community's financial strategy and the legal liability of the board may answer the commonly asked, "Why should I pay a professional when I can do it myself" question. The key word is professional. You can fix your own car or write your own will, but without a professional mechanic or lawyer, will you feel comfortable that your car will stop on time or that your estate will be distributed properly?
The Community Association industry has spent years creating standards and procedures for the process of providing proper Reserve Studies. And now that the information provided by Reserve Studies is required for FHA financing and many bank loans, Reserve Studies are even less of a DIY project.
If you are interested in a professionally prepared Reserve Study, please contact Kipcon for a proposal.
