If you are helping manage a homeowners’
association, you might be wondering how much to keep in your association’s condo
reserve fund. The answer might seem simple enough. You need
enough in your fund to cover all of the expenses you expect over a certain time
period, but a number of factors can affect your decision, including:
●The
condition of the common elements. If your association has put off maintenance on
the condo properties for several years and the elements of the condos are
reaching the end of their useful life, then you might need more money, sooner
rather than later. This means that your association likely has little time to
accumulate reserves.
●The
time value of money. Things typically cost more tomorrow than they
do today, due to inflation. That being said, most condo associations invest
their reserves, so that they earn interest and other returns over time. These
two factors can affect how much your association has in reserves over 20 or 30
years.
The Community Associations Institute, also known
as the CAI, developed a concept known as full funding, which refers to the
reserve balance in direct proportion to the fraction of used life of the
current repair or replacement cost. If something, for example, has an estimated
useful life (EUL) of 10 years and will cost about $10,000 to replace, then in
order to be fully funded, the association should have $3,000 towards replacing
the item in the third year. You should calculate the same costs for each of
your common elements and add them up to create your reserve budget.
There are several factors that drive the
funding strategy, including:
●Rainy
day funds. An association might not be able to foresee the potential defects of
common elements and results of natural disasters, so they usually designate an
account balance or threshold that they never want to drop below.
●Improvements.
Since communities are not static entities, homeowners might want to
make some improvements, including adding amenities, replacing existing
equipment with higher quality items rather than in-kind items or complying with
new regulations and standards like the Americans with Disabilities Act.
●Statutory
Requirements. Associations are beginning to come under more
and more regulation, so there might be statutory requirements from state and
local governments, lenders and insurance companies that you need to adhere to
as an association.
●Actual
performance. Many associations rely on estimated useful
life (EUL) tables to figure out when common elements need to be replaced.
Components usually don’t wear out at exactly the end of their estimated useful
life, and preventative maintenance can usually extend the EUL. Your
association’s engineering consultant can usually schedule their work fairly
accurately based on their experience and observations in the field.
●Vacancies
and delinquent accounts. Homeowners are usually under a lot of stress
these days, and the number of units in foreclosure has increased exponentially
over the past few years, so associations should take into account their
inability to collect from some unit owners.
