Why do you need a homeowners association reserve study? A reserve study is a budget planning tool that can prepare HOAs for large capital expenditures. With an HOA reserve study, you can ensure the long-term financial health of your community.
Importance of an HOA Reserve Study
What is a reserve study and why does your HOA need it? Here’s what you need to know.
HOA Reserve Study Definition
An HOA reserve study analyzes the major components of an association. It will look at the current condition of HOA assets and determine how much life it has left. The reserve study also estimates how much it will cost to replace an HOA asset once it reaches the end of its useful life.
For each HOA asset, the estimated replacement cost is divided by the number of years left in service. Then, the numerical quotient for each asset is added. Thus, the result of the reserve study determines how much you need in your association reserves.
The total reserve amount is equally divided among the homeowners. Depending on your HOA, the amount can be covered by annual fees or it could be collected as a separate reserves contribution.
Benefits of an HOA Reserve Study
An HOA reserve study helps associations prepare for capital improvement projects. Unlike regular maintenance projects, capital improvements have larger scales and larger costs. For example, a roof replacement can cost anywhere from $5,000 to $50,000, depending on the size. The reserve study will determine how much time is left before the roof needs to be replaced. Thus, it provides HOAs with a timeline for saving money.
Given the results of the HOA reserve study, the board can come up with an accurate annual budget — which includes HOA reserve fund requirements. If the estimated revenue is not enough to cover operating expenses and reserve contributions, the board can determine early on if there is a need to increase HOA dues or levy a special assessment.
However, the main purpose of an HOA reserve study is to ensure that these two scenarios do not happen. With proper planning and an up-to-date reserve study, HOAs can protect the financial wellbeing of the community. The earlier you plan for capital improvements, the smaller the financial burden on homeowners.
Essential Components of a Reserve Study
An HOA reserve study has two main components: the physical analysis and the financial analysis.
This section of the reserve study contains information about the physical condition of HOA assets. You’ll find a detailed inventory of components with the following:
- Quantity of Components: The reserve study should have an accurate count of HOA components. Some components may require additional details such as type, exact measurements, square footage, description of materials, and so on.
- Average Useful Life: Each component has an average useful life, or how many years it is expected to serve its exact purpose — given that the component is regularly and properly maintained.
- Remaining Life: The reserve study will consider a component’s age, physical condition, and maintenance history to determine how many years are left until it must be replaced.
- Estimated Cost of Replacement: A reserve specialist will draw on his/her experience, as well as a detailed survey of current market prices, to determine how much it will cost to replace each component. Estimated costs are relatively stable but it’s still important to account for your local market trends and inflation rates.
- Maintenance Assumptions: The reserve study also makes certain assumptions based on the maintenance history of each component. Was the asset properly maintained? Improper maintenance can have an effect on replacement schedules and cost estimates.
The second portion of the reserve study analyzes the current financial status of an HOA Your reserve specialist will look at income, expenses, and current reserves.
Based on these figures, the reserve study will recommend a funding plan for your reserve contributions.
There are three potential funding models: fully funded, threshold funded, and baseline funded.
- Fully Funded: The reserve study will recommend a funding plan that will have your reserves at or near 100%.
- Threshold Funded: With this funding plan, the goal is to have your reserve cash balance meet a certain threshold — typically at 70%.
- Baseline Funded: The goal is to have the reserves at or above $0. This is not recommended for most HOAs. However, if your reserves are severely underfunded, this funding plan can serve as a temporary strategy that will guide the HOA to a more stable position.
Each funding plan has its own pros and cons. It will depend on financial goals and the types of components that an association has. For instance, if your major components are “life-critical,” such as elevators, fire alarms, and security systems, a fully-funded reserve is a must.
For many HOAs, threshold funding provides adequate financial security. In case a component fails ahead of time, you won’t have to raise as much money as compared to if you had minimally funded reserves.
Additional Reserve Study Guidelines
An HOA’s governing documents contain guidelines and requirements for the reserve study. There are also different reserve requirements by state. For instance, reserve studies are required in places like California, Virginia, and Utah. Most other states have legal requirements for reserves but not reserve studies while certain states have no requirements at all. Nevertheless, here are some general HOA reserve study guidelines to consider.
How Often Should an HOA Do a Reserve Study?
Regardless if they are legally mandated by your state or not, HOAs must conduct reserve studies. A good rule of thumb would be to have a formal reserve study every 3 to 5 years.
A professional reserve study specialist will come in to assess your major assets. HOAs must also update their current reserve study every year to ensure that the annual budget and reserves are likewise up-to-date.
However, a reserve study should be conducted after a major construction project or if there was a recent natural disaster as these two scenarios could have an effect on the current condition of HOA assets, as well as the financial capabilities of the association.
How Much Does an HOA Reserve Study Cost?
There’s no specific amount for an HOA reserve study. A formal reserve study with an on-site visit may cost around $1,500 while annual updates may cost around $300 to $600.
The cost will also depend on the size of your association and the number of shared assets. The cost of a reserve study for an HOA with basic amenities (swimming pool, park, basketball court) will be much lower than an HOA with private roads and golf courses.
Even though HOAs want to keep expenses low, don’t skimp on your reserve study. A CAI-certified reserve specialist will have the experience and expertise needed to conduct a reserve study. They also have software and resources to properly calculate the useful life of each HOA asset. The more comprehensive the report, the better you can budget for your reserves.
An HOA Reserve Study Is a Must for Your Financial Security
Without knowing the importance of an HOA reserve study, board members might think that it is just an unnecessary expense. However, a reserve study is essential for the financial health of your association.
Board members will have a better picture of the HOA’s assets, which will guide them as they create the annual budget, collect assessment dues, and contribute to the reserves. A reserve study ensures that your community can handle major expenditures — without putting most of the burden on the homeowners.
Want to get the best out of your HOA reserve study? Reach out to the Condo Manager team today! Call us at (800) 626-1267, email us at firstname.lastname@example.org, or contact us online to learn more about our HOA financial management software.
- 4 HOA Financial Reporting Mistakes To Look Out For
- Property Management Accounting Basics
- Your Ultimate Guide to HOA Fees