Something has been bothering me for a while regarding the reserve funding level that is appropriate for a given association. Many associations strive (and set the dues) to achieve 100% funded. Do they really need to carry such high balances? Wouldn’t it be enough to carry only sufficient balances to meet the future projected reserve expenses (with a sufficient contingency cushion for uncertainties)? Why should we be paying dues to maintain an unnecessarily high reserve fund balance? Wouldn’t a lower percent funded objective of say 50% be more than adequate?
Thanks. B.G., Huntington Beach
Your question refers to comparing the amount of money in the HOA’s capital replacement reserve fund to the recommendation of the HOA’s most recent reserve study, and by “100% funded” you refer to the situation, also known as “fully funded,” in which the HOA has fully accumulated the recommended amount. I relayed your question to leading reserve study experts, and two well-known experts, each holding CAI’s “Reserve Specialist”(RS) designation, responded.
Scott Clements RS, CEO of Reserve Studies Inc, said, “the questioner mentions two important points, ‘appropriate’ and ‘adequate’. However, there is another element to consider- equitable. Maintaining at or near 100% funded means that everyone owning a unit is paying their share of usage of all the common area components based on their period of ownership. It is unnecessary go above the 100% level, but anything below is a deferral to future owners”.
Robert Nordlund RS, CEO of Association Reserves, Inc., said “the reserve fund provides for the predictable upcoming capital element replacement projects at the association. But life does not always occur according to plan, so some margin in excess of the bare amount of cash to provide for anticipated reserve expenses (called “baseline funding”) is needed to insulate the association’s members from special assessments. Full funding is the goal to set aside reserves to match the deterioration at the association. Our experience is that special assessments occur only about 1% of the time within the next three years among “fully funded” associations. For baseline-funded associations, special assessments are needed between 30% and 50% of the time within the next three years, so pursuing fully funded status is a worthy and responsible objective. However, for very large associations (budgets over $10,000,000) the benefits of full funding may be achieved at approximately the 50% level.”
B.G., Major property components are continuously deteriorating at a calculable rate even while you are reading this article. Associations that do not regularly deposit money to offset that deterioration are quietly falling into unliquidated debt. Since the reserve studies are designed to gradually accumulate repair funds at about the same pace as deterioration, any funding below the recommendation is a gamble. When a major item needs refurbishing, the debt becomes liquidated, and the HOA “discovers” a financial need which was predicted years before in its reserve study. Many HOAs are penny wise by keeping assessments lower (and not funding the reserves account as recommended) but pound foolish because they are forced to specially assess and/or borrow when repairs are needed. As Robert Clements said, it isn’t fair to foist the cost of present deterioration upon future owners.
Thanks to Messrs. Clements and Nordlund, Kelly.
Kelly G. Richardson Esq., CCAL, is a Fellow of the College of Community Association Lawyers and a Partner of Richardson | Ober | DeNichilo LLP, a California law firm known for community association advice. Submit questions to Kelly@rodllp.com. Past columns at www.HOAHomefront.com. All rights reserved®.