Reserve Studies: The Litmus Test for the Financial Health of an HOA

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HOA Reserve StudyReserve funds are a community association’s version of a “rainy day” fund. The financial health of an HOA can be determined by calculating the strength of that fund through a Reserve Study. If you’re considering moving into a new community governed by a HOA, one of the first things you’ll want to look into is their financial health. If you’re already living in such a community, you should know when the last time your HOA conducted a capitol reserve study. Having this information at hand will tell you a lot about how your HOA is managing their finances.
The Reserve Study
Community Associations should conduct a Reserve Study every year. The reserve study seeks to determine the strength of all those common areas which fall under the responsibility of the HOA. Things like roofs, courtyards, building foundation, elevators, air conditioning, or swimming pools would all be part of this study. The results should provide an estimate for any future repairs or maintenance. The reserve study will also product an amount that the fund should have on hand to address these findings. These funds will be used to make those repairs when the time comes.
For instance, if you have a roof with a 20 year life and it is only one year old, you are 100% funded if you have 1/20th of its replacement cost in your reserves, because that is the amount of the life of that component which has been expended or “used up” at that point in time.  However this term is generally applied only to all of the components collectively, so you would need to do the same process for each component and upon seeing that you have reached that funding level for all, you may then proclaim that you are “100% funded”.  This process, in essence, is the whole purpose of the reserve study.  To follow this process is to ensure an equitable financial relationship between current and future owners in any community.
Paying Into the Reserve Fund
You’re probably already paying into a reserve fund as a portion of your monthly homeowner’s fees. The goal is to have that amount funded as close to 100% as possible. Reserve funds that have reached a 70% target are in decent shape, but anything under 50% should be cause for alarm. Why? Because if one of these projects comes up for completion and the reserve funds can’t cover the costs, then the homeowners will be slapped with potentially huge assessments. That’s not something anyone wants to deal with.
While it might be attractive for an HOA to charge low monthly fees, chances are they’re not going to be buffering their reserve fund that way. This is an indication of a faulty management strategy. An HOA who wants to keep the “status quo” means they don’t want to rock the boat with regard to high monthly fees. That approach will almost surely come back to haunt them if a sudden capital improvement is needed.
Inadequate reserve funds also affect an HOA’s ability to sell their homes. The Federal Housing Authority (FHA) won’t offer loan assistance to a community which has low reserve funds. That’s going to stand in the way of a current owner hoping to sell.
Community Associations should seek a balance between setting monthly homeowner’s fees and contributing to the reserve fund. The Management Trust has been conducting for community associations of all sizes and composition. Click here to find out how you can get a free reserve study done for your Community Association.
This article is provided by The Management Trust.