The Role and Value of Reserve Studies

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Reserve studies are a critical tool for common interest communities. They play a central role in budgeting and planning for the future costs of capital components. They help the board set priorities for planning and management involvement. They affect potential liability of deferred maintenance and the useful life of the physical assets of the association. They can affect the marketability of homes in an association. Some state law requires them. So what are they?
Simply put, a reserve study is a snapshot in time of the material condition of the limited and common elements of a community, with a determination of the remaining useful life of the items and the projected costs for replacing them. This document, in turn, must be incorporated into the association’s annual budget so that adequate funds are scheduled to be set aside and on hand when the time for replacement arrives. Typically, the study includes charts and/or bar scales to depict funding needs and timelines for replacement. A properly performed reserve study arms the association with the knowledge of the annual funding needed to set aside for common element replacements when their remaining useful lives end.
Potential buyers can determine their level of comfort by viewing the status of reserve funds, and may pass on purchasing a home in a community that is not funding in accordance with the reserve study recommendations. They may determine that a special assessment is inevitable because of poor reserve funding and/or glaring material deficiencies in roofs or other major reserve components. If a special assessment is needed to address replacement needs of the physical components of the community, home values will be depressed. Lenders will balk at offering mortgages if there are inadequate reserve funds or too much deferred maintenance. On the other hand, a conscientious board of directors and manager can present the association in a very positive, sales friendly light by fully funding the reserves and not deferring maintenance when needed.
Reserve studies should not be regarded as static documents. The reserve study or update should be used as a planning tool each year during the budget preparation cycle. The board of directors should hire a person or company specializing in community association reserve studies to conduct the study and determine cash needs for the next 20 – 30 years. Typically, preparing a reserve study is beyond a manager’s expertise and contractual obligation.
In 1991, the American Institute of Certified Public Accountants (AICPA) issued guidelines that recommend that reserve studies be part of the annual budget process. Auditors will ask managers if the association intends to fully fund reserves. If it is obvious that the association is not able to fully fund the reserves in any given year, auditors will ask how it intends to do so in the future. Their concerns on reserve funding may be incorporated into notes in the audit or in their opinion letter.  Auditors also look to reserve studies when preparing annual tax returns, since federal tax law treats reserve funds differently than operating funds.
There are limits to the predictive value of reserve studies. Most preparers do not conduct destructive investigation of common elements, so they may miss hidden conditions in structures, roadways and other common elements. They may not find construction defects. Building components may deteriorate sooner than the reserve study estimated, or replacement costs may escalate quicker than anticipated. Nevertheless, communities with a reserve study from a reputable firm and with a pro-active board and manager are infinitely better served than communities with no plan for the future. Property values will reflect that difference, so owners should help protect their investment by supporting the board when allocating funds to conduct a reserve study and updates every 3 – 5 years.
This article was provided and written by staff at Associa Living.