Why is a Home Owner Association Reserve Study Necessary

Why is a Home Owner Association Reserve Study Necessary

I’ve heard people ask this question: Why is a Home Owner Association Reserve Study necessary? It’s because a Reserve Study is a planning tool for major repair and replacement of community assets. It details the money to set aside for replacement of assets not in the operation budget.
 
The association must budget for major repair, upgrade, or replacement of assets. That means conducting an inventory of association assets. Then determining the life expectancy of each asset.
Why is a Home Owner Association Reserve Study Necessary
Home Owner Association Reserve Study Budget
Let’s take a building roof as an example:
 
Assume a building’s tile roof has a life expectancy of 40 years. The anticipated cost to replace it in 40 years, adjusted for inflation, is $30,000. Divide $30,000 by 40 years. The result is the amount of money the HOA must contribute to the roof reserve fund line item each year. Therefore, in this example, the HOA must contribute $750 each year. Also, they must repeat that process for each asset.
 
The best way to do this is to hire a Home Owner’s Association Reserve Study Specialist to do the inventory. An association representative familiar with the association assets may assist the Specialist. The specialist will then determine a “useful life” and “cost to replace” for each item. So, if the useful life of the 15 year old roof is 40 years, the line item will show the remaining life of 25 years. The HOA should update the reserve study at least every 2-5 years.
 
A board should provide  a home owner’s association reserve study and keep it updated. This demonstrates that the board is acting by its fiduciary duty. Also, it reduces the individual directors’ exposure to personal liability risk.
 

Arizona HOA Reserve Study Law

There is no Arizona law for a Home Owner Association Reserve Study at the present time. Yet, even without a law, the operating and reserve funds should be in separate bank accounts. An HOA should not commingle the funds. Attorney Jonathan Olcott said a board may use reserve funds for capital improvements. However, they should be prudent and repay the funds to the reserve account. That prevents the account from becoming underfunded.
 
The HOA should fund the reserve fund at a level to provide the funds to replace assets as required. The association should contribute a set amount to go into the reserve account each month.

Why is a Home Owner Association Reserve Study Necessary?

It is important for the board to keep the reserve fund funded. That ensures that today’s owners, who are enjoying the use of the amenities, are paying their fair share. If the HOA under-funds the reserves, future owners will have to make up for the short-fall. That isn’t fair to future owners. Also, if the board under funds reserves, the association may be at financial risk.

Home Owner’s Association Reserve Study Funding Levels

There are three funding levels:
 
  1. Full 100% funding
       As assets age, the fund grows so that it is fully funded at the estimated end of the useful life.
  2. Baseline funding
    Baseline funding allows the reserves to get to, but not below, zero. In this method, there are funds available. But, there is   a  high risk of a special assessment or not being able to repair or replace an asset
  3. Threshold funding
    Threshold funding is any percentage between 0 and 100% that an association chooses to maintain.
An HOA can determine that many assets may never need replacing. That would be because of periodic operational type maintenance and repair. So, they don’t need to be at 100% funded. They could choose to be 80% funded, which is in the low risk category of requiring a special assessment.
 

Risk of Special Assessment

  • 70-130% Funded – Low
  • 30-70% Funded   – Medium
  • 0-30% Funded    – High

Sample Home Owner’s Association Reserve Study

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