After 2021, HOA reserve studies and reserve funding were never the same. Now in 2024, we’ll be sharing what we’ve learned after the tragic collapse of the HOA condominium in Florida. HOA reserve studies and reserve funding are needed more than ever! Thousands of properties are deteriorating every single day – so is your community association prepared to move with the times? Don’t leave your residents behind. Care for your community and put safety first among all things. HOA reserve funding is your first step to securing your association’s future.
Transcript
Robert Nordlund 0:00
And for everyone attending, thank you for joining us today. In our industry, everything changed on June 24 2021 when Champlain tower South collapsed, killing 98 people in the process that event changed the way reserve studies are perceived and the way reserve studies are prepared, and that’s because the consequences of underfunding reserves went from a special assessment to loss of life of some of your neighbors. Now we track a lot of the information on the kind of work we do here at Association reserves, and today we’re going to share some of that information with you, giving you a sneak peek at what has changed and also, interestingly, what hasn’t changed, and that’ll set you up in a better position to lead your association well, which is the bottom line of what we’re trying to accomplish here today. This is the outline we’re going to use, walking you through a clear understanding of the foundation of reserve planning, and then after that, we’ll tackle the changes in the community association industry. The board is set up with a legal and practical responsibility of caring for the needs of the association. Associations have financial assets and common area physical assets, but they also have an operational style that could be healthy or unhealthy, and either way, leadership falls on the shoulders of the board to manage the association, financially, physically and operationally, and here in the reserve, say business, it’s our job to guide the board forward, answering that critical question every board should be asking every year, and that is, what’s the right thing to do now, to take care of all we have, in other words, what’s the right and responsible path forward? And that’s important because this chart shows a typical set of reserve expenses through the years. They are uneven, some years high, some years low, and varying through the years. And this is the challenge that boards face. How do I prepare for all these uneven expenses through the years? Well, it helps to see how a reserve study is assembled. Every reserve study has three parts. It starts with a component list, which forms the foundation by establishing the list of the projects that occur and recur through the years. Then, based on the component list, we calculate reserve funds strength by comparing the needs the association to the funds you currently have set aside in reserves. Then based on the upcoming projects defined in the component list and the association’s financial starting point, we developed the funding plan, which is the path forward. So let’s go back and look at this in a little more detail. First, the component list. This is the component list that created all the expenses in that expense chart from a couple of slides ago. This is what needs to be identified in order to project things in the future. You’ll see on the left a list of projects. Then the UL is useful life expectancy. Our UL is remaining useful life expectancy. And then the current repair or replacement cost. And these all come about from the national standard three part test. And that three part test is that a project needs to be the association’s obligation to repair or replace. It needs to be reasonably predictable, and it needs to be above a specific cost that is significant to the association, not the little things that can slip into the operating budget. And we gather this information, or assemble this information, with three types of reserve studies. There’s a full reserve study, which is essentially a create from scratch. There’s an update with site visit, where we come back to the property and put our eyeballs on all your assets and look and see and evaluate. And there’s an update no site visit, where we update the reserve, say, based on correspondence with the client. Corresponds with the client. Telephone calls, sometimes with the associations major vendors, but it’s just communication without going on site. Now, another way to think about this is a full reserve study, typically only needs to be done once. Once we establish that the property has 185,000 square feet of asphalt and 76,000 square feet of roof. You don’t need us to re measure that every time we come back on site. And I’ve got an asterisk by the with site visit update, because that’s something that has changed since Champlain towers south, a with site visit update every third year has now become national best practice. So I want to highlight that. And then in the in between years, you have the no site visit update to help you stay on track of how costs have changed, rebalance based on how much cash you have in the reserve fund. But this is how we gather that information and re establish that component list. Then we go to. Reserve fund strength. And this is identifying the meaning of the cash that you have in reserves. If you have $100,000 or $500,000
you still need to know, Is this good or bad? Do I Is this a strong amount of money to have, or are we at risk of something? So we still need to get some meaning from this. And we do this by not just looking at the amount of cash, but by comparing the cash to the needs of the association. And that’s where we get the term percent funded, how much cash do you have, compared to the amount of deterioration of common area components at this time. And then third, we come to the funding plan, and often when it gets to reserve funding, it seems like what we’re talking about is a wheelbarrow full of money every month, every quarter, every year, but you have to remind yourself that owning real estate is expensive and deterioration is also a normal part of life. Everything wears out or gets old, so to maintain the assets of the association, to fulfill its job, to take care of all the common areas, physical, financial, operational parts of the association, the board needs to offset the deterioration with cash set asides to keep the association in balance, to keep it from sliding into a state of decay. All right, now it’s time to change topics to how the process of preparing reserve sites has changed since Champlain towers south. Now I know you’re not in the reserve site business. We’re the ones who are in that business, but I thought it would be helpful to you as Association decision makers, board members and managers and the industry professionals who tend to join us on these webinars to see what the changes look like from the insight from our perspective. And it starts with a big picture understanding that it’s not all about reserve studies. Reserve studies are just 1/3 of what you need to be doing at your association to get successfully into the future. Taking care of your physical and financial assets involves ongoing preventive maintenance, all the little things around the association that take care of the place the reserve planning that gets you the budget to do your major projects, and then the infrastructure inspections, the less frequent inspections by a structural engineer or an architect to help reveal how the bones of the association are doing those design built elements and how they are doing at the association. So you need to see the planning for the future that reserves indeed is just one part of it all. And with respect to the reserve study itself, what we’re talking about in the updated reserve study standards are updated just last year based on all these changes what we’re talking about with reserve components or actual projects, they don’t have to be tangible things. So it may be elevator load test, an expensive elevator load test, it may be a roof inspection, it may be a subject matter expert reports, but these things are going to be appearing as components in your reserve study. And major maintenance is now part of what can be a reserve component, if it’s common area, if it’s reasonably predictable, like a cooler rebuild, chiller rebuild, and a significant above a significant cost, you can see how major maintenance can be a reserve component, and also Corrective maintenance or repairs. We want associations to be able to tap into their reserve fund to do what needs to be done, to fix things at the association. And then we’ve opened the door to long life components. There tended to be a soft limit, or a window to reserve projects to only the first 30 years, and that’s gone away now. There’s a full embracing of what we call long life projects, maybe something like a sea wall or a boat ramp, or maybe a new elevator technology or roof material that is expected to have a design life over 30 years. It’s now appropriate to fund for those through reserves and also subject matter expert reports. Typically this is the structural engineer the infrastructure report, but sometimes it could be, in some cases, even as small as a reserve study, but those things are getting dialed into the reserve study or the Reserve component list. And so bottom line is, expect your component list to be longer than before, and something else that has changed is the best practice, is that an on site based reserve study is recommended to be done at least every third year. And that’s why I highlighted that a couple of slides ago talking about updates. And this is where you dial in the No. Site visit update in between those to keep track about prices and the size of your reserve fund, the strength of your reserve fund, how the recommendation needs to be adjusted in light of that and in light of things like the higher interest that you probably getting at this point in time compared to five years ago. So make sure you’re using updates appropriately and effectively. And that’s all because things have changed. I show some pictures here of technologies that at one point in time were the coolest things, wireless phones, mobile phones, the old monochrome monitors, pagers, things like that that were at one point in time they served us well, and even clothing styles or carpet lengths or furniture in the clubhouse. Styles come and go. Technology comes and go. So think about reserve studies being perishable assets. They quickly use their usefulness. They’re good for a year after that, you start doing really stretching things. And that gets me to a time where I need to turn the microphone over to Wayne, who’s going to spend a few minutes talking about what the numbers actually say about reserves we’ve been preparing for our clients since 2021 and think about this as Wayne speaks, I wonder if your experience is going to resonate with what Wayne begins to share with you. Wayne,
Speaker 1 11:18
hey, Thanks, Robert. I’m glad to be here with you and our audience today. Yeah, I’m going to spend a few minutes with you to show you what’s been normal and what we’ve seen in the data that we’ve collected after the Champlain tower South collapse. The image you see here on the screen shows what our normal reserve funding recommendations have been through the years as a percentage of total budget. It’s easy to see commonly what we find an association needs to set aside towards reserve to sustain the association is about 25% of their total budget, right there, that middle tall bar. Some types of associations can get by with less, and some need a little more, but this generally reflects the amount of common areas the associations and are responsible for and the different materials that they’re made out of. And it also takes into consideration like local wear and tear due to weathering at the association. Some associations have harsh alpine environments. Others are in salt water beach environments. So the chart is pretty stable ever since we started up collecting this data. The next chart shows the same information, but just since not january 20, January 1 of 2022, when associations began adopting their first budget since the Champlain tower South collapse. So what do you notice here? The peak is still at 25% but there are so many associations needing to set aside more than 25% of their budget. We call this having a high right shoulder, as the graphic clearly shows there. It also shows that in the last two years, many more associations than normal have needed to set aside more than the 25% possibly a lot more than 25% of their budget towards their reserves. You’re probably asking yourself, what’s going on? Well, there are two reasons we feel that explain this behavior. The first one is that we have so many new clients reaching out to us since Champlain tower, South Phil so many associations that hadn’t been doing reserve planning in a long while. Remember Robert’s recommendation a few moments ago that the best practice is to update your reserve study at least every third year with an on site visit. But what we’re seeing is a wave of associations influencing the data that hadn’t been responsibly funding their reserves and had gotten way behind on their reserve funding, and we are now in a significant catch up mode. Remember that mother nature and Father Time don’t care if your budget is tight, they’re not going to wait to wear out your roof paint or asphalt. They’re doing that every single day. But the good news is that the associations finally reached out for advice. The bad news is what we delivered to them, they were far behind, and they had to start setting aside more reserves than normal to prepare for their upcoming projects. The other reason is what Robert said about adding additional product projects to reserves. These are things like major maintenance and inspections that likely you were grumbling about and funding them from trade offs in your operating budget, but now they are legitimate scheduled reserve projects. Rather than being big old budget busters, they’re now just scheduled expenses the association needs to prepare to pay so it’s not making life more expensive at your association. It’s just finally get that these projects are appearing as line items in your budget. So on the next slide here, the takeaway lesson for this is, in a stable situation, most associations should be setting aside something in the range of 25% of their budget towards reserves. Some associations that got behind need to set aside more. But 25% is an easy number to remember. What’s interesting is that this number is pretty stable. When we slice it down further into condos versus town homes versus high rises versus homeowners associations versus large versus small, new and old this 25% budget. It going to reserves is a pretty stable and useful figure. Okay, new subject. Here’s a profile of the reserve fund, strength of associations all across the country, information that we compiled over the last 30 years. So what you see is the percent of associations on the left, in the red, that’s the weak range, the percent of association in the middle, which is in the fair range in the yellow and the percent of associations in green on the right side, that’s the strong range. This shows you the profile of associations across the country and how well equipped their reserves are to handle upcoming expenses. Now this slide shows a profile of our Florida Association. Clients. Note, there are so many more associations in the red week range, and this is why the deadly Champlain tower South collapse happened in Florida and not in other similar states. This is because in Florida, the law has historically allowed homeowners a line item veto on reserve funding. And in many associations, the homeowners regularly vetoed reserve funding with the result of that disproportionate amount of Florida associations didn’t have much cash in reserves, which meant they either didn’t do the repairs or replacements on their buildings in a timely manner, or they went from one special assessment to another. This is not a recent change. I just wanted to give you some perspective. Though, many people think that this is a profile of reserve funding strength across the country, and they’re very wrong. This is the only the case in Florida. So let’s go back to that historical national profile. Now I’m showing you the percentages of associations in each category. If you notice, 26% of associations have a strong reserve fund. And if you add that 26% of strong associations to the 40% that are in the fair category, that means 66% or two thirds of associations are doing either fair or pretty good with respect to funding their reserves. It’s only the associations in the red zones that are making all the bad news and giving associations and their boards a bad reputation. Now here’s a recent profile of Champlain tower South note, the percent of associations in the poor red zone jumped from 34% up to 42% so recently, more associations are falling in the red poor zone, meaning they don’t have enough reserves on hand to take care of the necessary projects at their association. And this is really unfortunate. So again, we ask the question, why is this happening? And we feel the primary answer is the same, lots of new clients coming to us, reaching out for help, and for the same reason, we’re recommending catch up size reserve transfers, it’s because they’ve been slipping for years due to underfunding their reserves. And we also feel that a factor is that we’re recommending more projects to be included in the reserves that were previously only being deferred or being budget bugsters in the operating budget. But we believe that’s a secondary effect. So the lesson to learn is that there are still plenty of associations in the fair or strong range, I sound like a brokered record always saying, take care of your property and fund your reserve so that the money is there when you need it. So now here’s our third topic for today, where I can show you the correlation between percent funded, which measures the reserve fund strength, and special assessments. To no one’s surprise, when the association doesn’t have much money. On the left side of the chart, the zero to 30% red zone special assessments are pretty common. Roughly 50% of those associations need a special assessment to take care of major products at their associations. And notice on the right side of the chart all the associations at or above the 70% funded house special assessments are rare, and no surprise when an association has been responsible setting aside reserves to offset deterioration, projects get done on time without special assessments. Here’s the same information, but for just the last two years, since Champlain towers, it’s the same profile, no real change here. In fact, why don’t you flip back to that other slide, Robert, so people can see the difference that nothing really has changed. Not
Robert Nordlund 19:06
much change. So this is historical, and this is now just the last two years, right?
Speaker 1 19:13
And that’s because the relationship between not having money and needing a special assessment hasn’t really changed anytime an association doesn’t have enough money to take care of itself, we need to recommend a special assessment, and that’s unsettling and disruptive to the homeowners. It always it delays a project getting done, and it forces the unlucky set of homeowners at the time of the expense to pay the entire cost of a project. Remember that deterioration occurs gradually over the years. It’s very predictable. This chart shows us that special assessments are a preventable problem. So the takeaway from this data is pretty simple. It’s now and it always has been a good idea for the reserves at your association to be at or above 75% funded. That’s when you enjoy smooth budgeting, with projects getting done on time, because there are real consequences for not having money and the asphalt being full of potholes or the roof leaking, property values suffer, and homeowners get hit with unfair and unwarranted special assessments. And remember, these are special assessments for things that deteriorated in plain sight over the course of many years, it really takes a stubborn board to ignore the obvious and let the association fall into decay because of not doing their job to collect the funds from the homeowners that are necessary to sustain the association. Thanks, Robert, yeah.
Robert Nordlund 20:35
Well, thank you. Wayne. A great job of digging into that data and making the story pretty clear without having to look at a whole lot of numbers, it’s nice to see what did change and also what didn’t change, like the last point, where it does indeed make perfect sense that when you run out of money to do what needs to get done, or you don’t have the money, it puts the association into a special assessment situation. There’s that strong relationship, and that has nothing to do with pre Champlain tower south, or after Champlain tower south, there’s that whole idea that deterioration is predictable and you can put the money into reserves and plan to avoid special assessments. That’s kind of neat. Okay, now it’s time to wrap up our time together, summarizing what we’ve learned. So you have all these ideas fresh in your mind, Wayne told you about the relationship between reserve funds strength and special assessments, and in this cartoon showing a real estate agent showing a home in a deteriorated Association, it reminds you that funding reserves affects home values. You can skimp on reserve funding keep a little bit more in your own bank account by not giving it to the association, but you lose it in home equity. It’s never been a wise financial decision to underfund reserves before Champaign tower south or after. And just to reinforce what Wayne said, Mother Nature and Father Time, don’t care about your tight budget. They’re going to drive expenses. They’re going to drive costs at your association, whether you are preparing or whether you are prepared or whether you’re underprepared. They just drive projects because everything deteriorates, and whether you see it as Mother Nature or Father Time or monsters, they’re all coming to get your money. Owning real estate is expensive and the forces of deterioration are real. And remember, it’s the board’s job to provide for the needs of the association, and so you can’t get caught holding on too tight when your best defense is to spend money to take care of the property. And there is one more point that I want to make here, and it’s illustrated by this cartoon, where it helps you understand how to look at reserve projects. The gentleman here is complaining about not wanting to fund reserves because he has a short horizon. He’s not even buying green bananas, so he doesn’t care about these projects in the future, the roof, the asphalt, the stucco, things like that. And so I want to take you back to a reserve expense chart. And a lot of people see it as an expense. So a boiler in five years, a roof in 12 years, asphalt in 18 years, siding in 26 years. And thinking that these are projects or costs to avoid or possibly dodge. And I want to challenge you to think that it’s all about deterioration. A reality is that deterioration is driven by the sun coming up and going down, and the rain, the wind, all those other elements that just happen on a daily basis. Deterioration is smooth and steady. It’s ongoing. It is unstoppable. There’s no avoiding it by not funding reserves or minimizing your reserve funding thinking, well, we’ll wait till that becomes a problem. It’s becoming a little more of a problem every day, and I want to think of it, or I started thinking of it like the pace line when you’re watching some of the Olympic races, where it illustrates the point that you’re either keeping up or you’re falling behind. If you were to stop or slow down, your reserve funding, deterioration keeps on going, driving those expenses. It’s not like you’re avoiding anything. All happens is you get farther and farther behind, driving you into a cash flow or a cash consideration. And I want to have you imagine that it can be a bit like we’ve all seen on a new car lot, where there’s a sticker on one of the windows showing you what the ongoing expenses will be to own this car, what the cost, or the miles per gallon that you should expect with this type of vehicle, there is this ongoing expense, and you have to have an appreciation that the cost will continue to come at your association. It’s not a buy the home pay. Your mortgage and forget about it. There’s a lot of costs going on to maintain the association. So I want to encourage you to see this as deterioration. Is just know the bill that needs to be paid and you need to budget for it. Now I don’t want to say you need the budget for it, because that’s why Association reserves and other companies like ours exist. We’re here to guide your association safely and successfully to the future, to keep you on the path, to let you know when you started wandering off and going to get yourself into trouble or some danger. We’re here to help keep you on the trail and get you safely and successfully to the future. We’ve been up and down this path so many times, reserve studies are all we do. So at this point in time, I want to thank you for joining us today for this webinar, and point you to a few additional resources. If you go to our website, which is reserve study.com you’ll find written and video resources under our resources tab and also on our website. If you’d like us to help your association, by all means, click on the Request to proposal link at the top right of the home page. And if you like this kind of content, we have a deep library on YouTube. You can search for reserve study videos there, and if you find them there, consider giving them a like and subscribing to our channel. And another medium that we have is a book. It’s called Understanding reserves, something you can easily get and put on your desk or bookcase. It summarizes the major reserve, say, concepts that we’ve addressed today. So consider ordering that it’s called Understanding reserves. You can download chapter one for free from our website, and if you like what you see, grab a copy ordering from Amazon and remember one of our perhaps best resources, our online reserve calculator called you plan it. It allows you to test different funding plans and different expenses, really getting your fingers and hands into what’s going on with reserve funding at your association. You can make adjustments to some of the expenses, adjustments to your funding plan, interest, inflation, starting balance. It’s all cash flow methodology, so it’s a optimum tool for your association. Access is free with every professional reserve study from Association reserves, or it’s at a low cost, if you haven’t had a recent reserve study and you just want to get an annual subscription. And yet, another resource is our weekly 30 minute podcast for board members called HOA insights, common sense, for common areas. Episodes drop every Monday as 30 minutes to encourage and equip board members to do the hard work of leading their associations forward. You can listen. You can subscribe from any of the major podcast platforms. You can watch the episodes on our YouTube channel, or you can also listen from HOA insights.org and with that, I’ll turn the microphone over to Paige, who will coordinate our Q and A time together.