Reserve Studies 101: The Component List

Robert Nordlund 0:07
Thank you everyone for taking some time out of your day to join me for a program on reserve components. We’re here to help you be prepared and not surprised for your upcoming major repair and replacement projects. This is the outline we’re going to use today. Before we dive into the answer to the question of which components should appear in your reserve study, and why I’m going to take a few moments to lay a foundation of why anyone should care. Otherwise, the whole idea of getting the right projects listed in your reserve study is just an answer to a trivia question doesn’t really matter in the big picture. So in that big picture, reserve studies are just one of the three ways you care for your building. I’m here to talk about reserve stage today, but they don’t exist in a vacuum. Since reserve studies are just budget and cashflow documents, associations should also plan to hire subject matter experts to help investigate their structure, critical building elements beyond the scope of the visual inspection performed by a reserve study budget specialist. And it’s also important to stay on top of ongoing maintenance. While the field of reserve studies is preparing for major common area repair and replacement projects. It’s all those little maintenance projects throughout the year that keeps the property looking sharp, and extend the time in between all those major repair and outpatient projects. So Reserve studies by themselves aren’t the only thing you should be doing to care for your property. Reserve studies are only one piece and they fit together nicely with significant infrastructure reports and ongoing maintenance. Reserve projects are those major predictable projects that are done to keep the property in good condition. Preventing other problems, you can see that this roof top boiler is rushing through. And when that boiler fails, it’s going to create a big problem for this association. no hot water. And this tennis court has a major crack right down the middle. You don’t want to invite problems when creating tripping fall hazards when something is supposed to be fun. And this is the back side up on the roof, the central roof area of a building, they were painted the year prior. And the roof or just plain forgot to paint this area. And so they’re going to have some real carpentry problems here. Because all this wood is now just fading and fraying and deteriorating. It has no protection from the elements from the paint. So most reserve projects are that larger problems. And some of them are just cosmetic problems. cosmetic problems like the pool area furniture that’s here clearly seen better days. And a cosmetic issue of too much caulking here, painting right over dry rot. And yet leaving gaps that may turn out to actually be more physical problems. And doing projects on time provides the funds. So you can do Property Care projects on schedule, minimizing the significant decay that creates an invite structural concerns. Notice here that they’ve supported this garage column, but they still have significant cracking. And they still have significant cracking underneath these two balcony areas. And not just these two balconies, easy to look at with your eye, but you can see it on upper levels. Also, when you’re caring for your property, you’re taking care of things and preventing bigger problems from occurring. And just by the nature of how many people we have here on the webinar, I know so that you came in thinking that reserve planning might not be necessary because of your legitimate life experience that the major projects that you come across, have all been solved by insurance, Firefly flood, earthquake, things like that. And that’s fine. That’s your experience. Or you may have come in thinking that any wrong decisions you’ve made will be covered by your DNO insurance, but it just doesn’t work that way. And that’s because insurance is for accidents for unpredictable expenses. Ongoing deterioration is not an accident. There’s no triggering event that causes ongoing deterioration, it’s just a normal part of life, things going from new to old. Now, insurance may actually force your hand to perform some reserve projects. Sometimes your insurance carrier may require safety updates to to code to maybe prevent an accident from happening like On the left you see balcony or stairwell railing spacing, or they may require major projects. When deterioration is spotted, like you see on the right picture, like the balconies in the photo, some spalling and chipping here, exposing some metal to the environment, and some more spalling and chipping up on the balcony above it. No insurance company wants to insure an unsafe building, threatening to cancel your insurance because your property presents too many risks is a significant motivation for you to do the right thing. And it would be nice if you had the funds and reserves ready to do all your normal repair and replacement projects in a timely manner. I’ll look at these photos and the risks that they present from reserve projects that were delayed, usually by the board thinking they’re gonna save some money. This is a dock over saltwater. And I’m not a big guy. But I did not walk out on this dock I didn’t want to fall in. And obviously the significant trip and fall hazards on the sidewalk. I’m thinking, what what was the board thinking? What were they trying to accomplish? And the question is, what do you think the insurer would do to your rates after seeing these risks at your property, and I’m not the insurance expert, but I bet those higher rates would make these rebuild and sidewalk grinding projects look small or inexpensive by comparison to what the insurance higher premiums would be. Or think for a moment what your governing documents say about your responsibilities to care for the common areas, you should maintain the common areas if it’s not too expensive, or you actually are required, you must maintain the common areas. What do you think your governing documents say? Well, of course your governing documents require the board to maintain the common areas on behalf of the owners. The owners maintain their separate spaces, and the board has a responsibility to maintain the common areas and set the budget. So the common areas are sustainable. Now, look at these photos from our recent site inspection. You see an old roof you see broken down fencing, you see crumbling asphalt, you see unsightly and dented siding, and unsightly mildew on the siding. What’s your impression of how well this board is doing? Caring for their property? What do you think this lack of ongoing maintenance and delayed reserve projects is going to do to property values. They’ve been focusing on minimizing costs to minimize homeowner assessments. And in the process, they’re shooting themselves in the foot by minimizing home values. They’re not saving anyone money. And this cartoon sums it up real estate agent showing a worn down property to some prospective buyers. Homes in this association aren’t going to Command strong prices. And maybe it’s because their insurance has become difficult to afford. Maybe it’s just because they haven’t been doing their job of proper maintenance, small projects and large projects. Now, reserve planning all this talk about components is just theory until it affects board decisions. And not just the board decisions but management’s encouragement and support of the board to make those good decisions.

So now the you know the objective taking good care of the common areas on a drive home that point with a few minutes are focusing on other factors influencing board behavior, areas where the board does not have a choice. And that has to do with deterioration. deterioration is ongoing, it does not take a day off. There’s nothing anyone can do. The stop deterioration is just a part of life. Mother Nature and Father Time don’t care that you’re trying to keep costs down. They’re going to do what they do every day. Gradually, take everything that was new, and make it old and unusable. Now your property is doomed to deteriorate, and your owners will suffer the fate of that deterioration living in a lackluster Association unless you have a plan to fight deterioration. Reserves are your plan to save your association from the higher costs of deferred maintenance and the higher cost of insurance. The save them from surprises due to big and predictable projects that you failed to plan in time to accomplish and reserves are your plan to accomplish those major projects in a timely manner. And for the board to do their job maintain the common areas and a nice side effect is maximized home values. I also know that based on the amount of people joining us today that many of you are thinking or you have owners that you’re Association you think well, why should we set aside funds for the future for others to enjoy. And I agree that sounds like charity, or reserve funding is not charity. For future owners, you own the property. Now, it’s deteriorating every day, or it’s and managers need to care for it. And homeowners have agreed to pay for that deterioration, because they’re members of the association. They can leave if they don’t want to pay. And they have agreed to pay in those little pieces month by month, but we call the ongoing assessments. So set the budget to pay the ongoing deterioration bill, it’s an ongoing usage cost, a cost of owning a home in the association. So think of the reserves portion of your budget as paying that monthly deterioration bill. It’s your bill to pay month after month, after month, year, after year after year. So the funds are there to do the necessary projects in a timely manner. deterioration is going to occur a little every day. So if you don’t plan for it, you’re essentially preparing or planning to fail. Now it’s time to spend a few minutes addressing reserve component selection, she can plan ahead to offset deterioration, constantly repairing or replacing all those things at are destined to wear out. Now to introduce this section, here’s a typical list of or a graph showing typical set of reserve expenses through the years they are defined, or the Reserve component list. And this is like a fingerprint, every property’s reserve expense map is going to be a little different. Reserve expenses are typically 1000s, or 10s of 1000s, or even hundreds of 1000s of dollars scattered out over the years in an irregular pattern. And by their size they make the monthly operating expenses look small. Now you’re the decision maker for the association, you create the future with all the decisions you make, whether the big decisions at budget time, or in all the smaller spending decisions you make throughout the course of the year. Having an accurate reserve component list gives you in your association, an advantage over the other associations who don’t plan ahead. So we try to set you up for success with training sessions like this. So you’ll know what components you’re facing, and make sure you have all the right components listed in your reserve state. And this webinar is part of our annual reserves a curriculum. We presented reserve city basics just a couple of weeks ago, where we gave a big picture summary of what reserves are and how it’s used. And that’s available on our website and on YouTube. Here on reserve studies 101, we focus on the reserves on that list. And later this year, we’ll have reserve studies 102, where we introduce the whole concept of the financial side of reserves studies. And finally, we’ll present reserve studies 103, or we’ll spend the entire session on the funding plan itself the pros and cons of different strategies and some helpful hints on how you can communicate most effectively to the homeowners about plan to prepare for all these ongoing expenses. Now, today’s program and our entire webinar curriculum is based on national reserve say standards, first published back in 1998. And the most recent update was last year. And those changes after the tragic Champlain towers South collapse in 2021. Make a reserve study an even more powerful tool to prove the future of the Euro Association. And this is where it all starts with a sector components. The 2023 revised report test that defines which projects are appropriate for funding through reserves. And here it is to be funded through reserves a project needs to pass all three elements of this three part test, that it’s the association’s common area maintenance obligation, it needs to be reasonably anticipated meaning you can see it coming so you can budget for it. That needs to be a cost that is significant in size, the association meaning not easily absorbed in the ongoing operating budget. And that’s often in the range. That threshold is often in the range of a half a percent to 1% of an Association’s annual budget or the border managers signature authority. The project doesn’t pass all three elements of this three part test. It shouldn’t be funded through reserves. Now there’s no industry master checklist or any list proprietary to any reserves a company. If you’re trying to follow a checklist, you’re always going to miss something. That’s why we’re using the three or test. And that three part test effectively helps you find the right projects that should be funded through reserves at your association. All types of associations, like the nice new townhomes shown here, high rise associations, older associations, and exotic or resort associations. Now you’re going to see deterioration most obviously properties where they haven’t been fighting it. So make sure all the right projects are on your reserve component list, all the ones that meet the three part test, and let’s plan for now, let’s practice that, as I take you on an imaginary walk around a few associations applying that three part test. So here we go to the side of some of the buildings, the governing documents here, say the air conditioning condensers are private property responsibility to the individual owners. So they fail test number one and shouldn’t appear in the Reserve component list. And we go in the onsite managers office. And they have equipment there that is owned by the management company, not the association. And you’re looking at this picture you’re saying, Robert, that’s an old picture in us. No, I took this picture last month, management company needs to do a better job of providing a new desk, a new chair, and putting a newer computer for this manager. But this is all on the management company. We shouldn’t be funding these assets through reserves. And this association has a concrete underground parking garage. Now it’s protected by building waterproofing so we can’t reasonably anticipate the eventual need for major reconstruction. And since we can’t reasonably there’s that important word, anticipate a time, the building and its underground garage will need reconstruction. It fails test number two, and shouldn’t appear in the Reserve component list. Now, in that same garage floor there is a sump pump. And this is a common area association maintenance responsibility that pumps water up from a catch pit at the low point in the garage. Up to the street level drains. Nobody that I met during my inspection had ever heard it run the garage and never flooded so must be working. building engineer said it’s never been replaced in the 10 years that he’s been working there. And knowing a pump like this usually has a useful life of about 10 to 15 years, we set the useful life 15 years and because it’s old, and the association should be ready to replace it any day now. Next time it rains, perhaps we need to set the remaining useful life at zero. The point here is you need to start getting comfortable with making some estimates. We are going to have some uncertainties when predicting the future and setting the association up now to pay for that ongoing deterioration.

Okay, let’s pop up to the roof. On their flat roof is a small hallway ventilator fan. This is further in this case, second floor hallway. While you can see some rushed on the housing, obviously, it’s facing the elements getting old. Inside is a pretty simple motor, fan and a belt. Now the on site maintenance staff fixes this ventilator as needed as a minor operational expense with fails test number three and shouldn’t appear in the Reserve component list. Alright, now that you’ve seen how the three part test works on a few easy components, let’s take it up a notch and show you how it works in tougher situations. Like this one. Here’s a photo of looking at the ceiling of another underground garage. This association as you can see is put some sheet metal gutters under the areas of piping in the ceiling that are leaking on the cars protecting the cars is plumbing through the three part test is plumbing in this condo association, a common area maintenance responsibility. Yes. Does this project garage plumbing have a reasonably predictable useful life? And I would say obviously, yes, it’s clearly deteriorated and it is failing. So it has spent its useful life. And do you expect a repiping project like this to be above a minimum significant cost? Absolutely. So repiping the garage area is clearly an appropriate reserve project. And here’s another one picture of a hillside that just experienced a slope failure. It may look like not a big deal, just throw some dirt back on the hill. But they got a $50,000 estimate to regrade a slope and replant it. So is this reasonably predictable? Well, nobody knew this particular hillside was going to fail. But this large Association has extensive hills and at 20 years old. This is now the fourth Time, a hill somewhere or other in the association has slipped. So the simple math is that that a hillside here slips on average about once every five years. They may not know exactly where. But Association history suggests that if it happened before, it will reasonably happen again. And we can really reasonably expect it to happen about every five years. So let your own history help you prepare for your future. Are What about this a client who wanted to install a pickleball court and a small space between their clubhouse on the right and the edge of their property? You can see the iron work fence on the left, is this reserve project? Well, no, because it failed test number one, because it wasn’t yet an association maintenance responsibility. It was still someone’s idea. It was just a plan. So that makes it a capital improvement. And you shouldn’t be spending reserves designated for deterioration, ongoing deterioration. Spent, you shouldn’t be spending it creating new assets. Okay, now you know which projects appear on the Reserve component list and which projects are filtered out. filtered out projects are the uncertain or indeterminate ones, projects that last a life of the building small cost projects, they’re all filtered out. And note that this will also filter out capital improvements, because in the planning stage, they don’t yet exist. Now, applying this test means that for the average Association, they’ll end up having a reserve component list, pretty reasonable 35 to 50 components. But of course for some larger or more complex associations that can easily grow to be hundreds of components. All right, so what information should you see or a component? Well, first, you need to describe the project accurately remember, it’s a project not a thing. And for each project, expect to have accurate identifying information. Third floor second floor lobby, it may mean quantity like a serial number, the square yards, square feet could be a size like the BT rating of Oh, a water or heater or the maybe the horsepower of a pump. And of course, we expect to see useful life then in years, remaining useful life in years and the current replacement cost. Now remember, we’re going to inflate these costs in the financial analysis portion of the reserve study as we look out the future years. But here in the component list, all we show is current costs, it gives us a foundation for what are things expected to cost now. Now let’s look at this simplified reserve component list. I’ve taken the quantity field out just for space consideration. Every component should show a clear description of the project. Like you’re for asphalt you can see it’s one thing it’s asphalt, but two different projects sealing on a five year and resurfacing on a 20 year cycle. And remaining life abbreviated Are you well, and the project’s current replacement cost. And that useful life tells you out often the project occurs and the remaining useful life tells you when it’s next going to occur like the little furniture here and needing to be replaced this year, because it’s worn and time to be replaced. The cost is the all inclusive total cost of performing the project. So it should include shipping, permits, installation disposal, things like that. And note that reserve component list for a small association is going to look different. And a reserve component list for large association for instance, a $4,600. Well, furniture project may be significant to a small Association. But it may be too small, it may be just an operating expense. For a large Association. It depends where your threshold is significance. So this is your plan for the property’s future projects get a little fuzzier and those projections get a little fuzzier, the further you go out into the future. But major projects like roofing siding or elevator modernizations are significant. And they’re predictable. So it’s wise to prepare for these expensive projects with as many years as possible, even if it’s more than 20 or 30 years. So we make those estimates and no worries, you’re going to have plenty of reserves that he updates in the coming years to refine all those estimates, as they gradually draw closer and closer. Now I have every expectation that in reality as the years goes by, these expenses are going to move around a little bit get slightly larger or smaller. Maybe again, Draw closer, or maybe they’re gonna get pushed out here at you. They are predictable, but they’re still estimates, but you’ve got your best chance to be prepared. If you have a plan. Remember that Benjamin Franklin slide, like this map of projects, have a plan, and you update the plan regularly. Okay. Now question is how these components affect reserve funding, it’s a little bit of a view into the future of funding for these projects. Now, while you may have a one component list, not all the components have the same effect. Typically, most of your reserve funding is driven by just a few of your components. So of all the components in a typical reserve study, take a moment and think how many actually dominate the size of the reserve funding needs. Take about it, the answer is usually five or less to a wonderfully small number. And often the number is just two or three components that derive reserve funding. Your association type, and region of the country are going to affect your component list makeup, and which ones for you are the big and influential ones. But for typical townhome associations all across the country, the dominant opponents are roofing ating, and asphalt. In cooler or moist climates, you can add siding, and either window or deck or both type projects. In mid or high rise condos, you typically don’t have as much asphalt or roofing. But you do have major interior hallway projects, and major mechanical components such as HVAC systems, boilers, elevator fire alarm systems, things like that. Now in HOAs, and planned developments, it’s usually the roadway system, and the recreational components that are the most significant. Maybe the docks, maybe the eight tennis courts, things like that.

And here’s a pro tip to learn how to be able to identify the influential ones from the others. And the secret is, don’t just look for the largest costs, what really matters is the cost per year may be found in a reserve study as a cost per year, or sometimes called a deterioration rate. For instance, let’s say we have two projects, one that’s $100,000. One that’s 50,000 hours. Clearly $100,000 is twice as expensive as $50,000. But if that $100,000 project only occurs every 20 years, and means that you’re funding $5,000 A year of deterioration, you’re offsetting by $1,000 a year of deterioration. But if that painting project is something you need to do every five years, it’s deteriorating at the rate of $10,000 per year, twice as significant. So keep that in mind. Now I mentioned a time or two that we’re in the business of estimating here of projecting the future based on what we know today. And that’s the key. As time goes by, we can refine our estimates. Most of you probably know that there are three reserves at levels of service. Most associations only need to do a full reserve study a top level of service only once. And that’s when you measure all the assets, count them identify the Reserve component list. Best practice now is to do a with site visit update at least every third year. And to help you catch the changes in between years maybe like inflation, or projects that don’t occur exactly as planned. There’s inexpensive, no site visit updates that you can do in those in between years. That helps you stay on top of your reserve planning, but component selection, the choice of which components is going to help you plan ahead for a safe and successful future. And it all boils down to that three part test. And that should provide you with a stable component list from year to year. Now, in addition to help you select the components that helps you know which expenses to not include further funding, like insurance deductibles. And the reason why is that they don’t occur on a predictable basis, they fail test number two, and that’s why you need some operating budget available for those unforeseen events. And there should be no confusion about conflicts with IRS standards. You prepare your taxes according to IRS standards, and you prepare your reserves according to National Reserve say standards. And that means you’re free to fund the for non capital projects or IRS definitions like a roof inspection, tree trimming, painting or other projects. And with no maximum useful life limit you can and should fund some reasonably predictable long life projects like sea walls or boat ramps. And if your buildings were built a different RMS, clearly are free to have different components for the different ages and timing of those various phases. Or you can have reserve components for Marshall replacements with huge systems like sidewalks, grinding a certain percentage every year, or maybe replacing a certain percentage of your perimeter fencing every year. You can also have a reserve component for building structural inspections or other expensive inspections, or every few year tests, or maybe just scheduled significant maintenance like the 1000s of dollars you’d spend maintaining a chiller in its mid life rehab project, all this so you have the funds to help your most expensive components reach a nice, long life. And it’s all done. So you can see and prepare for the future, minimizing expensive surprises at your association, you want to be able to plan for these things. Now it’s time for me to summarize this reserve components webinar and bring it to conclusion. I hope we’ve made it clear that the reason we’re talking about reserve components is it’s your property, and it’s going to deteriorate every day, insurance is going to help pay for normal deterioration. And ignoring deterioration doesn’t make those costs go away. A reserve study is how you see those big upcoming expenses, prepare for them, and keep them from causing problems at your association. And the key is your attitude. Your mindset. You need to be caring about the condition of your association will learn what it needs, and then budget for it. So care about the condition of your association. Be curious, learn what it needs, and have the courage to budget for it. Now, the overall plan for billing to aid successfully was summarized nicely in the April 2020 CDI Research Foundation reports a free download by the way on aging infrastructures. And remember the plan, update your reserve study fund reserves. Make sure that dollars are there. Spend reserves, do your projects on time and perform periodic infrastructure inspections. And there’s so much more we could talk about. But we have a number of written and video resources that you’ll find on our website, reservestudy.com. And if you’re interested in getting Association reserves on your team, the top right corner is where you can find a link to click to get a no cost proposal for reserve study for your association. Or you can skip our website and go straight to YouTube. Or you’re going to find full webinars and webinars shorts. And if you are signed up as a subscriber to our YouTube channel, you can get notified of new content when it is dropped. And on our website, you’ll also find a link to a free download. So the first chapter of our understanding reserves book that’s available for sale on Amazon, great Summary of when I’ve talked about our reserves to hit basics when I’ve spoken about here, and the basic building block concepts of reserves studies. And for those of you who enjoy podcasts, we have a weekly 30 minute podcast called HOA insights common sense for common areas. You can find it wherever podcasts are found, or on the website hoainsights.org – It’s a podcast designed to encourage and equip board members in weekly 30 minute bursts. The hard work you do leading your associations and episodes rotate among guest speakers, current events, and some featured word member heroes that we elevate and just congratulate in front of everybody. And if you found this webinar helpful, join us for future webinars getting reserve studies done after a long time with no planning that’s coming in may, reserve study 102 of the financial analysis. And then funding to keep your association current in the real estate marketplace. He should have three upcoming webinars, sign up for our email list by scrolling to the bottom of any page on our website, if you want to be on the invitation list, and you currently aren’t. And that brings us to the end of our prepared content today.