Reserve Studies 102: The Financial Analysis (2025)

Robert Nordlund 0:00
By the end of today’s program, you’ll leave knowing how to tell if you should feel good or bad, or actually somewhere in between, about your reserve fund size and how that starting point influences your reserve funding and why physically similar associations may have very different reserve funding recommendations. Now this is the outline we’ll be using today, starting with an overview, then mark will walk you through understanding your reserve fund strength and those funding plan issues I mentioned just a moment ago, and it starts out with appreciating that we’re all on a journey to the future. It’s going to be full of twists and turns and bumps and obstacles and things like that, but by planning ahead, we’re going to eliminate the majority of the surprises that can get in the way so you can arrive to the future successfully. Every Association has a set of expenses in his future, reserve expenses, specifically like you see on the chart here, although they may look kind of random and scattered, here, they are predictable. The roof will fail, the paint will dry and chip and peel, the asphalt will crack and get potholes. Elevators will start to break down more frequently. We know these things, and we can predict pretty closely how much they’ll cost and when they’ll occur, and that gives us this type of expense chart. Now we identify, we cover, identifying all these expenses in the reserve studies, 101, webinar that Colleen mentioned moments ago, and that webinar is available for re watching on our website and on YouTube if you want to catch up and see that program and catch up with the content that we’re going to be sharing today. Now these are the questions we’re going to answer for you in today’s program, these three things where we now are reserves weak, fare is strong. How does our starting point affect what we need to do, and how can there be so many options going forward? So settle in volume, and we’re going to take you on a journey here, and this is an important journey and an important discussion, because you need to understand that deterioration is ongoing and inevitable. There’s nothing you can do about it. Deterioration never takes a day off. It’s a formidable opponent, and it’s expensive if your association is not actively fighting this ongoing battle, and if you’re ignoring the reality and the cost of the damage that you’re taking on little by little, every day, week, month and year, you’re losing. But no worries, they were going to arm you with the tools for success. Our starting point assumes that you do have a reserve component list with components wisely and appropriately selected according to national reserve study standards, and that’s because all your financial decisions, all the decisions we’re going to cover today, rely on knowing the expenses, the projects ahead of you in your journey to the future, and what a technical reserve component list looks like. It’s a little bit simplified from what you might see for your association, but it’s what we’re going to be using for today’s program, and it’s from this list that will show you how we calculate the answers so to those three questions, how much cash or association should have based on the current condition of the components in your component list, how that starting point affects the options that you have moving forward, and how there can be so many funding plan options for your association. So it’s now from the corner of the first topic, calculating your reserve fund strength. It’s not just looking at cash in the bank that appears on your bank statement or balance sheet. It’s all about gaining meaning, about if the cash balance you have is a lot or a little compared to the needs of your components at this time. So let me turn the microphone over to Mark Bradley, who, at this time, will guide you through this topic. Mark,

Mark Bradley 3:59
hey. Thank you very much. Robert, very glad to be here. Very glad to be here with all these wonderful owners and managers and board members helping us get through the reserve studies one or two. Let’s just take a look at this photo. Looks like a newer Association, and we can already see what kind of components that they’re going to be looking at. We’ve got a courtyard. We’ve got to resurface the pool we’re painting and eventually replacing this trellis, we’ve got balconies that need caring for, and that’s just one picture that you can see. And if you’re a board member or you’re a manager at this association, the choices you make about funding reserves will determine if you’re able to stay on top of this deterioration, or if this deterioration is going to get the better hand, and you’ll begin to fight roof leaks. You have paint becoming faded and stained. You’re talking about big repairs in a pool area or maybe your rec room, and they stop becoming an inviting area, and the property values a curb appeal as a property starts to lag the market. So let’s just start out our journey to the future by understanding our. Starting Point calculating how much you should have in your reserve fund at this point in time based on the condition of all the components in your component list. Financial Analysis starts with the component list. This outlines the cost and the timing of the projects in the future. This is a pretty simplified component list, but it’s good for our example. Today, this shows a basic description of the component of the project, the useful life cycle. That’s how long this should last, and the number of years remaining before it’s got to get repaired or replaced. And current today’s cost, this list of year Association should be assembled based on the national reserves today standards, three part test, which is shown here. If you’re not familiar with this concept, go back and watch 101, we’ll explain it all in a little more detail there, and I’ll make sure that there’s a link to that program in the outline. So question is, how much cash in our reserve fund is enough? Again, talking about national reserve study standards to find a solution. That solution gives us a reliable calculation that works for all types of associations. We’re not talking about $1 per unit or a percent of the unit value, or even just a straight cash number. This is a calculation. It compares your current reserve fund balance to your Association’s needs, telling you how well that reserve balance fits the needs of the association assets. Let’s do an example. First, the component from that sample component list we just showed pool furniture replacement. This one’s pretty straightforward and simple. It has a five year useful life remaining. Useful life of zero. That means that it’s time to be replaced. Time’s up. Current replacement cost is $4,600 if you’re a board member, need to buy a new pool furniture. How much would you want to see in reserves? $4,600 that’s right, when the remaining useful life is zero, it’s time to have the money on hand. And that’s how much you should have in your reserve fund for this component. Well, let’s just do another example. Let’s say it’s the pool. Pool needs to be resurfaced every 10 years. Currently has a remaining useful life of five that means you have five years until you have to do that resurface. So the life is halfway used up, that $10,000 cost you don’t need right now, because the expense is still five years away. With a current replacement cost estimate of $10,000 and the life is halfway used up, we understand now how much cash we think would be good for the association to have at this time, you’ve probably guessed it’s about half $5,000 it’s a good amount for this association to have set aside now that the component is halfway used up. Okay, so let’s put some graphics for those of us, like me, who learn a little bit better through pictures and numbers walk through this ignoring interest in inflation or reserve study is going to have interest in inflation on it. But for simplicity sake, we’re going to put that aside at five years old. You’d like to have half of the $10,000 set aside, right? So in the next year, we want to have $6,000 set aside, and seven, and then eight, and then nine, and then finally, when the resurfaces, it down to a zero remaining useful life. We need to have that $10,000 ready to go to spend on the pool resurfacing. And then once we’ve done the resurfacing, the life of the pool resets. So in the 11th year after you spent the money, you only need to have $1,000 in reserves, and you start the cycle all over again. So we’ve shown that the reserve needs at your association go up and then down over the years depending on the timing of your reserves projects. Your needs are not the total cost of your reserve components. Now, due to inflation, your reserve needs will generally trend upwards, but you understand that it’ll go up and down. There will be up years as you get big projects, and then down years when you accomplish big projects. So that’s a pretty simple calculation done by your reserve study provider. In your reserve study, just the fractional age of every component multiplied by the current cost total of all those individual calculations is called the fully funded balance. Let’s take a look at what that looks like. So right here, I put in another column on the component list table over on the right the fully funded balance column, that’s the calculation of the current reserve needs of the association. The highlighted row shows what we did for pool furniture. Since it’s fully deteriorated, you need the full amount in reserves now. Same is true for the pool resurface. One and $10,000 project is halfway deteriorated. The fully funded balance is $5,000 pretty straightforward math here. When you add them all together, you get the fully funded balance total for the property this year. Remember, this calculation is going to change each year. The fully funded balance is $154,100 that’s the amount of deterioration at the Association this year, that’s the ideal amount to have in reserves. If you had that much in reserves, you would feel good. Okay, so let’s talk about connecting this calculated target to your actual reserve balance. Okay, once we have a target, you can compare your reserve fund to that target. You have an ideal and you have reality and gain. Seeing from comparing those two as you can see in the graphic, we’re balancing them, how does your cash compare to the needs of your association? That’s what tells you if your reserves are strong, fair or weak. That’s another calculation that’s done in your reserve study, and that comparison between your current cash and your fully funded balance is called the percent funded. All right, let’s go back to this component list, a fully funded balance of $154,000 if you had $308,000 in reserve, you’ve learned that your reserve fund is twice as big as your current amount of deterioration, meaning 200% funded. On the other hand, if you only have $77,000 in reserve. You know now that you are 50% funded, you now have a point of comparison to learn if your reserve fund is bigger than or smaller than this important comparison point, okay, but what does that mean to you? Now we’re getting into the answer of how we can learn if your reserves are strong, fair or weak, it’s all about your percent funded, which is a good indicator of special assessment risk, meaning, how often do associations who don’t have enough cash to do their reserve projects run into a special assessment? That’s what you want to know, and that’s what percent funded tells you. It’s a powerful risk indicator. Just like with your own health, you care about things like your weight, cholesterol, blood pressure. These are all things that factor into your risk. Your percent funded is low. So the left side of the chart, in red, for those in the zero to 30% funded range, you have around a 50% chance of needing a special assessment to pay for your scheduled reserve projects because you simply don’t have enough money on hand. You don’t have enough on the right in the green range for associations at or above 70% funded, special assessments are rare. That means associations above 70% have enough they have enough reserves to do their projects on time. That board can feel comfortable that the reserves are strong. Now we have to figure out where is your association again, percent funded should be a number calculated in your reserve study, like a grade in school, it’s nice to score near 100% now the metaphor is not perfect, because unlike in school, a score of 75% is still pretty good. Unlike a perfect score of 100 of school, there’s also plenty of association with a percent funded. It actually goes above 100% so first homework assignment after today’s webinar, is to go check your latest reserve study, find out your percent funded. Find out what range you were in. Are you in the zero to 30% or the weak range, or the 30% to 70% fair range, or above 70% strong range? This is not about your cash balance. It’s about your fit. It’s about how well the cash you have on hand fits the needs of your association at this current time, it’s important for the board and the owners, and knowing the reserves and strengths also helps managers understand the pressures the association is feeling, and importantly, outside parties like real estate agents, lending agents, can learn if the association is prepared for the future or if a new owner is going to be needing to face a special assessment in the near future. Okay, so this is a national profile of reserve fund strength. Many people tend to be surprised when they see this. They maybe they think that there should be more associations in the strong range, or there maybe they’re surprised of how many associations are in the weak range. But these are the numbers. 34% of associations are in the weak range. 40% enter into the fair range, where special assessments are pretty infrequent, and then the final 26% are in the strong range, where special assessments are very rare. The point I’ll make in the next section is now that you know where your association stands. Let’s create a multi year plan to make sure you have enough cash to pay your bills, and for many of us, getting on a plan to gradually strengthen our reserve fund and lowering the chance of a special assessment at your association, well, that’s

Robert Nordlund 13:51
great Mark. Thanks for guiding us through that, showing us how some simple calculations really reveal the fit if your reserve funds on hand really get the needs of your association at this time. Well, now that we’ve learned all about how to measure your reserve fund strength, let’s turn to the next topic, funding reserves. Mark, back to you.

Mark Bradley 14:11
Thank you, Robert. All right, let’s do big picture, remembering that deterioration is happening and it’s expensive, nothing you can do to stop it or to avoid it, but it is predictable, so that makes it very similar to any other bill that the association needs to pay. We look around the industry, associations address the cost of ongoing deterioration in one of four ways, budgeted transfers. That is your regular contributions, your excuse me, distributions into your reserve fund, catch up, special assessments, loans or net loss from declining property values. What I’ll focus on for the next few minutes is the least expensive way, and fairest way to pay the cost of reserve deterioration, and that’s budgeted transfers, not calling them contributions. There’s nothing. Voluntary about them. The cost of reserve deterioration is real and predictable. You ignore this cost at your own peril. Reserve deterioration, it’s real, just like any other bill that your association is going to face. Now, just like the reserve study provider did some calculations to find the percent funded, there’s some more calculations to figure out the path forward into the future, but it’s a little different. Calculations done to measure your reserve fund needs, your fully flood, your fully funded balance and your percent funded are different from the funding calculations your reserve provider are going to do to figure out what’s needed to get successfully towards the future. Main difference between the two is that the reserve fund strength is a current calculation, so it uses current costs. Funding plan calculations deal with costs many years into the future. So funding plan calculations typically are going to start incorporating our interest of inflation. Reserve Fund strength reveals where your association is now, and reserve funding affects the kind of future you’ll have at the Association. I want to suggest that they’re related, and I want to pose an important question, what is the purpose of this year’s reserve funding? Why should I pay for reserve funding this year, for the here and now or for the future? Give it a moment. Maybe you can figure out between one or the other. It’s important to understand that the reserve funding you’re doing now pays for the monthly bill of ongoing deterioration if you pay it on an ongoing monthly basis, it stays small. Doesn’t grow into a big, special assessment that a new owner will need to pay for the deterioration which occurred while the previous owner owned the home at the association. Everyone needs to be paying their fair share along the way. The actual payout to perform the project is going to be in the future, but the deterioration is ongoing, daily occurrence. Right now, reserve funding this year offsets this year’s deterioration. And if this year’s funding offsets this year’s deterioration, and next year’s funding offsets next year’s deterioration, the future is smooth and practically takes care of itself. If you do it this way, the owners are paying their fair share for ongoing deterioration through budgeted funding, as long as they are in the association, reducing our risk of special assessment. Everyone pays their own way, and this is really important to communicate to your homeowners. They’re not setting funds aside for other owners in the future. This year’s reserve funding pays for this year’s deterioration. It’s as simple as seeing your reserve funding like you are paying the monthly roof deterioration bill or the asphalt deterioration bill. You’re going to have a lot more success as managers, as board members, communicating with the owners when you help them to understand that reserve obligations in this way, these are present costs that everyone is responsible for in paying their fair share. So little bit of change gears. Stay with me. I’m going to talk about swimming. You’ve probably seen the swimming races on television where there’s the world record pace has shown. You can see the swimmers trying to keep up, and it’s just like the reserves at your association, your assets are all deteriorating at a noble, predictable pace. Question is if you’re keeping up or falling behind. Remember that your percent funded tells you where you are in the race, ahead or behind. Your rate of reserve funding will tell you if you’re great, gaining ground or losing Okay, here’s how it works. This chart shows the same components we’ve seen before. But instead of calculating the fully funded balance over on the right, let’s do a different calculation. Let’s do the deterioration rate. Here. We’ve labeled it the cost over year column. You divide the cost by the useful life, you get the annual cost of deterioration per year. It’s easy to see in the second line, the pool resurface again, $10,000 over 10 years, it’s deteriorating at a rate of $1,000 a year. Another easy one, let’s look down at this asphalt seal. It’s a $5,000 expense every five years. So it’s deteriorating at the rate of $1,000 a year. You can do that same calculation for all these components. Then just add up the total. You get 20,000 $170 a year. Your reserve funding is going to be need. You only need to be pretty close to this value. This is the association’s pace line, 20,000 $170 a year. When I showed you the slide of the swimmers in the pool with the pace line, this is what I’m talking about, ongoing deterioration that your association needs to keep pace with. Okay, I’m going to use this graph to begin showing you how your reserve fund strength is related to your reserve funding rate. I’m going to plot reserve fund strength over time, time left to right here, and as we talked about earlier, strong reserve fund, over 70% funded. It’s in a green range at the top of the of your screen, weak or underfunded reserve fund, zero to 30% funded range that’s in the right at the bottom of your screen, the 100% funding level is indicated by the arrow here. All right, let’s try and figure out what different funding rates are going to do for our sample association. So typical Association, they’re starting at about 50% funded again for this. Look at the example. We’re ignoring interest in inflation. Just to keep it simple, let’s presume they’re funding reserves at the 20,001 70 a year. They’re matching the deterioration rate, which we just calculated. Funding the reserves at that rate is going to keep up with deterioration, but it’s not going to cause the reserve fund to gain or lose strength over the years, just kind of bouncing around as the fully funded balance goes up and down over the years. This association is essentially just keeping up with deterioration that is going on at their association, like in the swimming pool we saw. You’re not catching up, but they’re not falling farther behind. Okay? You see where I’m going, right? If an association wants or needs to strengthen their reserves per capita, because they find out they’re in a precarious situation with very little reserves on hand, they’re going to have to step on the gas. They’re going to have to fund reserves at a rate higher than 20,170 a year. Total effect will be that the percent funded is going to trend upward over the years. It’s lowering their risk of special assessments. Associations with a weak reserve fund, need to fund more than their pace rate in order to prepare, prepare financially for significant expenses, or worst case scenario, a bunch of significant expenses that hit at the same time. Ultimately, we’re just trying to avoid an upcoming special assessment. You can imagine that there are special assessment sharks swimming behind you, down in that red area. If you slow down, you’re going to get bit. It’s in everyone’s best interest to distance yourselves from those special assessment sharks. Okay, here’s what happens if you fund reserves less than the rate of deterioration your reserve fund drops in net strength over the years as your reserve fund falls farther and farther behind the amount of deterioration at your associations. Associations that do this are going to increase their risk of reserve related problems, getting closer and closer to those sharks of special assessment. Many associations have been doing this for years, underfunding reserves, allowing the reserve projects to get closer and closer. They’re not building their reserve fund. They’re only focused on keeping assessments low, and these reserve funds are coming up and they’re not prepared financially. These associations have just been kicking the problem down the road, pushing that problems onto the shoulders of future owners, and it’s saddling them with a special assessment or deteriorated assets that are going to reduce property values. Okay, let’s boil it down. If you learn your reserves are weak and you need to be doing some catching up to prepare for upcoming expenses, you need to step on the gas. It’s going to be expensive. Raising your reserve funding requirements, it means making up for years of underfunding. But if your reserves are currently strong, you don’t need to be moving on the accelerator. Your reserve funding requirements are actually going to be lower. All you have to do is keep pace with the deterioration. In that case, often people are going to make mistakes of thinking that having a strong reserve fund costs them more money. It’s not correct. The costs are fixed. The only choice is how you pay for them, through budgeted reserve transfers or special assessment. It deterioration is happening, and it’s going to be the same cost. Little perspective, no matter what type of association, we do find that reserve funding typically needs to be in the range of about 20% of your total budget. This is just to offset your deterioration. Some associations need more. Some association needs less, which is why it’s important to have a good reserve study. But for the purposes of this conversation, 25% is a good ballpark number. So if your reserve funding is much less than 25% of your total budget, there’s a good chance you are underfunding your reserves, and your reserve fund strength is dropping, and you’re getting closer and closer to the special assessment sharks. Okay, homework assignment number two, compare your current reserve funding rate to your total assessments. See how much of your total budget is actually going towards reserves. Okay? Sometimes you don’t need a reserve study to look to understand what underfunding looks like. If your association is beginning to look like this, it’s likely because you haven’t set enough side set aside enough reserves. In the past, you don’t have the cash to take care of the property. That is the most expensive way to pay for underfunding reserves. When sales prices for homes in your association fall behind the associations in your area that are better maintained and more attractive to home buyers. Deterioration affects home values way more than the cost of reserve funding. This is just a funny little cartoon. Real estate agents just doing their best showing the association to some prospective buyers. The buyers aren’t going to pay top dollar to become a member at this association, so you have to do what you need to do. If that means raising assessments. That’s what’s required. Your property values are going to be are going to rebound, and they’re going to return that reserve funding. And more.

Robert Nordlund 24:31
Asked you Mark Well, you got me in about the sharks in the water and that red zone blood in the water from all the sharks nipping at your feet. Great way of making it very clear that being in that zero to 30% funded zone is a bad place to be. Well, now it’s time to wrap up today’s program and summarize the lessons we’ve learned today about calculating reserve funds strength and also calculating the ongoing cost of deterioration at your association. Now there’s lots more to find. Like, which goal is your association best, and that has you with how much tolerance you have for the risk of special assessments, how much margin you want or need for the uncertainties of the future, basically how far above that red zone you want to be. And ultimately, hey, we didn’t address the different multi year funding plan calculation method, component and cash flow. They’re also called straight line and cooled. And then another factor is what that multi year funding plan could actually look like over the years, if it’s a plan based on gradually increasing reserve funding over the years, which is case A, gradually decreasing reserve funding over the years, which is case B or a flat rate over the years, which you see in example C here. And the good thing is both the copies will address in our next program called reserve stage 103 in early April, and then after that, in late April, will be a brand new program called Engaging homeowners how to communicate the importance of reserve funding, and then we’ll follow that in May with a reserve say, program designed for managers, helping those managers follow what we call the reserve say, roadmap forward towards the future. So make sure you’re on our email list to get the notice when registration opens for those dates, just scroll down to the bottom of any page on our website or sign up link and our website, as a reminder, is www reserve study.com you can also click a link on our home page up in the top right to get a free reserve study proposal for your association to get Association reserves on your side, helping you get to an improved future. Also on our website, we have a deep library of additional written and video resources where you can go straight to our YouTube channel for even more videos on reserves, full length webinars or edited shorts on specific topics. And if you’re a board member, like so many of you are, or hopefully will be, got some interested homeowners here. Also, we have a great new resource called common sense for common areas. It’s our weekly 30 minute podcast, and it features guest experts and regularly featured once a month, board member heroes and so on a weekly basis, 30 minutes at a time, the podcast equips you and encourages you of the hard work you do leading your association forward. Just sign up on your favorite podcast platform or go to the podcast website at HOA insights.org, as you see down at the bottom of the screen. And we also have a book available to help with your planning decisions called Understanding reserves. It’s designed to be an easy desktop reference, reference summarizing components, funding, all the things we covered today, and some helpful hints on communicating with your homeowners. There’s a link to a free download of chapter one on our website, and I’ll include that link in the outline of today’s program, and I’ve got a couple of books here on my desk. I’d love to get out to someone who asks an interesting question here today. Well, I hope Mark and I have left you feeling more comfortable understanding how your reserve fund size is calculated and measured, and how the ongoing deterioration of your reserve components are again calculated and measured. This is not just feelings. Here. We want you to make informed, wise decisions for the future of your association, understanding where you stand and able to plan wisely for the very predictable, ongoing deterioration bill that your association faces every month.