Reserve Studies 103: The Funding Plan (2025)

Robert Nordlund 0:07
Today’s curriculum is reserve studies, 103, so Wayne and I are here to help you understand your reserve funding plan, and we’ll show you it’s a financial journey with some things out of your control and some things in your control, you’re the one that needs to be making properly sized reserve transfers in order to prepare for the large upcoming reserve project at your association. So you can get those projects accomplished on time. Doing your reserve projects on time will minimize the higher reserve funding needed when you have deferred maintenance. And what we find is reserve projects are already expensive enough, so having the cash on hand to do reserve projects on time will also maximize owner pride of ownership, and it will also maximize property values. So today we’re going to show you how to make those wise decisions, and this is the outline we’re going to use today to talk about reserve funding. At its simplest, it’s just the cash necessary to offset ongoing deterioration. A hotel charges a daily rate. So the funds exist so that Re Roofing, re carpeting and repainting all get done on schedule without having to special assess unlucky guests checking in the week before the carpeting needs to be replaced. And it’s the same everywhere else, rental cars, apartments, health clubs, they all collect enough funds on an ongoing basis to sustain their assets or facilities. This is not a new concept, so you should be budgeting to collect sufficient cash on an ongoing basis to do all your scheduled projects in a timely manner. During today’s program, we’re going to help you see how that’s done. Reserves are important, because if you have roofing or asphalt or even just gates or a tot lot, you’re going to have reserve expenses. Everything deteriorates. Reserve expenses are, by definition, too big to absorb into the ongoing operational budget. Typically, they are huge. Our job as a reserve site provider is to guide you so that you know how much to set aside. So when the time comes to perform the project, the funds exist. This means funding on an ongoing basis, during the time your components are gradually deteriorating. So we figured we’d start out with a pro tip right here at the beginning, making it clear that ongoing reserve funding is not an additional cost, making life at the association more expensive. The roof is going to fail and likely right on schedule, in plain sight, and it will be expensive. Your choice is if the homeowners at your association set aside a little bit of money each month over the 20 or so years, the roof serves the association, offsetting that ongoing, steady deterioration, or if your homeowners pay for it all at once in a special assessment, when the roof fails, it’s the same cost. Either way, there is no escaping the cost. So reserve funding is not an additional cost. It’s just a different way to pay the same cost of deterioration. Now it’s fiscally responsible to tell your owners the true cost of ownership along the way, like a hotel does, rather than bumping along from one unwanted and unfair special assessment to another, giving your owners false and unrealistic expectations that low monthly assessments will be all it costs to be a member of the association, this is just going to set them up to complain as they should each time there’s a special assessment for a eminently predictable expense. So why not just have them pay the true cost of ownership on an ongoing basis, running a smooth financial operation? So today you’ll see that Wayne and I call them reserve funding obligations or a reserve funding recommendation, they’re not contributions. There’s nothing optional about reserve funding. Your assets are deteriorating, and the board is responsible to budget to maintain the assets of the association. Look at it, you’ll see it there in your governing documents, just as you have a water bill or a management bill each month, the roof and the asphalt are all deteriorating each month. Those deterioration bills are bills just like every other bill that you need to pay. They’re real, and if you ignore them, they don’t go away. They just accumulate. So on to the next portion of today’s webinar. What are we shooting for? What’s our objective here? Well, it’s important to start with a big picture. The board’s responsible to maintain the property, the common areas, that’s usually very clearly stated in the governing documents, doing that yields owner enjoyment and maximize property values. Both are very good things, and national reserves a standards guide us down this path, clearly stating. Four funding principles to follow in creating reserve funding plan. As you can see on the screen, we’re here to create a plan with sufficient cash to do all the required projects, budget stability from year to year, so your owners have an accurate expectation for what it costs to own a home in the association, and equitable distribution over the owners over the years, so everyone’s paying their fair share and the plan that is fiscally responsible. And anytime you see this little gold icon with the blue ribbons on it, that’s National Reserve say standards. So that tells you what, where the origin is for that principle that we’re showing in the slide. So if you were to look around, the most common reserve funding goal in the country is either minimizing assessments or just doing what we did last year, and neither of these choices are going to get you successfully to the future. So I’m glad you joined us here today for our webinar. We all know the power bills go up, janitorial and landscaping services get more expensive. Insurance is going way up, and with tariffs and inflation, other costs, roof replacements, carpet replacements, fence replacements, boiler replacements, everything all around you, they’re all getting more expensive inflation and the other economic factors we live in are real. And so each year, those big repair and replacement projects get closer, giving you less time to prepare financially. So you should expect your homeowner assessments need to go up from a year to year to year basis. Those assessments, that’s the income there. So you can pay the association bills. So we want you to set them up appropriately, and now we’re going to turn the page. So Wayne, now with the table all set, what does affect the size of our reserve funding recommendations?

Wayne Johnson 6:50
Thanks a lot, Robert. I’m glad to be here with you and our audience today. We’re here to talk about how much is required to fund reserves at your association. It usually seems like reserve funding recommendations are a lot of money, but owning real estate is expensive. Asphalt is expensive, elevators are expensive. Really, the key to minimizing your reserve funding needs is to spread the cost out nice and small over time. There are four factors that affect the size of your reserve funding recommendation. First is the components, the physical assets you’re responsible for maintaining. Second is your physical starting point. I mean financial starting point. Is it strong or weak? Third, how much margin for unexpected special assessments suits your association? And finally, even the calculation method used by whoever is calculating your reserve study makes a big difference. These four things are what I’ll be covering in the next few minutes regarding the component list. Obviously some associations have more or less common areas, and some have more expensive types of common areas than others, so the cost of maintaining and repairing the common areas will be different for each Association. It’s all summarized in your reserve component list that will look something like this. If you missed it. We discussed reserve component selection in detail in our reserve studies, 101 webinar, and it’s available on our website or on YouTube. Then we teach about the unavoidable ongoing cost of your component deterioration, and that’s mentioned in our reserve studies. 102 webinar, the ongoing cost of deterioration is a fact of life at your association due to construction style, types of amenities and level of maintenance, like our reserve studies, 101 program, it’s also available on our website and on YouTube. Second is your starting point, the size of your reserve fund at this time. Do you know if your reserve fund is strong, fair or weak? Your reserve funding requirements will be different. If your reserve fund is strong and you can coast along in good shape, or if your reserves are weak, and you’re going to have to hustle to gather some money together for an upcoming project, calculating your fully funded balance on the basis of your component list, and learning is the first step. Then you compare your reserve fund to that fully funded balance to learn your percent funded which reveals your reserves, if your reserves are strong or weak. That’s another topic we cover in our reserve studies, 102 webinar. Again, if you missed it, you can find that on our website or on YouTube. Third is how much margin for the unexpected is right for your association. That has to do with the size of major products, projects in your Association’s future, and how close or far away they are. Again, it’s based on your component list. This chart shows the anticipated projects from that sample component list I showed moments ago. So the question about margin has to do with how well prepared you want your association to be for these anticipated future expenses. Do you want to just barely have enough cash on to be able to pay to get these projects? Done or like the green line, do you want a little bit of margin on hand in case these projects occur a little early or a little more than you expected? Some margin is good. The question here is, how much extra Do you want to have on hand to prevent special assessments? That’s another foundational topic that we cover in more detail on our reserve studies, 102 webinar, this choice is described by your funding goal. If you’re pursuing full funding, threshold funding, or just baseline funding. In this chart, the blue bars show fully funded ballots through the years, the amount of deterioration at the association in each of these years. The red line near the bottom shows where it looks like pursuing a baseline funding goal, just barely providing enough cash through the years to keep the reserve balance barely positive. And this chart highlights the green line where the association is pursuing a fully funded balance target. The Association will have more cash on hand through the years to handle the unexpected. Now you might want to ask yourself, why would any association want to sit on a bunch of cash? And that’s really a good question. The reason why is shown here associations pursuing a baseline funding goal have less cash on hand. So with a low percent funded on the left side of the chart, they much more commonly experience special assessments because if we’re honest about what we’ve learned in life, nothing ever goes exactly according to plan associations pursuing a threshold funding goal. Somewhere in the middle of baseline funding and full funding in the yellow middle section of the chart, experience special assessments infrequently because they have a little more cash on hand. I hope you’re starting to see that the money in the bank is not just sitting unused. It is reducing the chance of owners getting hit with a special assessment because they kept their reserve fund too lean, giving back the to the association all that they thought they had saved. And look here at the green portion of the chart on the right side of the screen, associations pursuing a full funding goal rarely have special assessments, almost 0% of the time. And that’s the value of having more cash on hand. It’s there to be spent for the projects at the association that need to be to get done that otherwise could cause special assessments. It’s not money sitting idle in the bank. We recommend full funding because we don’t want our clients suffering from unavoidable or from avoidable special assessments. And how much does this cost? Full funding reserve transfers are typically 10 to 20% higher than baseline funding reserve transfers. Again, it doesn’t result in money sitting in the bank unused. It means fewer disruptive special assessments that would take money from the homeowners, because the association slowly and gradually collected a little bit more each month, enough to pay the cost of repairing and replacing the association’s common area components. This is one of the areas where you get to make a choice. The fourth factor is the mathematical calculation tool used for crafting the plan. There are two, the component method and the cash flow method. And making a wise choice is very important. Usually, this choice is made by your reserve study professional between the component method, also called the straight line and the cash flow method also called fooled. The cash flow method is the clear winner. Very simply, it is more flexible and more advantageous to the association. The funding profile over the years can be crafted to maximize smoothness and fairness to the owners, and it also is easily adjusted to provide more or less funding margin, as I spoke about a moment ago. But sometimes an association volunteer will just go down a path using one or the other, not really appreciating what they’re doing. I’ll show you in the next few slides how the choice of which tool is used is often very significant, and it affects the size of your associations calculated reserve funding needs. Let me start by describing the component method. Why would anyone use this? This topic is significant primarily to associations in Florida and New Jersey, where state law points associations in this direction. This is also significant for individuals building their own reserve funding plans on a spreadsheet, because the component method is very simple. Just do a calculation for each component, one at a time, and sum it up at the bottom of the list. So the component method is kind of an up and down way to calculate reserve funding requirements. Let me walk you through it. Let’s take a second component. Take the second component from that list, pool resurfacing. It’s a $10,000 project that needs to be done every 10 years. With that in mind, when the pool is new. And without complicating this illustration with interest or inflation, you have 10 years to collect 10,000 Dollars. So your reserve funding requirements are $10,000 divided by 10 years, or $1,000 per year. That’s pretty simple. But if the association doesn’t make all its budgeted reserve transfers and gets to the five year old point halfway to when it needs to be replaced, but only has $2,500 set aside, instead of $5,000 then the association has five years to fund the remaining $7,500 needed to prepare for this $10,000 expense. That’s $7,500

over five years. So now the reserve fund funding needs for this component are $1,500 a year. In other words, getting a little behind our reserve funding has made the reserve funding requirement for the remaining years much higher. They are clearly in catch up mode. Now let’s let the association get a few more years down the road. Their pool reserve has grown to $6,000 but now they only have two years until they need the $10,000 to resurface the pool. So they need to collect the remaining $4,000 in the last two years, or $2,000 per year their reserve funding. Funds are now now need to be twice what they would have needed to collect if they’d been setting aside reserves responsibly through the years. This is what I was talking about a few moments ago, about the importance of your starting reserve fund strength. But let’s say they are able to collect the necessary necessary funds, and so the project gets done, then their cycle is reset and they’re back to having 10 years to collect the next $10,000 to replace it again. That, of course, means their reserve funding needs for this component drop back down to $1,000 a year. This is an opportunity for the board to enjoy learning their reserve funding requirements have dropped. This little example illustrates the problems with the component method of funding. Their boards find that if they get behind the funding requirement begins to climb up pretty steeply, but if it drops down again right after the expense, then you have a full useful life cycle to prepare for the next project. Funding plans calculated with the component method, where each components reserve funding requirement is calculated separately, tend to be high in the first few catch up years dropping as the project gets accomplished. This is the shock many associations face when starting a reserve funding plan using the component method. They face their highest costs right in the first few years in the cash flow method. All we care about are the expenses per year, not line items. So we look at the annual cash needs of the association and design a multi year funding plan that smoothly provides for the projected experience that’s expenses. It’s a matter of looking at the needs of the association from left to right, not up and down. You design or create a funding plan that provides the desired amount of margin or protection from special assessments desired by the association. So remember that we’re dealing with exactly the same expenses. The component method looks at projects one at a time from top of the list to the bottom, while the cash flow method deals with exactly the same expenses, just looking at them one year to the next, left to right. And when you do that, you can create a funding plan that is smooth over the years, gradually floating upward, upwards with inflation. If you remember the four funding principles Robert showed at the beginning, this type of funding plan very nicely meets the equitable distribution funding principle. This is possible because your focus is on the annual cash needs, not individual component needs. In the cash flow method, all expenses share one reserve fund, so there’s never a rush in the last year’s last few years to of the components life, reserve income and reserve expenses can be smoothly balanced through the years, because all the reserve funding goes into the pool and all the expenditures come out from that same pool, a lot of sharing and no rushing. This means reserve funds can be used more efficiently than being divided up into all those separate different accounts where each component stood on its own. When I show them side by side, it’s pretty clear the same net funds go into the reserves over the years. Remember, they pay for the for exactly the same expenses over the years. It’s just that the cash flow method doesn’t force associations to pay a steep price in the first few years to rapidly resolve any underfunding. So in either method, the same total amount goes into reserves, but the cash flow method is and always will be a more efficient use of the associations reserves, and will always be more favorable to the vast majority of associations in the country that find themselves in at least somewhat of an under. Funded situation, the cash flow method makes life in an underfunded association so much more palatable. What’s important to note is that initial year funding requirements calculated with the component method are regularly about twice as much as funding requirements calculated by the cash flow method. That’s why we so clearly state that it’s best to avoid the component method. Reserve professionals across the country try to avoid that. If you’re calculating your own reserve funding requirements by the component method, where each component reserve needs are funded individually, you should stop doing that. Hire a reserve study professional and let them create a smoother funding profile for your association using the cash flow methodology that doesn’t punish your homeowner so severely in the first years of the plan.

Robert Nordlund 20:51
Fantastic. Wayne, I love hearing you talk through that that’s so plain and easy to understand. And the other good thing is you didn’t ask anyone to pull out a calculator. So let me spend just a few minutes here drawing this program to a conclusion. Indeed, this is all we do here at Association reserves, day after day, guiding our board and manager clients down the trail towards the future, recommending funding plans that answer the question, what do I do now? Having an association reserves project manager on your team means that you have someone familiar with the tools, methods and influencing factors, someone who sees the multi year perspective, and someone who can design a funding plan that’s just right for your association. Remember, deterioration is real and ongoing. There’s nothing you can do to stop it, the ongoing deterioration of the components you’re responsible to maintain and your starting reserve cash balance define your reserve funding starting point. From there, you have some flexibility about how much margin your reserve professional will select and which funding method is used for your association, but that combination of components, starting point, amount of margin and funding methodology all mean that the funding for one association might be very different from another, physically similar Association. There’s no magic solution to lowering your reserve funding needs or trying to match a similar Association in your city or area of town, deterioration is real and expensive. I think Wayne said it earlier. Owning and maintaining real estate is expensive. The best thing you can do, like Wayne said at the start of his section, is to spread it out, thin and evenly over as many years as possible. If you’re not funding your reserves adequately, you’ll soon run your association right into an unwelcome trip to what we call special assessment land. And in the big picture, looking at the funding data from 1000s of our clients in all 50 states, most associations find they need to plan on setting aside between 15 and 40% of their total budget towards reserves. Many associations find their just right amount of reserve funding to be at about the 25% point of their total budget, like we show here in this pie chart. So it’s a significant portion of your annual budget, likely one of your largest budget line items. And even though that might seem like a big number, you may be doing some mental math in your heads, looking at your monthly assessments, and thinking, what’s a quarter of that? And then dividing by 30 days, I’ll argue that reserve funding is not too expensive for the average condo owner. It boils down to just a few dollars a day, and that’s about the cost of a premium cup of coffee. And remember, that little bit more per day or per month doesn’t increase the homeowners cost of ownership. It just means that homeowners are paying the true cost of ownership at the Association on an ongoing basis, instead of with those unwelcome catch up special assessments every few years, underfunding reserves is always going to catch up with you. You can’t fool Mother Nature and Father Time. So to book in this presentation, I’ll end with another pro tip for you at your next board or budget meeting when you’re discussing reserve funding. When you do discuss reserve funding, don’t describe it as contributions or for the future or for a rainy day. That makes it sound like something you can defer, or maybe a problem for someone else out in the future. When you discuss reserve funding, remember, it’s a bill, just like any other bill, reserve funding pays the ongoing deterioration bill. It’s just part of the true cost of home ownership in your association, and just remember what you’re trying to accomplish, providing for the predictable needs of your association, to stabilize the budget where every owner pays their fair share over time, so that you. And maintain the property and maximize property values. And when you do that as a board member, you maximize owner enjoyment, keep your complaints down and keep your liability exposure to a minimum. Well, Wayne and I want to personally thank you for joining us today for this webinar and point you to a few additional resources. So if you go to our website, www reserve study.com you’ll find written and video resources under our surprisingly enough resources tab and on our website, if you’d like us to help your association, by all means, click the Request a proposal link at the top right of our home page. And if you search for our reserve study videos on YouTube, consider giving them a like and subscribing to our channel, or to have something on your desk or bookcase that summarizes major reserve study concepts, like the funding we address today. If you want to have something a little more tangible, something you can see on page after page after page, consider ordering our book understanding reserves. You can download chapter one for free from our website to get a taste of what it’s like. And if you like what you see, get a copy by ordering from Amazon. I have a copy here at my desk that I’ll sign and send to someone who asks an interesting question during our Q and A time on the program. And remember, perhaps one of our best resources, our online reserve calculator, called uPlanit. It allows you to test different funding plans and different expenses, different interest rates, different inflation rates, so you can see, if you like, what happens, and make informed adjustments to whatever was contained in your professional reserve recommendation. It’s all cash flow methodology, so it’s an optimum tool for your association. Access is free with every professional reserve study from Association reserves and another great resource for our board member audience, it’s our weekly 30 minute podcast just for you. It’s called HOA insights, common sense for common areas. Monday this week, we dropped our 100th episode, and it’s full of guest experts current issues, and once a month we feature a board hero. So join us at HOAinsights.org, or by subscribing from your favorite podcast platform.