Reserve Study Basics (2024)

Robert Nordlund 0:07
Thank you everyone for joining me today, reserved funding should be one of an Association’s largest budget line items. But all too many boards think reserve funding is optional. And that creates a problem for the sustainability of the association. We designed this webinar to give you a clearer understanding of the challenges facing your association, wanting out what is in a reserve study, and how it can help your association. We also want to give you some key takeaways at the end to help you make sure you have enough reserves to be able to accomplish your necessary repair and replacement projects in a timely manner. So you can take good care of your association. And that’s what we’re defining as success. So let’s jump right into today’s content, on reserve study basics. We’re going to start with an understanding of the challenge, and then your Association’s role in addressing that challenge. And then we’ll talk about actual reserve study issues before bringing the program to conclusion. And you start with a explanation or a reminder that living in community is a division of two things, something or someone needs to define what and how it all works. And so there’s some things that belong to the association, which is the common areas, everyone owns that together in aggregate, and the board controls the maintenance and repairs and replacements of those things. And some things belong to individual owners. And so there’s that interesting combination in that mixture of who is doing what and the challenges, get gets involved with those interfaces. But it boils down to the board responsible to take care of the common areas, for the benefit of individual owners, they don’t have that power, they don’t have that, right, they’re relying on the board to take care of all the common areas that surround their individual space. And that means the board needs to be diligent. And that’s true, because all the common areas are in a constant state of deterioration. If a board gets casual, and start starts not paying attention, they’re going to get caught behind all the assets of the Association wants renew, then they inevitably get old and worn out. And that’s just a fact of life on this planet. Mother Nature and Father Time are undefeated, and they don’t negotiate. And that ongoing deterioration creates a cost, because everything needs to get repaired or replaced. It’s then up to the board to set a budget that keeps up with that ongoing cost of deterioration. So I want to be clear that reserve funding is driven by the ongoing cost of deterioration. reserve funding is not caused by reserve studies. It’s not caused by an overly conservative board. It’s not caused by state laws. It’s not caused by Fannie Mae or Freddie Mac, the need for reserve funding is driven by deterioration. And again, the board has no control over those costs. They are deterioration driven. But the board does have a choice about how to deal with those costs. They can ignore them, which leads to deterioration conflict in leads to declining home values, many things all because the association won’t have the money they need at the right time to keep things in good repair. So they can just ignore that reality that deterioration is happening, or they can budget funding to offset the ongoing cost of deterioration. That’s the choice. So there’s no choice in are the costs going to occur or not. The choice is in how to fund this very predictable cost. And there’s three parties involved. There’s the board that you see on the left, and making decisions, doing their best to move the association forward. There’s the manager in many cases, a professional who guides coaches gives their years of experience to recommend how things should be done. And then there’s the homeowners on the right. And they’re the ones who have the responsibility to pay for their ongoing assessments. And they are the ones who actually get to enjoy the maximized home values when things are done well. So what we’re dealing with are associations, entities that are truly multimillion dollar not for profit, real estate organizations, and they are relying on good decisions made by an untrained volunteer board of directors to run the physical and financial The operation of the association. And so you wonder why associations have challenges? And sarcastically, you can ask yourself What could possibly go wrong of big organizations relying on untrained volunteers? And clearly, there’s opportunities for things to go really well, what does happen? Classically, associations tend to run themselves out of money. And that’s because they’re budgeting optimistically, they’re reluctant to address the true cost of homeownership sounds like a lot of money, I don’t want to do that, that’ll raise the assessments, you know, just that anxiety over and I should I do this, and that just the concern that they have about what’s going on at the association. And when they run themselves out of money when they’re running low at create special assessments, liking home values, and even the safety concerns like we saw a little over two years ago, with the tragic collapse of champion tower south. And what I want to make clear is that when you don’t have the funds to take good care of the common areas, bad things happen. So keep that in mind can be small, it could be just a special assessment could be that you have to wait for a leaky roof to get repaired. To get on a roofers calendar, you have to deal with an entry gate that have to get on the gate companies scheduled to get that fixed, or it can be something significant, but bad things happen. You don’t have the cash to get things done. All right. So let’s turn on to the next portion of the program. What does your association in particular have to do with and where does it fit into this situation? Well, every association I work with feels like their budget is tight, and that’s rightfully so the board has the power to set the budget. In most cases, sometimes it actually requires a homeowner vote of approval. And that sucks money out of the pockets of every owner, it’s an obligation. And so the board members are rightfully cautious about moving too aggressively in this manner. And also because it’s gonna take money out of their pockets. So traditionally, boards, keep budgets very lean, but bills are built, they need to get paid. If the association is using a service or taking the availability of someone else’s time, they have an obligation to pay for that. If you don’t pay the power bill, it doesn’t go away. It just stays there. When you get paid, the next month doesn’t go away, if ignored. So bills need to be paid. They don’t disappear. If you close your eyes. Generally, boards are pretty good at paying the monthly bills, they arrive on a regular basis for the things the association consumes, whether that’s electricity, water, janitorial services, landscaping, management, whatever it is, every month, those bills arrive, and they need to get paid. And board get on your practice paying these bills 12 times a year. And worse comes worse. If you forget to pay a bill, if you miss the electric bill. It’s actually kind of no big deal. You just are reminded the next month when they say hey, you missed the February bill. It’s still there. And so your bill is about twice as much as it usually is. But again, no big deal because the funds are there. And you say oh, gee, oops, sorry, forgot about that. Here you go. And you’re paid in full.

So when you have the cash, you can get things done. And you’re not subject to the problems of just minor human behavior. But what about reserves? I like this cartoon from the GO gladly.com website, making fun about setting aside funds for future projects. When homeowners legitimately have a short term focus, they’re talking about, why do I care about things 2025 15 or eight years in the future? I’m talking about now, what does this reserve budget have to do with me? And the answer is, the truth is that the roof deteriorates every month. It’s a static entity, it does not send bills. But that cost of deterioration is as real as any other bill. The board doesn’t pay that bill that month. It like that electricity bill just builds up and builds up and builds up until a future point in time when someone else ends up paying the cost of that bill. And that’s what we call a special assessment. Now a reserve study is where you find out how big that monthly bill of deterioration actually is. And that could be the roof that could be the asphalt, the carpet. It’s everything that fits as a reserve component, you learn that monthly cost or that annual cost in your reserve study. And if you choose to ignore it, your association begins to look like this association that was ignoring its perimeter ironwork fence, where this association that was ignoring it The condition of the pool bathroom, or this association that was ignoring the condition of their tennis court deterioration keeps going, it’s an unstoppable force, whether the board confronts it or ignores it, it’s still going to occur. And remember, for the governing documents, the board is responsible to provide for the needs of the association. So they have a legal responsibility to address the cost of deterioration, Mother time and father nature are always going to be mounting the association with deterioration and reserve funding is how a board addresses that challenge. Now, the second cartoon is going to poke fun at an association where the board was ignoring the ongoing cost of deterioration. You see the real estate agent here trying to carefully describe this worn down beaten down Association as rustic and saying, Well, they’re not wasting the association dues on funding reserves. And you can see the couple that are the restrictive buyers, they’re not amused, they’re not least they’re not impressed. You can just imagine what lack of reserve funding does to depress home values. And that’s the choice that I want to make sure you understand here, deterioration is going to occur, the choice is not on the cost side, that choice is on the how do we fund for it? How do we offset that deterioration, that’s the choice. And I want to encourage you to start to think that the $50 A month $100 A month $200 A month of reserve funding, that’s going to be the lever that gives you 1000s of dollars in approved home values. That’s the big win here. So it’s really your choice, you can offset the predictable cost of deterioration and have your 20 or 30, or 40, or 50 year old Association look nice and attractive like this or not, you’re the one who gets to choose. And it’s all about reserve funding, as far as what’s going to be the result at your association. Okay, back to our outline. And now it’s time to dive into our reserves, it helps the board make wise informed decisions about having this ongoing deterioration bill. Now start out with describing that there’s three types of reserves that he’s to start with. And anytime you see this kind of seal on one of our slides, it’s an indication of this is written into national reserve, say standards. So there’s three types of reserve studies. There’s a full reserve study update with site visit, update, no site visit. In a full reserve study, we inventory and evaluate all the assets of the association. Want to find categorizing, evaluating photograph and all those kinds of things with an update with site visit, we still go on site. But it’s a matter of using the the numbers that were used in the full reserves, and we may do some spot checking. But basically, if the asphalt was established as being 100,000 square feet, in the full reserves day, we’re going to presume that the asphalt is still 100,000 square feet in the West Side visit update, you don’t need to hire us to re measure it. And the update, no site visit is the third product, it’s an opportunity to update all your numbers. And I’ll show you what those numbers are a little bit later. Without the additional expense of being on site. That’s a big consideration in the situation like we had the last few years where there was such significant inflation. And why is associations we’re updating the reserve study more regularly, with no site visits, very inexpensive new site visits, reserves that he updates to make sure that they were staying on track. Now, another way to look at this is a full reserve study is typically only done once again, because once you’ve measured things and identified things, and you have 100,000 square feet of asphalt, you have three or stop elevators, you have a boiler on the third floor, you have a 20 foot by 40, foot pool, whatever all the stuff you have that’s been identified, you don’t need to spend the extra time to identify that in the future. Now with the collapse of Chaplain towers out behind us, reserves say standards were updated and best practices very clearly, every three years. You have a with site visit update. And the no site visit update is recommended in the in between years. This is all national reserves a standard concepts. But there’s this other thing that is what we call the root for reserves rules that lie this all together. Remember, the expenses are inevitable. They’re driven by deterioration. And the board remember is responsible for the governing documents to care for those common area assets on behalf of the homeowners. And I want to make sure you understand that delays usually get expensive. If you don’t hate the wood fence On time, then it’s not only going to start to look lousy, it’s going to start to basically deteriorate. And you’re going to end up having some carpentry expensive, that’s classic, or a roof. If you wait, then all of a sudden, it’s going to leak. And you have leak related expenses for the units, the unit interiors. And the fourth rule is that there’s no magic outside, rescue, homeowners always get stuck paying the bills. So this is how it comes together. Boards are responsible, the expenses are always going to happen. They need to be time driven, because delays get expensive. And do it for your homeowners make the decisions that are going to keep the association looking nice, a great place to live and moving forward maximise on values. Okay, another concept that I want to address right up front is that it’s not about the laws came asking if our reserve study or reserve funding is required by the law in your state, that’s really not the point. Board members are responsible for the common areas everywhere. And they’re responsible for the budget everywhere. Now, again, there are some areas where the homeowners get to vote to approve the budget. But the board still needs to do the job of setting the budget and politicking to create a budget that will pass. And remember that mother nature and Father Time are consistently and predictably deteriorating, creating costs that the association needs to bear. So it’s not all about legal compliance, it’s about taking care of your association, the board responsible, and the costs are going to be there. So reserve study planning boils down to three questions about what do I do here? It’s first off, as you see at the top, what are we reserving for? What are our obligations? And then what’s our starting point? Do

we have enough? Knowing what our costs are going to be? Knowing our starting point a strong, weaker fair? And how much do we need to be setting aside? That’s really what reserve planning boils down to. And fortunately, you get three very discreet answers in a reserve study. And we start with a component list component, this is what we call the foundation of every reserve study. It’s where we define okay, what are the obligations that the association has? What condition are they yet? What are those project cost challenges and when are they going to be and the result is a component list table, you may have seen something like this. It’s a description of projects. And we’re not going to call them things we’re going to call them projects. Because you see here, asphalt may have a seal project every five years. But it may also that same asphalt may have a resurface project every 20 years. And then there’s replacement of pool furniture, but it may be only resurfacing of the pool. So think of them as projects, elevator, modernize the guts of it a refurbished this may be carpet replacement, it may be wall painting, it may be the furniture in the elevator lobby. So there’s different elements to these different kinds of projects that are getting done. Ul stands for useful life, it’s the expected life of the that the project will serve the needs of the association. remaining useful life tells us where we are in that lifecycle. Here, the pool furniture needs to replaced now. And what’s its cost $4,600. That’s the estimated current cost for this project. Current costs because later on in the funding plan will inflate these numbers for future years. And we’ll apply interest to the reserve fund in working to make sure that we are getting a matching point with sufficient cash to do these projects in the future. But for the Reserve component list table, this is all shown in current costs. And the question is Will what appears on the Reserve component list? Well, it’s a national standard report test. And this is found in reserves a standards. So you think is that the association’s obligation? And number two, can we predictably see it coming in number three is significant to the association. So I was in property a couple of weeks ago, where they had an office on site. Everything in that office was owned by the management company. So we’re not replacing the desk, the chair, the furniture, the filing cabinet, the computer, the bone, all that stuff. First question is Is the association’s obligation or not? Number two, is it reasonably anticipated? Can we see it coming? If we can see it coming? We should budget for it. If we can’t see it coming. That’s what you want to make sure it’s covered with your insurance insurance. Not just for accidents, reserves are for the things that you can reasonably anticipate and see coming. The things are driven by mother nature and Father Time. And then projects that are a significant cost. You don’t want to be dealing with trivia. Trivia is something that the board and the manager should just take care of reserves is where you plan ahead for a significant cost. Okay, then we ask ourselves, How are we doing? We have $80,000 in reserves or $800,000. In reserves? Is that for our association, a lot, or a little? And that’s a great question. And so we look at it this way we think about and calculate the value of deterioration at the association. And then we then compare that number to the reserve cash, and then you can start to establish, are we in a balanced situation? Do we have enough cash have we been collecting enough cash over time to offset deterioration? Or have we gotten behind. And that’s what you see, with this term called percent funded, it’s a comparison between the assets that we have compared to the deterioration. And when deterioration is a lot more than the association has a weak reserve fund or a more reserve fund. So knowing your percent funded is much more insightful than knowing a cash value because it falls into the poor range of zero to 30%, the fair range 30 to 70%. And the strong or good range above 70% ideal when you have a match between the value of deterioration and the value of cash in the bank. That’s the ideal point, though. 100%, or fully funded level. And let me show you what this means the association, we can plot our special assessment recommendations, against percent funded, so 0% funded, the low or the weak range is on the left, and a strong percent funded is over on the right. And you can see that the risk of special assessment how frequent are special assessment recommendations are, are very high on the left, when the association relatively speaking, has very little cash, they get themselves into a jam. And they’re in a situation where they have projects that they just don’t have the money to afford. And so we need to recommend a special assessments. So high risk of special assessment on the left in the zero to 1010, to 2020 to 30% range. And then a low risk of special assessment out here. Now, this is where we want associations to exist, where they have sufficient cash to take care of their own projects. And so this is the evaluation of your reserve fund. Now, I can tell you that most associations are in this middle rage. It’s the ones on the left that make all the news. And there’s plenty, roughly 28% of associations are over here. In the strong range. There’s plenty of associations in the strong range. All right, so we know what we’re responsible to accomplish that component list. We then have an evaluation of reserve fund strength measured in percent funded so you know where you stand. And the question is now, what do we do? How much do we collect? That’s always going to seem like a lot of money. But I want to encourage you to think about what’s it doing for us, if it’s maximizing home values. This is the smartest investment you can make, again, that 50 100 Couple 100 bucks a month that you set aside toward reserves, is going to have leverage on your home values over 10% increase or effect on your home value. So if you can have a strong reserve fund, that’s where you start making 1000s of dollars on a maximized home value. And that’s when reserve funding starts to sound like trivia. Okay, what we see across the country is that most associations need to be setting aside 15 to 40% of their budget. ords reserves. Typical number is 25%. If you come to me and say, Robert, we’re setting aside $100 of our $400 monthly condo assessments. I’m gonna say you’re you’re in the right ballpark. And that range is 15 to 40%. So think about that. That’s what’s going to define the obligation that the association has, it’s all based on what are the expenses, the ongoing deterioration, typically, it’s amazingly consistent 15 to 40%, is what it’s going to take to offset your ongoing deterioration. Now, that same component list that I showed you a few moments ago, here’s that move furniture in the first year, just a few $1,000 that reserve expenses. The projects are some phased out over time, there’s going to be high expense years and low expense years. The funding plan is designed to provide us steady cash value going into reserves, reserve transfers, so that after a year of big expenses, your cash value will go down. But then there’ll be a couple of years of no reserve projects, so your cash balance in reserves can grow. And this is what reserve funding does revise for the needs of the association over time. After expense, it drops by you have enough time to build it drops again, you build it back up. That’s what reserve funding is all about. But another reality of this world that we live in, is that nothing ever happens exactly according to plan, you need to have some margin on that prior chart, some of those expenses are going to be a little more than expected, some of them are going to occur earlier than expected. So you don’t want to run your plan to a play, you want to make sure you have some margin. And that means there is a lot of value in giving yourself a little bit of extra room here to allow for things that don’t occur exactly according to plan. Now, your reserve state provider is going to recommend this and develop that into your reserve funding plan. But I want to make sure you understand that this is a wise move. They’re not just being overly conservative. things in this world do not always happen exactly according to plan. All right.

Let me bring this in for a landing. And I want to remind you that the theme here is that ongoing deterioration is a force of nature, it can’t deal with it. This is a classic looking old, weathered barn that you see driving down the road. What I want to point out is down here in the left, there’s a brand new townhome development across the street from where this barn is where their buy was open field 10 or 20 years ago, this new townhome association is going to look just like this barn in 3040 50 years, if they don’t take care of it. deterioration is real. And it’s going to mean that your asphalt starts to look like this kind of cars trip and fall hazards like this. And if you’re not taking care of things, you’re going to have to replace the individual steps you’re going to have, if you don’t take care of the metal, it’s going to deteriorate and weak and crumble to the point that it’s unsafe. It’s just this ongoing deterioration is an issue that you need to work with and address. So keys to success, set a budget, and that’s the monthly bills that you receive. And the cost of deterioration that you learn about and your reserve say those are not monthly bills, but they are as real as those other monthly bills, they affect the association, then you budget to collect the funds, and you pay the bills. And that means sending some money to the electric company some money to the water company, and transferring some money to reserves, move the money where it needs to go. And in doing that, when you’re doing that, you minimize special assessments because cash is there to get the projects done on time. Everyone has paid their fair share evenly over the amount of time that you lived at the association, you minimize deferred maintenance, again, because projects can be done, when it needs to get done. And you maximize property values. And the reminder, that’s where the big leverages and that’s where you all make the big benefit in owning a home with that association. So as you’re working with reserve planning, may be a little early in the year here in where we march. For many of you associations that are planning in the summer and fall. Make sure you’re choosing words like the funding needs or your reserve transfers, don’t call them contributions contributions sound like they’re voluntary, and don’t call them for the future or for a rainy day. For emergencies. They’re not there for very bland, predictable costs. And all we’re asking is that the owners offset ongoing deterioration one month at a time when you take care of the present, offsetting deterioration one month at a time, the future takes care of itself. And here’s a picture from a property that I saw that I enjoyed seeing. You can see a parking deck on the left here and tennis court and the building is off to our right. I liked this sign. We all want the structure to be perfect. Please let us know about anything that isn’t right. And the Rhenus hotline there. They’ve this board has enlisted the eyes of the association and enlisted the spirit of the association all its owners to say we are on board here taking nice good care of ourselves. Association, we’re going to have strong owner enjoyment, we’re going to have strong property values, and it’s worth a little bit of our money to do this. They have their eye on the prize. And another sign that we all see is a sign that’s on the window of a new car talks about how much fuel this thing is supposed to burn. And this is a big path binder Armada burns a lot of fuel. But you have this understanding of what you’re up against. And a reserve study helps you understand what you’re up against that your association helps you know, what the ongoing costs will be, to own a home in the association. And I want to encourage you to think if you were doing mental math, when I talked about 25%, being a good fraction of annual assessments to have going towards reserves, maybe you’re thinking, Oh, wow, that’s a long way from where we are. It may take a few years to get to an improved future. I get that work with your reserve study provider, develop a funding plan that works for you, that works within your political constraints, it may stretch the budgets of some of your homeowners, and that’s fine. They’ve lucked out, sneaking by for a few years, it is time to catch up, can’t do anything about the bills, Mother Nature and Father Time are gonna deteriorate everything. But I want to encourage you to think it’s worth the journey. Get a reserve study to guide you where the path is, help you stay on that path as it curves and meanders through the years. With project that happens early Leyshon that’s higher than expected. All those things, but you have a reserve study, and you have a reserve a provider on your team. Well, for more information. If you want to dive deeper, you can go to our website, reserved a.com, where you’ll find plenty of additional information, videos and articles on various reserves a topics. And of course, you can subscribe to our YouTube channel to get notified of all the full length and video shorts that we publish. That’s a nice, free way to stay on top of reserves issues. Just go to YouTube search for reserve study. And most likely you’ll see our videos there and be able to subscribe for an easy to read reference for your association, you can get our book, it’s just 2499 on Amazon, you can download the first chapter for free from our website, or I’ll put a link in the summary the outline that we provide for everyone who completes the survey at the end of this program. And I’ve got a copy here on my desk that I’ll give away to someone who asks an interesting question in our q&a section. And another resource we have is our weekly and I’m happy to report fast growing 30 minute podcast for board members called HOA insights common sense for common areas. You can find it wherever podcasts are found. You can find it also on YouTube. And on the website Hoa insights.org. It featured guests experts, discussions with hosts on current events. And one episode a month we feature a board hero. So we are elevating, encouraging equipping board members for the hard work they do helping them have success about running their association and moving it forward safely and successfully.