Reserve Study Basics (2025)

Robert Nordlund 0:07
Welcome everyone and thank you for joining me today. Reserve funding should be one of an Association’s largest budget line items, but all too many boards treat reserve funding as optional, and setting it off to the side like that creates problems for the sustainability of their association when inevitable deterioration related expenses come due. This webinar is designed to give you a clear understanding of the challenges facing your association. Point out what is in a reserve study and how it can help your association, and then we’ll give you some key takeaway concepts to help you have enough reserves to be able to accomplish our necessary repair and replacement projects in a timely manner. And that’s where you can meet your responsibility to take good care of your association. That’s success. So let’s get right to today’s content. This is the outline for today’s program. It all starts with understanding the challenge. Then we’ll go into your Association’s role in addressing that challenge, and I’ll turn to reserve studying issues of themselves before bringing the program to conclusion. Starts out with understanding that living in community itself is a challenge. Something needs to define who does what and how it all works. Associations are divided into common areas and separate spaces. Common areas are those owned and maintained and the maintenance responsibility of the association. The separate spaces are those that are individual home spaces that you take care of yourself. These are all defined by your governing documents. Individual homeowners rely on the board to do their job taking care of the common areas, because the homeowners maintain their space and the board takes care of the common areas on behalf of the entire Association. That means that the board needs to be diligent, because all the common areas are in a constant state of deterioration. They once were new, but they inevitably all get old and worn out. That’s just a fact of life on this planet, Mother Nature and Father Time are undefeated, and they don’t negotiate. They don’t care if your association has a tight budget. They don’t care about that kind of thing. Ongoing deterioration is expensive because everything needs to get repaired replaced. That’s a lot of common areas for most associations. It’s up to the board to set a budget that keeps up with the ongoing cost of deterioration. So I want to be something real clear with here at the start, as a reserve funding is driven by the ongoing cost of deterioration. Reserve funding is not caused by the reserve study. It’s not caused by conservative board. It’s not caused by state laws, and it’s not caused by Fannie Mae or Freddie Mac the need for reserve funding. The cause of reserve funding is mother nature and Father Time. So if you want to blame someone, blame them. And if your homeowners are starting to blame you turn that around, deflect that and tell them to blame Mother Nature and Father Time. All you’re doing is paying the bills of the association, which is your job. Okay? This cartoon illustrates a pretty common misconception that reserve funding is about expenses in the future. You can see the homeowners here reacting to a presentation about the roof getting replaced in 20 years, asphalt in 25 years, all these type of future things. And of course, they’re reacting and upset because the gentleman speaking doesn’t set aside doesn’t want to set aside reserves, because at this point in time, he isn’t even buying groceries well in advance. Okay, they’re thinking like this, that reserve expenses are discrete, separate expenses at scattered points of time in the future. But that’s not a true understanding of reserve expenses. Reserve expenses, I’ve said, is due to Mother Nature and Father Time. And a good illustration is like time passing through an hourglass, just a little bit at a time. And that’s how reserve deterioration occurs a little bit at a time, gradually using up the life of your common area components, so your actual reserve expenses are smooth over the years. Deterioration is consistent and common, okay, at just the very predictable cost of something that may have a 20 year life, but spread out over 20 years, it doesn’t suddenly fail at the end. It’s failing every day, every week, every month, since it was in.

All new. Now, another key concept and part of the challenge here, is your choice of how you’re going to pay because, like I’ve said, deterioration is ongoing. Your choice is between special assessments and loans catching up to those expenses, or providing the funding on an ongoing basis, budgeted set asides at the same rate that things are deteriorating, because the expenses are going to be there. The question is, how you’re going to react to them? And it certainly looks a lot more attractive in the short term to ignore reserve funding and just say, oh, we’ll deal with it in the future. Maybe it was special assess, maybe we’ll take out a loan, but have it be something that they defer on forward. But I need to make this concept very clear that deterioration is ongoing, and the most appropriate way to deal with deterioration reserve funding is through budgeted funding, that way everyone pays their fair share over time. Okay, another big picture idea Association leadership, the boards and the managers, they’re responsible to care for the association and nurture it forward, and the homeowners are reliant on the board management doing their job so that their homes get well taken care of. They’re sitting on the side over on the right, saying, Okay, we’re expecting. You’re taking care of a roof we’re expecting. You’re taking care of the asphalt we’re expecting. You’re getting the gate repaired at the right time. They’re reliant on the board and management doing their part. So it is this combination of people doing their role. But there’s another weak link. And the weak link is that all these community associations all across the country, about 375,000

of them, they’re non profit entities. Each one consists of millions of dollars of home values, but they’re relying on the education, the courage, the care, the commitment of untrained volunteer board of directors to run the show, to make those decisions, and with this kind of delicate situation where we have multi million dollar not for profit, real estate corporations run by an untrained volunteer board of directors. There’s no surprise that things do go wrong, and there’s challenges left and right, and that challenges. The Challenge often means that the board makes the mistake of not collecting enough cash too many boards are running their associations out of money or attempting to operate their multi million dollar non profit real estate Corporation just on fumes. That’s not a successful strategy, and that creates a situation where special assessments are common.

The homeowners are regularly upset. Home values lag the market and perhaps even safety concerns, like we saw with the tragic collapse of Chaplain tower south a little bit over three years ago. When you don’t have the funds to take good care of the common areas, bad things happen. That’s what I want to underline here in the early part of this webinar, and that’s why I’m glad you’ve joined me for this program today,

so you can clearly see the challenges in front of you and then start to appreciate what the path to the future is going to start to look like.

So on to the next program of the association.

Let’s talk about your association for the next few minutes.

Every association I work with, or the we work with here at Association reserves, tells me their budget is tight, but the board has the power to set the budget in most cases. Now, in some cases, the board needs to get a vote of approval.

But remember, when they purchased a home in the association, every homeowner signed an agreement to pay what the board determines it takes to sustain the association. They committed to paying their portion of the budget. But even so, boards are generally reluctant to raise the rates and charge the homeowners what it really needs to run the association, but bills are bills. Bills need to be paid. If you don’t pay the power bill, that power bill doesn’t go away. If you ignore it, it’s still there the next month, and it still needs to be paid. Well, generally, boards are pretty good at paying those monthly bills. They arrive in the mail via email on a regular basis for the services rendered, things that you use up, electricity, water, insurance, janitorial, then depends.

On your association, landscaping, management. Bottom line is, every month, these bills arrive and they need to get paid. And boards get plenty of practice paying those bills, generally, 12 times a year. And even if you forget to pay a bill, you make a mistake, you don’t get the invoice. No big deal. You just pay it the next month with no fuss, because the funds are there to pay it. You’ve budgeted to pay your bills so you keep up with the costs. But what about reserves? The truth is that the roof deteriorates every month. That cost of deterioration is as real as any other bill, you can see it has a monthly deterioration if the board doesn’t pay that bill that month, it only builds up until a time when someone else will need to pay that same bill a little bit later. And reserve study is where you find that monthly bill of roof deterioration and asphalt deterioration and carpet deterioration and front gate deterioration, and everything common area at your association, all those costs of common area deterioration you’ll find in the reserve study. And what I want you to do is start thinking of reserve funding as a bill that needs to get paid if you ignore it, there are consequences. Your association begins to look like this perimeter ironwork fence or this pool bathroom where they’re just letting it go, where this tennis court is gradually turning back to the hillside, natural landscape that was there before it was installed. Deterioration is real. It’s going to take over. It’s an unstoppable force. And remember further governing documents the board is responsible to provide for the needs of the association. You can’t ignore the power, the force, the inevitability or the cost of deterioration. Mother Nature and Father Time are always going to win. And the second cartoon pokes fun at the association, this one where the board ignored the ongoing cost of deterioration, and you can imagine the very real way that this deterioration is affecting the home values that this real estate agent is talking to this couple about. You can see the smirk on their face, they are not impressed. Doesn’t look nice, but maybe they’ll get a good deal, because the place has run down. There’s a relationship between how well you take care of the association, how well you take care of the common areas and home values. So it’s not just the budget, it’s the equity in your home. So really is your choice at your association, 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 like that cartoon on the last page, you get to choose, you have the power. So now back to our outline. It’s time to dive into reserve study topics that reserve study tool and see how a board can make wise, informed decisions about paying that deterioration bill. Well, I start off by talking about the three types of reserve studies. We talk about reserve studies, there’s actually three types, almost like when you go to a gasoline station, and there’s three, typically levels of fuel that you can get there. In reserve studies, there’s three types, there’s the full and then two update products, update with site visit, update no site visit. A full is the level of service where you start basically with a blank sheet of paper and you itemize inventory, evaluate and quantify all the common area components. You measure the roof, you measure the asphalt, you count the light poles, and measure the square yards of carpet. All that stuff is inventoried and evaluated and quantified in a full reserve study. And once that information has all been established, then you have a much smaller project in the future, and that’s updating it, and you can update it on the basis of a diligent site visit where you’re looking at things, how is the carpet doing? How is the roof doing? How is the asphalt doing? All those kinds of things. You put your eyeballs on them, you make observations, and you see, is it deteriorating on schedule, faster than expected, or slower than expected? And there’s the update. No site visit where you’re getting a nice, inexpensive update based on the time that is lapsed. Everything’s a little bit older. There’s been some inflation in the last year. How has the reserve balance changed? Have you changed your interest earning rate? Has the board priorities changed? It’s all.

All those kinds of things you can get done very inexpensively In Update, no site visit. Now there’s a different way to look at this, and that’s the way of looking at it, that a reserve site generally a full only needs to be done once for an association, once you’ve measured the roof and measured the asphalt and counted the boilers and itemized how big they are, that information exists doesn’t typically change, but now national reserves a standards after Chaplain towers south, the national best practice is for a WIC site visit at least every third year. That’s because things change with time. And so you can see the asterisk there, that’s new information every third year is national best practice. And some of you are in states where state law says you need to do this at least every 10 years, at least every five years, at least every three years. But I’m telling you that it’s in the best interest of the association special assessment risk goes down significantly when you update your reserve study with a site inspection at least every third year, it’s in your best interest, and then it’s also in your best interest to I’ll tell you this a little bit later, because reserve funding is such a significant portion of your budget, it’s important to keep it well tuned, aimed, correctly, And so a no site visit, update, great, inexpensive tool to tweak your reserve funding rate, get it adjusted and aim at the future. Again, very inexpensively, on an annual basis, you don’t want to be dealing with old information. And then there’s it almost sometimes people say, Well, how do you how do you game the system? How do you win this game? Well, let’s talk about what the rules to the game are. Forward zero rules. Pretty simple. The expenses are inevitable. I hope I’ve made that very clear. The board is responsible for setting the budget. You all know that you’re members of this industry. Delays get expensive due to the higher cost of deferred maintenance. When you delay project scope creeps and you’ve got more to do, instead of just painting the woodwork, now you’re doing painting and carpentry instead of just sealing the asphalt. Now you’re sealing and repairing so doing it in a timely manner keeps costs to a minimum. And speaking about costs, the homeowners are always the ones who get stuck paying the bills, and those simply are the four reserve rules. The rules are the game. And some of you are saying, well, it’s not required in my state. I’m going to say, well, that’s really not the point, as I’ve said before, Mother Nature and Father Time really don’t care what the laws in your state say board members are responsible for. The common areas everywhere, and deterioration exists everywhere. So in order to keep your budget balanced, in order for you to pursue your personal best interests, as leaders of the association, as homeowners in the association, as board members in the association. You want the place well taken care of. You want enough cash, or you can do the roof project on time, enough cash. Or you can do these other things. It’s in your best interest to budget for the needs of the association, to be able to pay your ongoing deterioration bill. So to get this done, you’re going to have three questions. What do we reserve for? Do we have enough at this point in time, or are we behind the eight ball to start with? And where do we go from here? What do we need to do to get successfully and safely to the future? Well, fortunately, there’s three parts of a reserve study that answer those three questions. So let’s start with the foundation of a reserve study, which is the component list. That’s where you’re going to find out, what are we reserving for? And this is a typical component list. I’ve simplified it here, but you’re going to see the four elements description of the project, the useful life, which is UL, the remaining useful life. You may also hear it described as remaining life, RL, and the current cost. What’s the cost today to get these things done? And another thing to point out is these are project descriptions, not physical assets. You can see here we’ve got two projects that you’re going to do to the same physical asset. Asphalt is a physical asset, but every five years you’re going to seal it, and maybe every 2020, years you’re going to need to resurface it. Very different time cycles, very different cost amounts and the roof, replace it little furniture versus the resurfacing of the pool, and that’s the segue to the next thing. But we’re talking about description of projects, useful life, remaining useful life, and current replacement cost. And you say, Well, what projects should appear on our reserve study? Well, the answer that question.

Is found in national reserve study standards. There’s a three part test. That three part test is that to be funded through reserves, it needs to be the association’s obligation, basically common area, so not something that the developer owns, not something that the management company owns. So when we go into the on site office, we ask, Who owns this desk? Who owns this computer? If it’s the management company, we don’t itemize it for the reserve study, because it belongs to someone else, and also furniture, patio furniture, 99% of the time it belongs to the association. But if we see some matching pieces on balconies, we ask, are those individually owned pieces on balconies, or are those Association pool chairs that someone brought up to their balcony? Okay, we’re going to find out. Is it the association’s obligation? Number two, needs to be reasonably anticipated. Can we see this project coming? Reserves are not forgetting, it’s projects that we can see coming that the board is going to get slammed with if they don’t prepare. And that’s because reserve projects are need to be of a significant cost, a cost threshold that it would upset the operating budget if you were to cross your fingers and hope it could be absorbed. So we’re talking about significant projects that when we spread them out, it takes years to properly prepare. Then you think, years to prepare. Oh, offsetting ongoing deterioration that comes full circle here, where you have to reserve for things that are the association’s obligation. They’re reasonably anticipated, and there is significant cost. So in summary of the components, the question is, what do we reserve for? What

we’re talking about is major projects that you can anticipate with reasonable certainty that are the association’s obligation to repair or replace. We’re not talking about trivia. The trivia the mops and buckets and light bulbs. Do those from the operating budget? There’s no guessing, because we know that there’s going to be a failure of the roof. Eventually. Roofs fail. We’re not going to guess about things that might happen. So guesses are still maybes. They don’t appear in the reserve budget. We want you, with your reserve budget, to look at that and therefore not be surprised by the things that are not surprising. All right,

reserve components are there. They’re going to deteriorate. And we don’t want you to be surprised by something that deteriorates in plain sight over X number of years. That’s just foolishness. Okay, so now we get to the question of, do we have enough? And that’s the portion. That’s a question that’s answered in the portion of the reserve. Of the reserve say, where we calculate reserve fund strength. Now an important word there we calculate reserve fund strength. You can look at the reserve balance by looking at the balance sheet. Find out how much money you have in account number one, account number two, account number three. Add them all up. You have $300,000 in reserves, or 100,000 or 3 million in reserves, whatever the number is at your association, we’re going to calculate if you have enough. We do that by comparing balancing the value of deterioration at your association to the reserve Cash At Your association, there should be a balance. We’re trying to make sure that your association is on track. And let me give you this hypothetical. Think with me. If you have a brand new association, sparkly, shiny new, you don’t need much in reserves, because nothing has deteriorated, the ongoing cost of deterioration. Gee, it’s been nothing. You’re brand new. You’re a year or two old, close to nothing. But if you’re an old association where you have a lot of deterioration, the roof is old, the siding is old, the asphalt is old. To be in balance, you’re going to want to have collected a lot in reserves over the years so that you’re ready to spend that money on a new roof, new siding, or to resurface the asphalt. What we want to prevent here is the case like we show here in this picture, where the deterioration gets way ahead of your cash, and that’s a dangerous situation, because you don’t have enough cash to keep up with the expenses that are now coming at you, left and right. So we measure this with a parameter, a number. It’s called percent funded, and this is the industry standard measure of how well your reserve cash balances against your reserve deterioration being in balance is the 100% point not too much cash.

Uh, not too little. You’re balanced left and right side,

and that tells you a lot more than how much cash do we have? X amount of dollars? We say, Well, that’s nice. We have $300,000 in reserves. But is that enough? Okay, so we calculate your percent funded, and that’s insightful, because knowing your percent funded reveals your special assessment risk, because if your association doesn’t have much cash, you’re at a high risk of special assessment when the project comes due and you don’t have the money. That’s just a known fact. So we add those numbers up, and this is the statistical relationship across the country of special assessments compared to percent funded. It’s very easy to see that special assessments are more common when relatively speaking, you don’t have much cash. That makes total sense. So we’re in the roughly 30 to 50% range, meaning every third year or every other year when you have effectively very little cash at the association. So when you’re zero to 30% funded, zero to 1010, to 2020, to 30, you have a high risk of special assessment. Now the opposite is true. When you’re above 70% funded, you effectively have enough cash to be able to write the checks and pay the bills and get a new roof when it’s old, get new siding, resurface your asphalt, take care of the building, because you have enough cash on hand. So knowing your percent funded is important. It helps you know, are we doing okay? Are we in catch up mode, as you would be here on the left, or are we well prepared for the expenses in our future? And then we get to the third portion of a reserve study, which answers the question, what do we do from here? And that’s called the funding plan. And of course, whatever number you get, it’s going to seem like a lot of cash. It’s going to feel like a wheelbarrow of money. That’s just the way it is. You add up nine units, or 90 units, or 900 units, you know, look at the recommended reserve transfer, and it’s going to say, Wow, that’s a lot of money. But you do need to get comfortable with the fact that owning real estate is expensive and the cost of deterioration is expensive. What I can tell you in summary is that, and this is a good takeaway, what we find in all the reserve studies that we’ve done is there’s a pretty nice little thumbnail summary that reserve funding typically needs to be 15 to 40% of the average Association’s budget. If you want to have a visual, I made this one quarter here. It’s typically a little bit more, or a little bit less than the 25% point. So if you have a million dollar budget, 250,000 of that should be going to reserves, leaving 750,000

for operating fund. That’s classic standard reserve funding at an association. So don’t think that your association is going to sneak by with 5% of budget. And don’t worry, unless you’re a real steep catch up mode, it’s going to cost 50% of budget, and your funding plan, using that money is going to provide for the anticipated projects at your association. These are the scattered expenses through the years. Remember, this is all due to deterioration that happened over many, many years. But having the cash means that when you have reserved projects, cash goes down. But in years that you don’t have expenses, your cash balance goes up, and so you always have enough money to pay the expenses and have enough cash to do the projects at your association now that kind of looks like success, and I say kind of, because nothing ever happens exactly according to plan. You need some margin so your reserve, say provider. Count in your reserve, say provider, to recommend a multi year funding plan that provides an appropriate amount of margin for the projects that inevitably occur a little bit early or a little more expensive than projected the green line in this slide. So we’re back to our outline to remind you of the material that we’ve covered and to summarize the main points of our program today, everything deteriorates. When you see this picture and you see a deteriorated barn, you all know that I like this picture, because if you look down here in the corner, you see a new town home development on the other side of the street, okay, this new town home association is going to look just like.

Like this barn in 100 years, if they don’t take care of it, everything deteriorates, and it deteriorates on a very predictable schedule. We’ve always seen asphalt alligator ring potholes. That’s when the owner doesn’t take care of it, or this stairwell, when the owner doesn’t take care of it, when they don’t take care of the metal work, it’s going to rust. It’s going to deteriorate and become a safety hazard. We all understand this concept. We’ve all seen a new car lot where they talk about the cost to operate the vehicle.

We understand that buying the car doesn’t mean we’re done. I got the car now. It’s going to take money to keep this car going, and similarly, takes a lot of money to keep a community association well maintained. Some are going to be more expensive. Some are less expensive, just by the nature of the common areas. They have materials, the amenities, things like that. I do want to leave you with some recommendations and some more hints here again, if this is going too fast, this is recorded program. It’s going to be available on YouTube in about a week. But understand that owning real estate is expensive, and that’s why we have these set asides? We want the owners to pay their fair share for the sustainability of the association, and we are not talking about reserves as set asides for the future. It’s not set asides for emergencies, not set asides for a rainy day, but it’s all paying the ongoing cost of deterioration. No one’s putting in charity for the future. All reserve funding is doing is allowing owners to pay for this month’s this quarter’s this year’s deterioration.

And I’ve tried to stress that what we’re talking about here is the bill for ongoing deterioration. It’s a bill. Therefore you should be talking about funding needs, reserve transfers, reserve obligations. Don’t use the word contribution. When people think contributions, they think optional. They think it’s the little kid at your front door selling $5 candy bars that you can optionally say thank you, but not interested. These are bills here reserve funding. Are bills that you can’t ignore.

I took this picture because I like the sign at this association parking garage is to my left, the high rise is to my right, and this board gets it. They understand that they want to take good care of this property. The objective is not low monthly assessments. They’ve enlisted all the homeowners to help them see where the maintenance areas what needs to be fixed. They didn’t want to let maintenance problems get a toe hold in their association and start to degrade it. So think about it. What’s your objective at your association? Are you prioritizing low monthly assessments? That folks is a destructive goal. So prioritize taking care of the property, because doing so going to reap great rewards with respect to property values. So your action steps, set budget to offset the ongoing cost of deterioration, collect those funds, and then, with those funds, pay the bills in a timely matter, that’s going to have you have an association that looks sharp after 2030, 4050, years, when you’ve set the budget to collect the money on an ongoing basis, and you have them ready, and then you pay those bills. And in doing so, you minimize special assessments, because the cash exists. You’re not hamstrung, you’re not panicking. You minimize deferred maintenance, because you can get things done on time. Small projects don’t become big projects, and that minimizes costs because you’re painting the siding, you’re not painting and doing carpentry work to fix the siding that has gotten dry rot. And you’re maximizing owner enjoyment. And the big one here, you’re maximizing property values, and those maximized property values are going to make reserve funding obligations look small. So if you’re thinking about your budget and thinking that, gee, we’re not there, or if you’re not even aware of what reserve funding rate is at your association, I want to comfort you in saying it may take a few years to get there, but you got to start on this journey. It’s a journey that’s well worth taking to enjoy, minimize special assessments, minimize cost, maximize property values, maximize homeowner enjoyment, and a reserve stage where you get that information about what are we.

Reserving for do we have enough? And what do we do from here? So you’re going to find more information on our website, reserve study.com, articles, video, information, things like this webinar. You can also go on YouTube, where we have a strong presence. You can type in reserve study. Many of the hits that you’ll find are probably ours. Kind of look at one of those. Sign up for our YouTube channel, and so you get alerted for the future

webinars, the shorts, all the different types of materials that we have on YouTube, or something I’m excited about is our weekly podcast for board members.

It’s there to encourage and equip board members for the hard work they do running their associations. So its name of the podcast is HOA insights, common sense for common areas. It’s a weekly 30 minute podcast. You can subscribe from all major podcast platforms. You can watch it also on our YouTube channel, or you can listen from www HOA insights.org We have board heroes that we feature people like yourself. We have industry experts, subject matter experts. We have hosts discussing current topics, lots of great things. It is your community to help you in the hard work you do running an association, if you’re a reader, we have a book. It’s called Understanding reserves, all about the basic concepts we’ve talked about here. It’s available on Amazon, like everything else, and there’s a

free Link to Chapter one on our website. I’ll include that in the webinar outline that we provide, and so you can check it out and see if you like the flavor of it. So you can basically kick the tires and test it. I have one of those here on my desk. I’ll give a signed copy out to free, for free, to someone who asks a great question. And that brings me to the end of my schedule content for today. So at this time, I’ll turn the microphone over to colleague, Corino, who will coordinate our Q A time together.