Understanding Components of a Reserve Study

Robert Nordlund 0:00
Thank you for taking some time out of your day today to join us for a program where we’re going to do an advanced class on reserve components. By the end of today’s program, you’ll see how we measure the difference between different material choices, how we decide if it’s worthwhile to spend money on maintenance, and how to design your component list to maximize your cash flow and still keep your property well maintained. That’s always going to be our first priority. So settle in, adjust your volume and get ready to learn how to challenge your reserve study provider to go beyond just plain vanilla decisions into decisions that support maximized owner enjoyment, maximize cash flow and minimize reserve funding. This is the outline we’re going to use today. We’re going to start out with the concept of how we measure one component or group of components against one another, because that measurement will allow us to get a metric that will help us make better decisions. And it all starts out with component selection. Let’s see, there was 38% of you who attended our Reserve Studies 101 program, and so you’re right up to speed on this for everyone else, a quick reminder, every component needs to pass the national standard three part test. You see it on the screen here, and that three part test to be funded through reserves, the project needs to be the association’s obligation to perform. It needs to be reasonably anticipated in both timing and cost, and that cost needs to be significant to the association, big enough that it would disrupt the operating budget if you tried to absorb it there. So if you haven’t seen that reserve size 101, webinar, you can catch up and watch it from our website or on YouTube at your convenience. Now this is a sample roofing component from a reserve study. We’ve isolated it all by yourself because we want to talk about it specifically. And as you can see, it’s a roofing project, 120,000 square feet, 25 year useful life, with a zero years remaining useful life. Are you? Well, it’s currently old and needing to be replaced. And this is a client that we’ve been watching over years. We’ve seen the roof gradually get older and older and older, and now it’s time to say it’s replacement time. We don’t casually recommend a client spend $600,000 this is what we see right here. It may look very simple, like a reserve line item, but Sean, what else does this component tell you about what’s going on at the association?

Sean Kargari 2:45
Well, thank you, Robert, and it’s great to be here on the program with you today and our guests throughout the nation. Thank you for joining us. It’s a really good question. Usually our eyes will fixate right on the dollar amount. But when I look at a major project, I also think about the and this is very important, the ongoing cost of deterioration. And what I mean by that is say, in this example, the $600,000 roof project that needs to happen every 25 years useful life is extremely important, because that will determine what the deterioration rate is and the cost of that ongoing deterioration. So in this example, a $600,000 roof with a 25 year life has an annual deterioration cost of $24,000 per year. Some projects are more costly. Some are less. Now, there’s some real opportunities here, when we’re considering useful lives and major projects, if we invest in the proper maintenance, which can be as simple as annual cleanings and inspections, along with additional proactive maintenance, we can extend the useful life of the roof from 25 years to 30 years. And now the cost per year is reduced to $20,000 per year. So $4,000 difference per year over a 30 year span. That’s a savings of $120,000 now the opportunity of extending the life goes both ways. So you can also run into the situation where no maintenance, the even the minimal maintenance, is ignored, the roof isn’t cleared of debris from the gutters and downspouts. And instead of reaching a normal useful life or maximizing the useful life, the useful life is actually reduced down, in this situation, or example, to 20 years, instead of the 25 or 30 years. And pay close attention to that cost per year, you can get $20,000 per year of deterioration costs over that 30 year span. Or if you knock it down to 20 years now, the cost is up to 30,000 and that extra $10,000 per year is half the value of the overall roof project. So I. This is really important to figure out on your reserve study, which projects are the truly significant projects. And it really boils down to the deterioration cost and maximizing useful life is cost effective, because the savings isn’t just pertaining to roof it extrapolates across the board. So the potential $10,000 savings per year could be much, much higher when you look at the asphalt roads, when you look at the gutters and downspouts, when you look at the siding, if you do the preventive maintenance and care, if you spend the money, you’ll actually save a lot more money in most situations. And what is it that we are concerned about? I wish that, you know, the buildings, uh, infrastructure, the exteriors, could be in a nice static situation, you know, in a vacuum, so to speak. But the bad guys are Mother Nature and Father Time. And you know, if you decide to defer maintenance and or defer reserve transfers to properly fund these projects. Just remember that mother nature and Father Time never take a break. The best way to fight back is to start the proper funding plan and as well the good maintenance plans. On top of that, that’s the best option you have on the table to put up a good fight and most importantly, make the community’s operations and the funding of these projects as affordable as possible. And so good maintenance is part of a good cycle of care. And this is an ongoing cycle of care, month to month, year to year. For every project on your reserve study component list, many of them will involve preventive maintenance along with reserve planning. And for some very important infrastructure type project, periodic inspections beyond the reserve study inspection, perhaps structural engineers to take a look at the balconies, or waterproofing experts to take a look at your planter beds. The goal is to catch small problems before they become gigantic problems. And this cycle all works together for sound planning and smooth operations in future years. And so it’s often tempting to cut back on the budget. You know, we are going to be very frugal with our spending. We are going to reduce spending. But it’s very important to really think about what exactly you’re cutting back on because a lot of situations, money spent wisely will save you money. It’s just that simple,

Robert Nordlund 7:28
Darn I want to continue on that idea. We want to encourage our audience. I think that preventive maintenance is a good expenditure of funds. But when does it come time to finally pull the trigger and replace versus continuing to repair. Let me walk you through just a moment of that concept, and it goes with the idea of the economic value of the component. What I’m showing here is a $200,000 project on a 20 year life we show a straight line deterioration. And in this case, the idea is, well, we’ve got a proposal. Well, let’s call it a roof right here. We’ve got a proposal for a $30,000 roof repair in the 18th year. Now, in the 18th year, that’s nine tenths of the way deteriorated. Nine tenths of $200,000 is $180,000 so talking just $20,000 left, the idea is you shouldn’t spend more than $20,000 at this point in time near the end of the roof life. You don’t want to spend over its straight line economic value. So this will help you decide, if you’ve got some asphalt, if you got a roof, if you’ve got a paint project and you’re doing some touch up painting here and there. When do you say enough is enough? And it’s time to spend the money on the big project. So you want to spend enough money on an ongoing basis to extend the life, right? You don’t want to go beyond the point of strong return and start spending good money after bad now, it’s time to turn the page here and talk about a whole idea of how do we actually start making decisions about this, how to balance quality versus cost? And want to show you a simple component list that should look familiar to you in idea. It’s a description of the project. It’s the useful life the UL, the remaining useful life, remaining useful life are UL and the current replacement costs pretty simple, leaked, straightforward component list. I’m going to do one more thing to it and add one more column to it, and it’s the deterioration. And notice how we’ve got a little more information here. The deterioration is the cost per year. Easy to see the number, perhaps on the pool repair, $10,000 cost over 10 years, and $1,000 per year. Or a $50,000 project over 10 years, it’s $5,000 per year. The idea is. These are components. They are all at Sean talked about a moment ago with that roof project deteriorating at a certain rate, and it’s a combination of the cost and the useful life. How long is it going to last? How much does it cost to replace? But at this point in time, these components are all deteriorating at the rate of 20,170

Sean Kargari 10:21
per year. And thank you, Robert, and this is what reserve funding offsets. Specifically, your ongoing reserve transfers are paying a current cost, not a future cost, which is a common pushback about about reserve funding. Your reserve contributions are simply offsetting this ongoing cost. And we know that our clients are very sensitive to our reserve funding recommendations, but the cost of deterioration is what needs to be offset by your reserve funding. If you fall below this offset, then you’re going to have to catch up, ramp up funding even sharper in the years to come. So you know you have to keep pace with this. This cost is largely driven by mother nature and Father Time again. They’re not going to rest on you, so you really can’t take your foot off the pedal. It’s better to start funding at the appropriate levels with nominal annual increases, rather than waiting and waiting and have to make even tougher decisions in the near future. I’d also like to point out on this chart that oftentimes biggest project costs is not the most significant. You’ll notice that the roof at $80,000 is less significant than your building repainting at $50,000 and again, it comes down to that useful life the building repaintings came coming up more often. And to the next slide. This is really interesting. This is a great asphalt life expectancy sort of scenario laid out here. The red line shows, you know, the remaining useful life of the asphalt. And you’ll notice that the first few years, the halfway point of its life, things are relatively smooth. It’s a very gradual decline, and then not long after, it’s a sharp nose dive, and the green lines, though, show a different route, sort of basically an extension of the useful life by implementing ceiling projects, and you can change the curve drastically and extend the useful life. And this is really important for a lot of communities, because a lot of communities, their most significant asset are the asphalt roads. And to visualize this on, you know, a single line item chart, we have asphalt here. And the question is, to maintain, or not to maintain? We have a 15 year life cycle at a quarter million dollars. The cost of deterioration is basically $16,700 now, if we choose to maintain the asphalt, we’re adding an additional project and an additional $14,000 expense up front, you’ll notice something magical happens. The deterioration cost actually goes down per year. Why is this? Again? It pertains to that useful life. It went from 15 years in the prior slide now to 20 years, Robert, if you jump back to the prior slide really quickly, you’ll see here, with that 15 year life, we’re really just leaving the asphalt exposed to the elements and Mother Nature. We’re not touching it, and it’s going to suffer, and it’s going to reach a very short useful life, and unfortunately, that’s actually by not spending money, by not actually taking on an additional project. It’s more expensive even the five years, five years of useful life. Doesn’t sound like a whole lot, but it’s actually cheaper to invest in the resealing. And at the same time, the roads are going to look a lot nicer. This is the more beautiful, less expensive option on the table. So it’s definitely a wise investment. And the same is true for a lot of projects. Your wood and metal surfaces on the exteriors, they are very vulnerable to weather elements, so the repainting and resealing of the exteriors is crucial to prevent high repair costs to extend the useful life of siding, which is critical decking ceiling prevents water intrusion that can cause structural damage. So ignoring $1,000 per deck resealing project could result in a 10,000 or 20,000 per deck reconstruction, mechanical equipment, preventive maintenance, along with gates, vehicle gates, taking the time to invest in preventive maintenance on the vehicle gate hinges is really critical. You can double their useful lives. Outdoor Furniture, a lot of our clients are able to refurbish them and restrap them, rather than replacing them every few years. If you have a lot of hallway carpeting, ongoing, shampooing and cleaning is a great investment. If you’re carpeting consists of carpet tiles, investing in a surplus supply of carpet tiles enable you to really extend the life by swapping out. The trouble area. So the list goes on and on, and the savings for each and every individual project by extending useful lives adds up to a significant savings, and it’s truly the best way to run your community. From our point of view, when we are working with a new community, new construction, especially, we are presuming that the board will be taking on the preventive maintenance project. So our asphalt reconstruction every 20 to 30 years, depending on the climate. That is based on the assumption that the asphalt will be resealed or re slurried or rejuvenated every four to seven years. The wood siding useful life is based on the presumption that it’ll be repainted every four to six years. Exterior deckings, you know, we are assuming that, and this will be, these will all be additional line items on your reserve study that the ceiling will be completed. And also, in some situations, the operating budget will reinforce the reserve planning with the annual maintenance that you aren’t handling from reserves, for example, gutter cleaning or roofing or decking cleaning like clearing out those drain lines and so forth, or hydro jetting the drain lines. These maintenance projects that are being handled from the operating budget are also benefiting the reserve budget by extending some of the useful eyes found on that report. Well, that’s

Robert Nordlund 16:25
fantastic, Sean, let’s turn the page now and take a few minutes and look at some examples, some real reserve study projects and reserve component list shaping in action, we’ll be able to show you in this section how shaping your component list can help you manage the cost of your association. Creating a good plan rather than something that just is plain vanilla, we’re going to create a good plan that meets your custom situation and helps guide your wise decision making. And I’ll take the first example. Here. It’s a client trying to figure out how to best handle their expensive elevator modernization project. Elevator modernization modernization is currently a multi month project and very expensive. This building has two six story elevators. The building is 100 years old. They have very old elevator equipment. It’s getting unreliable. And the question is, when and how to modernize? How to manage this project through their reserve budget. Are the issues here? Number one, cost, it’s going to be a lot of money to do this project, and they are a relatively simple group of owners, a simple building, and they don’t want both elevators to be down and unusable at the same time. Often, there’s some economies of scale to get things done at the same time, but they only want to do one at a time. And what’s interesting is we learned speaking to their elevator service company, is that they’re running out of people that are qualified to work on the old equipment at this building. They just aren’t trained in this kind of equipment anymore, so the service staff is fewer and fewer available because they are, quite frankly, retiring, and similarly, the parts are pretty unavailable when something does break. The way they’re getting parts is they’re being scavenged from other old units that have been taken out of service, old unit at their building. What was the plan here? The plan is that we’re going to take one at a time. Gonna try to space them five years apart. Do one first? Do one five years later. Cross our fingers a little bit. But the good thing is that most are many. I think I chose many here for the correct reason. Many units are unoccupied. It’s a lot of second homes for people in this downtown location, so it’s not jam packed with people, and so one elevator can pre effectively serve the needs of the residents who might be there at any point in time. So let me talk through the strategy here. The strategy is that we walked them through this project. We developed a plan to space out their cash flow, they were going to squeeze five more years out of the old unit. I’m standing right next to and behind the old unit, looking across the elevator room to the newer unit. And they figure that if indeed that old unit buys then they can live with the new unit, or perhaps an extended period of time. Will they get in line to order the parts, GET IT project scheduled to get this old unit redone. Now an important point to make is that the hoist units themselves, these big mechanical lift machines, they are not the issue. The hoists themselves are doing just fine. What we’re talking about here with elevator modern innovation as largely the control system themselves. So I’m standing behind the old unit, and I’m going to move to the next slide. I’ve moved to the left. I work standing by the doors back here now. Have moved to the center point. The new elevator is right behind me. And you can see here that this is the old control system with old relays. This is all very open. The relays are very big, the size of your hand, and it is the vertical control and literally a screw drive where the potential floors move and down, and a little miniature of what’s going on in the elevator a few feet away. The control they’re all fixed with little step screwed it was kind of fun to watch that little thing go on down as the elevator goes up and down, but basically it’s old technology. It’s very mechanical, and it’s unsophisticated controls and the electrical component, again, very loud, very noisy relay. Okay. From there, now take a few steps over here to the right and turn around, and let’s take a close look at the new, recently modernized elevator. It’s a new technology. It’s all electronic, nice, lightweight aluminum housing. The relied the relays that were the size of your hit are now smaller, smaller than a cigarette pack. Okay, they’re nice and small. The controls are quiet. It’s all board technology. And what’s very important is that the repairs, the staff to do repairs on this and the replacement parts are all readily accessible. So this is a example of how we took a very simple what could have been a two elevators, modernize line item, pull them apart, space them out. And this is going to serve the association well, because it manages their cash flow only one big hit at a time, and it also maximizes the life of their old unit. And for people like me that have been doing inspections for decades, it’s kind of fun to see the old and the new in one room, both at the same time. Sean, let me put it over to you, and you can talk about the example of a client that was wrestling with a fence decision. Thank

Sean Kargari 22:10
you. Robert. So in this scenario, the association is considering how best to handle the replacement of their perimeter wood fencing, but they are considering now pivoting to a different material altogether, and all the considerations that come with that. We all know that lumber costs have been outrageous the last few years, and then wood fencing also comes with a cost of repainting or resealing it. What are the main decision points when choosing between the existing option on the table, the wood fencing, versus an alternative option, such as vinyl, which is more expensive up front. There’s, of course, the appearance, the esthetics of the community, which is a huge part of that, the resilience of the product. You know, I’m picturing kids. If you have a lot of kids in your neighborhood, and they’re using the fences as backstops for their soccer balls and baseballs, the wood fencing could probably take a punch better, but if left alone, vinyl fencing should reach a longer useful life. So let’s put this on the charts again. You know, we’re looking at our wood fencing, which comes with the repainting or resealing. The combined costs are $4,000 per year for that wood fencing. If we want to restart this option again. Now looking at the vinyl fencing, it’s a much larger upfront cost actually. However, because of that longer useful life, again, the deterioration cost per year is much lower. So if you go back to the prior slide, $4,000 a year, versus vinyl with 3000 $3,333 so if you are opening sealed proposals and you go right for that total cost, you know, please don’t be too quick to dismiss the more expensive option. And you know, even though perhaps the vinyl fence was never considered until the past year, and the whole time you’ve been funding for a wood fence with your reserve studies in years past, it’s a good opportunity to reach out to your reserve specialist and just ask, you know, if we invest the extra $40,000 in this vinyl fence up front, how will that affect our reserves? Is that a responsible move? Can we avoid a special assessment? Do you feel this is a wise investment? You know, your reserve specialist should be able to help you navigate this. But again, the highest cost, sometimes it doesn’t turn out to be the most expensive one overall. And some other examples where you know you’re considering a different product, wood decking versus TRex decking or composite decking. The TRex decking, like the fencing, doesn’t require repainting. You don’t have to worry about termite infestation, energy efficiency. This is really important for our apartment style and mid rise and high rise clients who have blights that are on 24 Seven in the hallways, the stairwells, the parking garages, considering switching to LED fixtures, which are more expensive up front, or conducting an LED retrofit, where they can take your existing fixtures and remove the ballast from the fluorescent light, keep most of the fixture as is, and switching them to led this will have a huge cost savings benefit to the overall budget your monthly utility bills, which will give you more flexibility across the board, including reserve funding. So spending money can be very beneficial for your community. It’s not just keeping the wallets very tight and spending as little as possible. Definitely be curious and proactive and get the opinions of professionals in the different fields, because you could be missing very important cost savings that the community overall will enjoy for years to come.

Robert Nordlund 25:53
Fantastic. Sean, let me tell the story here of a third example. It’s a relatively new property with 74 buildings, 74 different roofs. We wanted to make sure that we were pointing this client in the right direction and helping them manage their cash flow and their expectations accurately. Our first assumption, our first idea, was, well, that’s $555,000 that’s current cost. 25 year useful life, 23 years away, and this is the way it looks on an expense map, where it’s you wait for 23 years and you replace it all, obviously some minor maintenance in the interim. But we started to think, if that really what’s going to happen, there’s a likelihood that some roofs are going to fail a little bit early. Some roofs are going to last a little bit longer. So we just pondered a moment, and we realized there is a better way to do this. And look what we came upon. We decided that we would have an expectation here, that 40% of the roofs would fail on schedule, 20% would fail a year early, and another 10% would fail two years early, and we parallel it on the other side. And so rather than have a single $555,000 project, we ended up spreading it out over five years. And there’s another nice advantage on this. It allows the association start, start to work with a roofer and check them out on such a small fraction of the project, make sure that they’re towing the line and doing a good job. With the idea that if they do a good job here, there’s more work to come. So it simplifies cash flow. It spread out the roof project over a number of years, and so there it’s rupping, arguably, over a course of time, but that all goes away when you’re thinking on a 25 year scale. So there’s multiple ways to think about getting a project done. We split out the elevator project over a span of years. We are planning for this association to spread out their roofing over a number of years. It doesn’t have to always be just a simple way. Let me take you now to the conclusion where we’re going to try to wrap up what we’ve covered today. And so let me spend a few minutes summarizing. First off is the idea that lack of maintenance may cause scope creep. That’s when something gets bigger, resulting in the expenses that are significantly greater than the original project. And here you can see they failed to paint the wood siding and the wood trim on a timely basis, and now they have wood rot. And so next time around, they’re going to have to hire a carpenter in addition to a painter. It’s going to be significantly more expensive, all because they thought they were going to save money. So the lesson here avoiding spending money on maintenance often actually costs. You might want to make that very clear. Yes, replacement is expensive. Projects are expensive nowadays, but we want to encourage you to think that preventive maintenance is cheap. It’s also an inexpensive way, as Sean showed earlier, to extend the life of these expensive projects and actually result in a lower life cycle cost. And course, it’s great for property values. Think what it’s like to come in as a protective buyer to the property on the right compared to the clubhouse parking lot on the left, and that’s where you get a lot of leverage out of the money you spend, because look at what lack of maintenance might do to the dreams of a prospective buyer. Are they going to want to look at this? Are they going to want to pay top dollar for place with pool furniture that look like this for a tennis court that you’re going to have to spend half your time looking at where you are on the court to not watching the ball because you don’t want to trip, or just the unsightly enough of how they’ve saved money on painting, yes, but potentially lost 1000s of dollars per unit if. In unit value. And I like that cartoon that showed the actual scenario. Notice the real estate agent showing a deteriorated property to a kind of disappointed couple thinking about buying. How do you describe this place, other than rustic? And yes, this is a result of not spending reserves on what needs to get done, and that results, that’s going to result in significantly lower property values, and again, 1000s of dollars less in property values, because you saved a few $100 here and there with reserve funding, not doing the property where it needed. And it’s not just the dollars in reserves or the dollars that you spend in operating maintenance, it may affect your insurance. Think what an insurance agent would do to your insurance premiums if your insurance agent sees this at your dock or these kind of sidewalk lack of repairs, these are hazards, and your already high insurance are going to get even higher if you’re not taking care of these things. But not only that, you may face loss of insurance. Your insurance carrier may inspect and require a change in order to renew your already expensive insurance, and you think it’s expensive now, wait till you get canceled. Stay on copy for maintenance. You’ll get the ultimatum from your insurance carrier. That’s just not something you want to face. Plan ahead. Plan wisely. Your reserve budget is where you can do that multi year planning. And as Sean showed earlier, think about it, spending maintenance wisely to extend the life of your component and giving you an opportunity to get more years out of something expensive, and being able to put the eventual replacement in a year that might be a little more favorable cash flow wise. Bottom line is minimizing your reserve funding requirements. The more you can minimize your cost of deterioration, the more you can minimize your reserve funding requirements. And if you’re looking for additional resources, we have a deep library of written and video resources on our website, reserve study.com at the top right corner of our website is where you’ll find a link to click if you’d like a free proposal for a reserve study for your association, so you can get one of our project managers working for your association. Or you can go straight to YouTube and find full webinars like this one, or the Reserve Studies 101, or webinar shorts portions of a webinar. And if you subscribe to our channel there, you’ll get notified every time we post new content. And on our website, you’ll also find a link to a free download of the first chapter of our understanding reserves book that’s available for sale on Amazon. I’ve got two copies here that I’ll hand out during our Q and A time together to some interesting questions. So get ready to start writing your questions. Those of you who enjoy podcasts, we have a weekly 30 minute podcast called HOA insights, common sense for common areas. It’s a podcast designed to encourage and equip board members in weekly 30 minute bursts and all to help you in the hard work you do leading your association. And the episodes rotate among guest speakers, current events and some featured board member here.