HOA Reserve Studies: Is Your HOA Prepared?

There are two primary accounts to consider regarding HOA finances — the operating fund and the reserve fund. Operating funds cover daily expenses and the maintenance of common community assets.  Some of the items that require care will be expensive and may not need to be replaced for 10, 20, or more years away.  Reserve Studies and a reserve specialist facilitate the HOA in determining how to prepare for these expenses.

The reserve fund acts like the community association’s savings account. The reserves act as insurance for uninsurable “expected perils” such as wear and tear of a roof, exterior paint, pool equipment, and other items with limited life. Specifically, reserves operate to put funds away over time to cover things that you know at some point will need replacement.  

Since associations are budget-driven entities to develop yearly budgets and avoid surprises, reserves are tools to facilitate that objective. On the other hand, actual insurance is for “un-expected perils” such as fire, lightning, explosion, smoke, windstorm, hail, riot, civil commotion, aircraft, vehicles, vandalism, sprinkler leakage, and sinkhole collapse,   

To understand the need for HOA reserve funds, you need to understand an HOA’s responsibilities, and its board of directors charged with these responsibilities. The duties and obligations are established in the HOA’s governing documents, including the declarations/Covenants, Conditions, and Restrictions, the By-Laws, Board made rules, and applicable statutes, many of which have applicable reserve fund requirements.

Typically, an HOA is responsible for maintaining, operating, repairing, and replacing common elements. Common Elements usually include pools, clubhouses, parks, common area landscaping and other shared infrastructure.

Typical reserve fund expenses in an HOA include:

  • Playground construction
  • Pool pump replacement
  • Roof replacements on common elements
  • Community structure painting
  • Major landscaping projects
  • Fencing projects
  • Construction and renovation projects
  • Trees and shrubbery
  • Parking Lot pavement

How much reserve funds should an HOA have?

Understanding current and future HOA funding responsibilities and duties are the first steps to managing HOA reserve funds. The second part is a little more complicated. Being faced with a significant repair or renovation project and not having enough funds could be a disaster for the HOA, the board, and managers. The amount of funds needed in reserves depends on your community, its features, and projected future needs.

The only way to project as accurately as possible the reserve account’s funding is to engage a Reserve Specialist to conduct a reserve study. The reserve study includes a physical analysis of the community and a financial analysis of the budget. Due to the aging of the infrastructures of many associations that may not be visible, many industry experts are also recommending that boards consider charging the reserve specialist to do a deeper dive in its investigation.  

A standard reserve study will provide an estimated cost of what needs to be replaced, repaired, or renovated in the coming years. It gives insight into how much should be contributed to the fund to prevent as many surprises as possible.

It’s a good idea initially to conduct an extensive reserve study every three to five years, or as recommended by the specialist. Along with a study, the board should conduct a yearly inspection of the community standard amenities and charge its employed or independent managers, if any, to do a regular review as is set by industry standards.

The investigation will help establish the annual budget.

What if the HOA reserve is underfunded?

Even if the board does everything that a prudent board should do, and no matter how well maintained the association is, things happen that were not or could not be expected.  Also, some boards and associations decide not to fund the reserves as recommended.

If you discover that the HOA reserves are underfunded, or there is an unexpected need, there are various alternatives that associations can look to, the following being the most common: 

  • Special assessments: Imposing special assessments on all homeowners is one of the most common ways to lack funds. 
  • Loans: If having the homeowners kick in more funding is not an option, applying for a loan can work. Many banks have divisions that specifically work with HOAs to help with possible loans. 
  • Delay of expenditures: If there is not enough funding, and the preceding are not possible or practicable, then postponing significant repairs or replacements can come into play. This can include closing specific amenities because they are not properly maintained and could present health and safety concerns. Also, this can significantly affect curb appeal, property value, and homeowner satisfaction. 

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Best practices for managing HOA reserve funds

Nothing will hurt an HOA’s reputation and financial health more than theft, fraud, or embezzlement. Here are some best practices to protect and manage HOA reserve funds and deter fraud:

1. Conduct a preliminary reserve fund

Suppose a developer did not prepare this type of report upon transition of control to the association. In that case, a Reserve Specialist should be retained to conduct the study.

It is a powerful risk management tool for the association to fund the reserves as recommended by the reserve specialist. Schedule continuing reserve study updates and include the costs of those studies in the budgets.

2. Checks and balances / monitoring

It’s part of a board member’s fiduciary duty to regularly oversee HOA finances. It’s a good idea to have at least two separate parties monitoring and reviewing the finances as a check and balance.  It is generally possible to have the bank directly email each board member’s banking statements.  It is also critical to reconcile accounts.  Since a reserve fund is not used for daily and current operations, either the board can maintain the reserve account, or the independent management company can have a dual signature requirement for any reserve account withdrawal.

3. Security

Many HOAs in the digital age use an online portal to accept HOA fees. The best practice is for the association to have its bank be the entity that accepts all assessments directly from homeowners and not independent management companies or board members.  This shifts the exposure here to the bank that is best situated in this regard, and this is the only way a bank will be held responsible.  

4. Perform annual audits

Getting an annual audit from a third-party CPA is one of the best ways to ensure your finances stay in order. A CPA is the best chance to discover evidence of fraud or embezzlement.

5. Insurance coverage

Ensure your HOA’s insurance covers any money lost due to employee theft or non-employment criminal activity.  Too often, HOA’s believe that its independent management company that is handling its finances will provide fidelity and crime insurance protecting them – and it doesn’t. It only protects the management company when management company employee steals money under the management company’s control.

Even if an independent management company, or a non-employee accountant or bookkeeper controls HOA accounts and handles day to day payables, The HOA must have a solid standalone fidelity/crime policy. It needs to include the independent management company within the definitions of “employee” or is added as a “designated agent.”

McGowan Program Administrators is a leading provider of Community Association Insurance products and risk management nationwide.

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