Reserve studies are essential to ensuring the financial security of community associations. When conducted properly, they aid in preparing associations for large future repairs and create a timeline so that the membership will have the appropriate funds allocated for such repairs. But what exactly is a reserve study? What information does it provide and where does this information come from? In this article, we'll explore the ins and outs of reserve studies so that your board will have an in-depth understanding of the process and be able to properly prepare for the future.
To begin discussing reserves and reserve studies, we first must discuss capital reserves - what are they? Capital reserves are essentially a separate account that is setup by the association to fund large repairs that do not come up on a regularly recurring basis. Some examples of these repairs are asphalt paving, roof replacements, or dredging and drainage improvements. Capital reserves are not used for regularly occurring expenses like landscaping, maintenance or utilities - those things come out of the operating account.
So, why do you need a separate capital reserve account to cover these types of repairs? Mainly because they're not covered in the annual operating budget - these repairs aren't needed every year and often you can't pinpoint exactly when they will be needed so there's no simple way to include them in an annual operating budget. Also, board members have a fiduciary responsibility to their associations and part of this responsibility includes ensuring that the association is financially prepared for the future. In fact, some states have statutes that require non-profits such as homeowner's associations to have capital reserve accounts; however, North and South Carolina do not have these requirements.
What is a Reserve Study?
The next thing that must be considered is how much money should be in a capital reserve account. That is where the reserve study comes in. Put simply, a reserve study is a niche product for homeowner's associations and some other organizations that provides an estimate of future capital expenses and therefore determines how much should be put into a capital reserve account. The study will include repair cost estimates of major expenses like roof replacements, exterior building repairs, amenity repairs, etc., and will include cost and time estimates of when these repairs will likely be needed over the next 20 years.
The reserve study process has a few different components. The person performing the reserve study must of course do a general evaluation of the condition of the association's assets - things like drainage systems, asphalt condition, building components and amenities. However, this person must also review the association's governing documents to determine exactly what the association is and is not responsible for repairing in order to begin making accurate repair estimate projections. It is worth noting that the association should not be expecting detailed engineering specifications from reserve studies but rather more of a general, broad study of the condition of the components of the association.
A thorough reserve study will also provide a financial analysis of the HOA's reserve fund and reserve contribution rate. The study provider will estimate the association's expenses over the next 20 years and compare that estimate to the current capital reserve account balance and contribution rate. This will allow him or her to create a model of what the account will look like over the next 20 years - including estimates of the end-of-year balance in the reserve fund for each year included in the study - and make funding recommendations.
Lastly, a reserve study will include maintenance guidelines and provide suggestions to the association on preventative maintenance and how to prolong the lifetime of certain elements. The study will also create a schedule for non-annual maintenance and repair items to go along with prolonging the life of these elements.
How is a Reserve Study Completed?
A reserve study will begin with an analysis of historical information about the community and previous capital repair projects. This will include a review of governing documents, consulting attorneys if there are any questions regarding the governing documents, looking at past bids on previous capital repair projects and reviewing county tax records, plat maps and site plans.
The next step is typically setting up a site inspection. The person performing the reserve study will meet with board members and the community manager to conduct the inspection and in doing this will get an inventory of components the association is responsible for, take measurements, evaluate current condition as well as determine the likelihood of repairs being necessary in the short-term vs. the long-term.
Once the site evaluation is completed, the study preparer will develop a financial analysis report. This will include an estimate of repair costs and a determination of when and how often these repairs will likely be required. These estimated annual expenditures will then be compared to current reserve revenue and some funding alternatives will be developed if needed. The completed report will then be submitted to the community manager who will share it with the board. The person who prepared the study will meet with the board to review the documents if needed to ensure everything is clear and make any necessary revisions. The turnaround time on this entire process is typically 4-8 weeks.
Why Have a Reserve Study?
You may be wondering why this process is considered so essential for community associations. At its most basic level, it prepares the association for future expenses and helps avoid special assessments. You may also think of a reserve study as a budgeting tool that allows an HOA to invest reserve funds efficiently - a reserve study shows you balances over time which allows you to make sound investment decisions for the association.
A reserve study is also an excellent maintenance guideline and allows the association to fulfill the requirements of some local governments and lenders. Not only that, but it provides a third-party professional guideline that shows what your association should be saving on a regular basis and creates a sort of roadmap of what major projects may be coming up.
What Else Should You Know About Reserve Studies?
Updating the Study
It is advised that reserve studies be updated every 3-5 years depending on your exposure - how many capital repair items you have, your association's level of expenses, how many components your association is responsible for, things like that. Regular updates will also help mitigate the risk of variables like inflation and cost increases.
How Far Out Should They Project?
The minimum standard for reserve study projections is 20 years as we've mentioned throughout this article. However, some studies will project up to 30 years and that is fine. Forecasting out beyond 30 years can get hazy and isn't advisable as it is hard to predict how things may age or how storms may affect coastal areas.
How Much do Reserve Studies Cost?
This of course heavily depends on the size of the community and the elements within. An average reserve study cost is somewhere in the neighborhood of $3,000 but they can be in the range of anywhere from $2,000-$10,000 depending on the community being studied.
Who Prepares Reserve Studies?
Though there are no laws dictating who can prepare reserve studies, engineers and architects are often who provide these services. The Community Associations Institute (CAI) allows people to earn the Reserve Specialist designation through previous education and experience and it is advised that associations choose someone with this designation to prepare their reserve studies to ensure they're getting the best, most accurate information.
As you can see, there are a lot of factors that go into reserve studies, but they provide essential information that will prepare community associations for future capital expenses and aid in avoiding financial crises. If your community is considering having a reserve study performed, has questions on the process or needs a study update, please reach out to your CAMS community manager for trusted guidance.
Mike Stonestreet, CMCA, PCAM, AMS, is Founder/Co-Owner of CAMS (Community Association Management Services). CAMS began in 1991 with Stonestreet and a few employees in a small office in Wilmington but has since grown to over 300 employees serving eight regions across North and South Carolina.
His current role at CAMS focuses on mergers and acquisitions, culture alignment and high-level business relationships. Stonestreet is an active member of the NC Chapter of the Community Associations Institute (CAI) and has spent time on their board of directors, serving as the chapter President in 2019.
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