The financial operations of running a community consist of two types of funds: operating funds and reserve funds. The operating funds are primarily used for the day-to-day expenses of the community, like contracted services (lighting, security, and gates). Operating funds are also used for utility expenses, taxes, insurance, and general office or accounting and legal fees.
For large scale projects that have been approved by the HOA in terms of replacement or repair, there are reserve funds that get set aside. These projects are often referred to as capital projects and must meet specific criteria in order to be covered by reserve funds. For example, according to the community bylaws, rules and regulations, and accountability, examples of reserve fund projects could be landscaping, renovation or construction projects, replacing a roof, or improving an aging building. Reserve funds are not traditionally intended to be used for something new to the community.
So, when it comes to reserve funds, how much does your HOA need? It’s best to have a surplus of funds for unknown expenditures. It may also be necessary to require a special assessment for any upcoming major projects, if the association’s savings are insufficient. We’re going to break it down, so you can decide just how much is right for your community and why.
Why Are Reserve Funds Necessary?
The governing documents used by the HOA to run a well-organized community are vital when it comes to making financial decisions. It’s important to be familiar with these documents in order to understand how to operate, maintain, repair, and replace the common areas within a development. The common areas include property that is owned jointly by homeowners and that every homeowner has a right to use. Pools, parks, clubhouses, sidewalks, parking structures, and entrance gates are all examples of common areas within a community.
Your HOA’s governing documents outline the HOA’s ability to collect assessments from homeowners periodically to pay for ongoing maintenance and expenses in terms of operating, repairing, and replacing property within the common area. The HOA implements an annual budget in order to determine how much money may be necessary for these projects.
Annual Budget: How Much Do You Need?
There are several factors that will determine the right amount for your community, such as how many common areas there are and what amenities are offered. It’s also important to consider the age of your community and what ongoing expenses there may be. Operating costs and the annual budget will be used to designate what assessments need to be collected and assigned to the reserve fund. The HOA must identify the appropriate amount to put into a reserve fund, and this information may be determined through a reserve study.
What is a reserve study?
A reserve study is created by setting a long-term schedule of potential costs and repairs that is typically completed by a professional reserve analyst. The analyst will assess the property and estimate costs and the timing of repairs to common areas that will likely be necessary over the next 20 to 30 years. This study’s schedule will allocate the estimated costs over an extended period of time. Based on this assessment, the HOA will determine the periodic assessments necessary to complete these projects and set aside a predetermined amount to cover the impending expenses needed by the association.
What do I need to provide for a reserve study?
The overall cost of the reserve study is generally determined by the number of common areas within a community, the overall size of the community, any deferred maintenance issues, and the availability of property blueprints, as well as other factors. The following items will be essential resources for a reserve analyst to complete a thorough and accurate assessment for the reserve study:
- Records of the history of common area projects, repairs, and replacements
- HOA governing documents
- Updated financial information
Planning for the Future
Having adequate resources in any HOA fund is important. Without money in the reserve, when an HOA is faced with expenses outside of traditional operational expenditures, there are two choices presented: 1) increase assessments by a significant margin to collect a large sum quickly or 2) levy a special assessment. Homeowners generally do not like either of these options for obvious personal financial reasons. Homeowners operate on a budget, too.
Increasing assessments or levying unanticipated special assessments are inefficient solutions and generally frustrate homeowners because of the HOA’s lack of planning. Properly maintaining a reserve fund is extremely important to a community and its homeowners. Some funding institutions and states may even regulate reserve funds in order to ensure they’re being properly collected to meet an HOA’s responsibility without placing any unnecessary stress or unexpected financial burden on the homeowners.
How Does Your Reserve Account Look?
After the reserve study is completed by the reserve analyst, the board must closely review the report and create a detailed plan overview to provide the homeowners, which would include a schedule of common area updates and any future assessments. The homeowners should be informed of the HOA board’s strategic outline and the steps necessary to complete these projects, how the HOA will save money for future expenses, and how they plan to keep the community looking nice for years to come. This information is important to homeowners, especially when it comes to property values. As future planning meetings are held, continue to analyze and predict future costs and schedules.
If your HOA hasn’t completed a reserve study yet, now is a great time to get started. If there is a reserve study analysis on file, be familiar with it and utilize its findings as a plan for the future of your community.
Once a plan for capital projects is in place, you will find it much easier to oversee the annual budgeting process. Your reserve study and the proper management of reserve funds will create a more successful environment in which you, the HOA board, and the homeowners can thrive. Like most important things, it may be painful at first, but eventually, you will look at your association’s improved financial stability and be grateful to have a fully funded reserve.