Many association board members and community management professionals are at a crossroads when considering the methods in calculating reserve fund needs. In the infancy of community association living, if Reserve Studies were done, they would simply leave it up to the management professionals to put a percentage aside of any association dues. However, things have become more complicated.
Both cash flow funding and straight line funding methods use the exact same data to put aside Reserve Funds, replacement costs and replacement years. The difference arises not from the data, but from the mathematical models used to calculate the funds for replacement costs.
Cash Flow Funding Method
The cash flow funding method makes a determination of the reserve allocation by estimating the costs over a specific period of time of 30 years, and it tests a variety of allocations until a minimum allotment is found that controls a net reserve or percent funded. The difference in the two is that the cash flow has a pool of money in the reserve fund instead of each element having its own balanced amount. Funds in the cash flow pool reserve can be used for expenses related to any item in that fund. An example of this would be both the painting and roofing reserve monies are pooled together into one fund. Unit owners don’t need to vote when costs from one reserve account are to be utilized for another purpose.
The guidelines still dictate that the reserve schedule that is associated with the annual budget, sets forth the necessary items like paving, roofing and painting with the replacement costs and maintenance exceeding $10,000. The cash flow method must also acknowledge an estimated useful life and replacement costs for each reserve element.
Straight Line Funding Method
The reserve schedule that is associated with the proposed budget has usually used the straight line method of figuring out the reserves. This method provides funding that is allocated for each individual element. The reserves for roofing, paving and painting are all calculated separately from the other necessary components.
An example of Straight Line Funding would be as follows:
A condominium roof has a 20 year life, and it is 10 years old. The replacement cost would be $50,000. If the association has $25,000 in roof reserves, the condominium association would need another $2,500 per year for the next 10 years to equal $25,000 to fund this project. This basis is used for all other reserve items like repaving, buildings and painting projects.
The Cash Flow Method versus the Straight Line Method
The straight line approach is a more cautionary method that ends up with more money being secured away into the reserves. However, the cash flow method is much easier to manage because the funds can be allocated for any reserve item. The straight line method has so many more restrictions in place.
The law dictates that reserve funds can only be utilized for their assigned uses when following the straight line funding method. If the community needs painting, the painting reserves can only be used for that specific purpose and no other. Monies cannot be taken from the painting reserves to pay for the paving expenses.
The HOA can use reserve funds for non-designated purposes if this has been approved ahead of time by a majority vote of the community owners. A vote waiving or adjusting the reserve funding, and a vote using reserves for items that are not within the schedule are two separate entities.
The cash flow method is much simpler and only needs a vote when using reserve funds to pay for jobs. That is why it the cash flow method is taking the lead with most associations.