Over the last 30 years we’ve helped thousands of clients across the country anticipate and prepare for their community’s major repair and replacement costs with Reserve Studies.
Armed with this knowledge HOAs can make accurate disclosures to homeowners and set their monthly dues accordingly.
But where do you start? Try this handy list of 5 tips for reading your Reserve Study:
1. Don’t get stuck on the Percent Funded Report.
A common misstep when reviewing the reserve study is getting stuck on the first section, the Percent Funded Report. While this report does offer valuable information regarding the condition of the reserves at fiscal year-end, it is only a snapshot in time prior to the beginning of the report.
While it is possible to review component data from the Percent Funded Report, it is not recommended as the information is incomplete. Quantity, unit of measurement and cost per unit data are only available in the Component Report; it is the last section of the reserve study and where serious review should begin (see #2).
2. Review the Component Report first
The component report houses what are essentially the “meat and potatoes” of the reserve study. The useful-remaining life, quantity, unit of measurement and cost per unit data are what drive all projected disbursements over the 30 year projection. This is where you will also find non-reserve components included for visibility such as those treated as maintenance/operating, individual homeowner responsibility, life of project, etc. There are also notes regarding any significant changes and their sources.
Once the component report has been reviewed and any necessary revisions have been incorporated, you can move on to assessing the financial condition of the reserves.
3. Understanding the Percent Funded Report
Percent funded is a rolling metric that measures the relation of actual to ideal cash on hand at the end of each fiscal year. The easiest way to understand what 100% funded represents is to take the example of a component that has a service life of 10 years and a replacement cost of $10,000.
The required funding is a straight line depreciation figure so for each year in service you should ideally have $1000 set aside to cover the use of that asset. In a perfect world after 5 years in service there will be $5000 in the reserve account, or 100% of the ideal value. If after the 5 years in service there was only $4000 in the reserves, this would represent 80% funded ($4k/$5k = .8).
4. Current, 100% & Threshold Funding models
A common question by both management and board members alike is “where is the recommendation?” The truth is, our reserve study format does not offer a recommendation, what it does provide are:
1) Current Funding – a picture of what the association is doing today and where it will get them, the year 1 annual funding will be whatever is in the current budget.
2) 100% in 5 Yrs. Funding – a goal oriented funding report with a self-explanatory title, the year 1 annual funding requirement is what would have to be approved in the budget to meet the goals of this plan.
3) Threshold Funding – a secondary goal oriented report that is designed for the association to sufficiently meet all scheduled expenditures over the 30 year projection while maintaining a threshold cash balance (5% of the current replacement costs rounded to the nearest 5k).
5. Implications of implied year 1 funding requirements
Ultimately if we have to make a recommendation we are going to say get to 100% and stay there as this is the most conservative approach. In reality this is either unattainable or undesirable for most associations. The beauty of our goal-oriented reports is that they create a high-and low-end benchmark for the year 1 funding requirement. By design, as long as the association’s annual contribution from regular assessments falls between the 100% and Threshold year 1 requirements the association will be projected to meet all scheduled expenditures over the 30 year projection.
If there is a cash deficit represented, the threshold funding year 1 requirement is usually a good place to start. Meeting the year 1 threshold requirement as previously stated will put the association on track to sufficiently meet all scheduled expenditures; however, it does not provide much room for errors such as unforeseen/emergency expenditures, borrowing from reserves, etc. It is not recommended to try and maintain a Threshold Funding level; it is simply a bare minimum requirement which will provide the association with a clean Disclosure Statement.
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