A homeowners association is responsible for many things, and perhaps nothing more important than overseeing day-to-day operations of the community. They hire landscapers to mow the grass and trim bushes and gardens. The HOA maintains common areas, like pools or parks that are owned jointly by everyone who purchased a residence in the community.
The HOA budgets for these everyday expenses and also plans for future, large expenditures – both known and unknown. Examples of larger, future expenditures might include the repair or replacement of major common area components, such as roofs, boilers, elevators, decks, swimming pools, balconies, fencing, concrete areas, asphalt surfaces and monument signs.
These less common, yet significant expenditures, are usually paid with designated, HOA reserve funds. Determining appropriate levels and uses of HOA reserve funds are often some of the most contentious decisions made by an HOA board. The HOA is charged with doing what is best for the community as a whole, and creating and managing reserve funds can best help the community plan for the long term. Keeping the community’s assets in top condition adds value to the community and the individual properties, something high on most resident’s list of priorities.
Operating versus reserve funds
Operating funds cover day-to-day operations and expenses. Significant short- and long-term projects are handled by HOA reserve funds. Of course, the sources of both funds are the resident members of the HOA. When association dues are collected, they are allocated to an operating fund and to a reserve fund. Operating funds are best kept in a transaction account, such as a bank checking account. Reserves are usually put into a savings vehicle, such as a simple bank savings account. It is wise and often required that the two funds are kept separate.
Uses of reserves
Residents and even board members are often uncertain on the true purpose of a reserve fund. For example, is the replacement or repair of a single defective HVAC system an expense for the operating budget or the reserve fund? If it’s one unit in a community with many HVAC systems, it may be appropriate to expense it through the operating funds. If it’s the planned replacement of all the HVAC systems in a large community, then it’s a good candidate to cover with reserve funds. Some people prefer to call the reserve fund a “replacement fund” to better indicate its purpose as a way to plan for large expenses and to avoid special assessments.
Special assessments for extraordinary circumstances
Special assessments (in addition to normal HOA fees) may need to be charged on occasion, usually to make major repairs or improvements that cost more than the amount in the reserve fund. Most residents are less than happy to learn they will have to pay special assessments, whether it’s due to poor planning or an unforeseen emergency repair. In the ideal situation, the reserve fund has enough dollars to avoid the need for special assessments.
Reserve studies bring clarity
Reserves are often underfunded and a source of confusion. A reserve study can bring clarity to the board and residents as to the purpose and use of reserve funds. A reserve study is a budget-planning tool that determines the current status of the reserve fund and fashions a stable and fair funding plan to manage anticipated future, significant common area expenditures.
Homeowner associations, regardless of size, should perform a reserve study and update it on an annual basis. A qualified third party, someone with experience performing reserve studies and a list of happy HOA client references, should perform the study. Professional Reserve Analysts (PRAs) hold the highest credentials in the industry to perform reserve studies. If you have a property manager, that organization may also be qualified to perform or administer a reserve study.
Reserve funds help HOAs meet legal, fiduciary and professional requirements. Reserve funds might be required by community’s bi-laws, local statutes or by secondary mortgage markets in which the association participates (Fannie Mae, Freddie Mac, FHA, VA). Reserve funds reduce the likelihood of the need for special assessments or borrowing. Most importantly, reserve funds share the costs and benefits among residents, promoting harmony and increasing property values.
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The Tiehen Group has been providing professional property management services for homeowners associations in the Kansas City area for more than 20 years. We enjoy sharing our knowledge and perspective with interested people and organizations. Contact us today if you like to discuss HOA reserves or other HOA matters.