Atlanta HOA and Condominium Companies and Reserve Studies: Part 2

Single Family Neighborhood

There are two components of a reserve study—a physical analysis and a financial analysis. During the physical analysis, a reserve provider evaluates information regarding the physical status and repair/replacement cost of the association’s major common area components. To do so, the provider conducts a component inventory, a condition assessment, and life and valuation estimates. A financial analysis assesses only the association’s reserve balance or fund status (measured in cash or as percent funded) to determine a recommendation for an appropriate reserve contribution rate (funding plan).

Types of Reserve Studies

Reserve studies fit into one of three categories: Full; Update, With-Site-Visit/On-Site Review; and Update, No-Site-Visit/Off Site Review (listed from exhaustive to minimal).

• In a Full reserve study, the reserve provider conducts a component inventory, a condition assessment (based upon on-site visual observations), and life and valuation estimates to determine both a fund status and a funding plan.

• In an Update, With-Site-Visit/On-Site Review, the reserve provider conducts a component inventory (verification only, not quantification), a condition assessment (based on on-site visual observations), and life and valuation estimates to determine both a fund status and a funding plan.

• In an Update, No-Site-Visit/Off Site Review, the reserve provider conducts life and valuation estimates to determine a fund status and a funding plan.

 Contents of a Reserve Study

A reserve study should include the following:

• A summary of the association, including the number of units, physical description, and the financial condition of the reserve fund.

• A projection of the reserve starting balance, recommended reserve contributions, projected reserve expenses, and the projected ending reserve fund balance for a minimum of 20 years.

• A tabular listing of the component inventory, component quantity or identifying descriptions, useful life, remaining useful life, and current replacement cost.

• A description of the methods and objectives utilized in computing the fund status and in the development of the funding plan.

• Source(s) utilized to obtain component repair or replacement cost estimates.

• A description of the level of service by which the reserve study was prepared and the fiscal year for which the reserve study was prepared.

Disclosure

Experts recommend the following items be included in a comprehensive reserve study:

• A statement disclosing other involvement(s) with the association that could result in actual or perceived conflicts of interest.

• A narrative description of the physical analysis that details how the on-site observations were performed, i.e. representative sampling vs. all common areas, destructive testing or not, field measurements vs. drawing take-offs, etc.

 • A description of the assumptions utilized for interest and inflation, tax and other outside factors for the financial analysis.

• A written explanation of the credentials (state or organizational licenses/credentials) held by the individual who prepared the reserve study or oversight.

• A report on how the current work is reliant on the validity of prior reserve studies.

• Discussion of material issues which, if not disclosed, would cause a distortion of the association’s situation.

• Reliable information provided by the association’s official representative regarding financial, physical, quantity or historical issues. The reserve study will be a reflection of information provided to the consultant and assembled for the association’s use, not for the purpose of performing an audit, quality/forensic analyses, or background checks of historical records.

• The actual or projected reserve balance total presented in the reserve study based upon information provided.

• Accurate reserve components as determined in the Update With-Site-Visit and Update With No-Site-Visit levels of service.

• A description of reserve projects which is considered reliable. Any on-site inspection should not be considered a project audit or quality inspection.

Determining a Reserve Schedule

A reserve schedule is the financial summary of the reserve study. Its format depends on the funding method used.

Establishing a Preventive Maintenance Schedule

Once you’ve determined which items are reserve components, it’s time to establish a preventive maintenance schedule. Associations should establish a preventive maintenance schedule for two primary reasons:

1. If associations do not maintain the components on the reserve schedule, they will not attain their full useful life. Consequently, the components will need to be replaced earlier and the replacement cost will need to be collected over a shorter period of time. This could result in possible special assessments.

2. If associations do not maintain the components that are not included in the reserve schedule, they may require replacement whereas if they were maintained, they would not. For example, wood siding, when maintained properly, will last indefinitely. Without proper maintenance, it may need to be completely replaced in the future.

Selecting a Funding Plan

Once your association has established its funding goals, the association can select an appropriate funding plan. There are four basic strategies from which most associations select. It is recommended that associations consult professionals to determine the best

Step 1—Review community documents and statutory requirements to determine the following: Is the component part of the common elements?

Step 2—Is the component covered under a maintenance contract?

Step 3—Is the component included in another part of the budget?

Step 4—Is the component a piece of mechanical equipment?

Step 5—Is the useful life of the component within the selected time window?

Step 6—Is the replacement cost below the operating budget  threshold?

Additionally, associations should consult with their financial advisor to determine the tax implications of selecting a particular plan. Further, consult with the American Institute of Certified Public Accountants (AICPA) for their reporting requirements.

7). The four funding plans and descriptions of each are detailed below.  Associations will need to update their reserve studies more or less frequently depending on the funding strategy they select.

Full funding—The goal of this funding strategy is to attain and maintain the reserves at or near 100 percent. For example, if an association has a component with a 10-year life and a $10,000 replacement cost, it should have $3,000 set aside for its replacement after three years ($10,000 divided by 10 years=$1,000 per year X 3 years=$3,000). In this case, $3,000 equals full funding.

Baseline funding—The goal of this funding method is to keep the reserve cash balance above zero. This means that while each individual component may not be fully funded, the reserve balance does not drop below zero during the projected period. An association using this funding method must understand that even a minor reduction in a component’s remaining useful life can result in a deficit in the reserve cash balance. Associations can implement this funding method more safely by conducting annual reserve updates that include field observations.

Threshold funding—This method is based on the baseline funding concept. The minimum reserve cash balance in threshold funding; however, is set at a predetermined dollar amount.

Statutory funding—This method is based on local statutes. To use it, associations set aside a specific minimum amount of reserves as required by statutes.  

Developing an Investment Policy

Developing an investment policy is suggested to set a standard and procedure for investing reserve funds. It also allows boards to make consistent choices and brings structure and continuity to the decision. When developing an investment policy, the board should discuss and evaluate the following topics: general policy, goals and objectives, investment strategy, investment securities’ selection criteria, and review and control policies. Additionally, many states have laws protecting community associations from making what some would consider risky investments. It is suggested that associations review state laws related to reserves; review association documents regarding reserves; consult with service providers such as an attorney, an accountant and a community association manager; and conduct yearly reserve policy reviews.  

Financial Reporting

In the early 1990s, the AICPA developed the AICPA Audit and Accounting Guide: Audits of Common Interest Realty Associations (CIRA) to establish accounting standards for accountants to use when composing the financial statements for common interest realty associations. The guide outlines what needs to be included in the financial statements and has requirements for information pertaining to future repairs and replacements.

The following should be included:

• Requirements, if any, in state statutes or association documents to accumulate funds for future major repairs and replacements and the CIRA’s compliance or lack of compliance with them.

• A description of the CIRA’s funding policy, if any, and compliance with it.

• A statement that funds are accumulated based on estimated future (or current) costs, that actual expenditures may vary from these estimates and that the variations may be material.

• Amounts assessed for major repairs and replacements in the current period, if any.

• A statement indicating whether a study was conducted to estimate remaining useful lives, future major repairs and/or future replacement costs.

• Information regarding special assessments if associations fund major repairs and replacements using them.

Share This Post

Latest posts

Browse By Category
Browse By Date