Unfortunately, many aging condominiums lack adequate financial reserves. It is essential to building up reserve funds to plan for expected and unexpected repairs and maintenance in the future. HOAs (Homeowner Associations) can’t control personal financial matters, but they must maintain adequate financial reserves for the the community they represent. Reserve studies help condominium associations learn to better manage the funds they have. HOAs should have money set aside “in reserve” to cover emergency and scheduled expenses.
The Federal Housing Administration (FHA) is the primary lender for condominiums and under its rules, an HOA must prove to the lender that the “funding of replacement reserves for capital expenditures and deferred maintenance” represents no less than 10 percent of the HOA’s budget.
Board of directors must avoid making estimates when it comes to the financial management of the property. HOA boards and property management companies must hire a reserve study company to prepare an up-to-date reserve study. Reserve studies enable boards to determine next year’s expenses based on the available funds. The board cannot plan to spend more than reserves available to the community.
Beyond general operating expenses such as insurance, landscaping, water bills, etc., boards have to be ready to pay for major repairs, alterations, and property improvements. Many older condominium buildings require an increased amount of money to properly maintain. A driveway might need immediate repair, or a building might have to be tented for termite control, or a roof might need to be replaced. All of these cost money, and the additional expenses must be paid for in order to maintain the value of the property. Of course, all of these numbers must be incorporated into the annual budget.
How does the board project reserves? A well-run HOA board relies on periodic reserve studies. They either hire a reserve study consultant or a reserve study company to perform a reserve study for them. The reserve study is based on a comprehensive architectural and engineering study of the condominium. The reserve study includes the projected useful life of the elevator, roof, boiler, roof and other components. The reserve study also includes potential repair costs. The reserve study enables the board to set aside the necessary amount each year to cover each potential repair costs.
For example, the reserve study might point out that the board would need to spend $75,000 in five years when the community roadways need to be resurfaced. To accomplish that the board would need to set $15,000 aside a year to pay the cost. Of course, this money must be collected from the homeowners as part of their HOA fees.
There is no magic formula to determine how much is adequate. But, reserve studies performed at least every five years will help the board maintain a healthy reserve.
If reserve funds are unavailable, the board still has some options:
- Increase monthly HOA dues. The board could increase HOA fees by the required amount to build up adequate reserves. The problem with this approach is that it will not help with immediate financial needs.
- The board might be able to impose a special assessment. The governing legal documents should authorize the board to impose a special assessment on homeowners. For example, if the board immediately needed $100,000 to replace a roof and if there are 125 owners in the building, this would require each owner to pay $800 immediately.
- HOAs can apply for a loan, but there are some potential legal and financial hurdles that the HOA has to overcome. To apply and receive a loan might also take longer than the board has to cover a major expense.
Although the above options are available to homeowner associations it is best to have adequate reserves set aside. A well-managed condominium must set aside recommended reserves based on a recent reserve study. Boards have a fiduciary obligation to the owners who elected them to make sure there is an adequate reserve for the property.