For most associations, budget season is right around the corner; which means it is an important time to think about the status of the reserve funds and schedule for capital projects. A 2020 poll commissioned by CAI’s Foundation for Community Association Research found that 60% of community association members said that their association utilize a reserve study to plan for capital projects. In this article, we breakdown the financial analysis of the reserve study and the best ways to utilize the reserve study during budget season.
UNDERSTANDING
RESERVE FUNDING To comprehend current fund status and to effectively communicate the recommended funding plan, one must understand the purpose of reserve funds. The purpose of establishing and maintaining adequate reserve funds is to ensure an association can afford capital projects when they are needed. Sound financial planning for long term capital improvement needs is an important duty of the association’s executive board in acting in the best interests of the association, utilizing sound business judgment.
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By prioritizing all capital projects and developing a customized reserve funding plan for the next 30 years, the reserve study supports a board’s ability to proactively manage replacement events and facilitate the annual budgeting process. Furthermore, the reserve study aims to minimize the risk of additional financial assessments (or special assessments) as the community ages. This understanding is also critical to developing a comprehensive annual budget and maintaining the physical condition of common property. It is critical to review the reserve study’s funding plan as the recommendations for the next several years speaks to an association’s financial status.
A properly funded association can generally expect consistent annual reserve contributions with inflationary adjustments over time.
Adequately funded associations likely experience annual reserve contributions that are relatively flat, or in certain cases, decrease at a future point in time.
Underfunded associations generally experience stepped increases (i.e. $15,000 annual increases for x years, which
are designed to get funding back on track) followed by inflationary adjustments thereafter. In extreme cases associations may see contributions double (or more) than that of their current budgeted amounts.
MISCONCEPTION ABOUT
RESERVE FUNDING A common misunderstanding by associations is assuming their funding status is “healthy” due to its high balance. For example, “we have $600,000 in the bank and minimal expenditures. As such we do not need to increase annual reserve contributions for several years.” Without a current reserve study, the reserve balance is not necessarily an accurate indication of overall financial health.
Important questions to consider include:
Are critical projects being deferred?
Does the association have a clear understanding of both near-and-long-term replacement needs?
In the chart on the opposite page, year-end reserve balances are projected to peak at $724,646 followed by more than $1,350,000 of
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