All too often, associations decide for themselves that they can’t handle the truth about not just being underfunded, but exactly how underfunded they are; what infrastructure maintenance has been ignored to preserve funds, and what it will take to get back on track. The truth is that 82% of associations are underfunded at the time of their first reserve study, and a significant portion face the need to catch up with both funding and deferred maintenance. The other truth, one that communities should be eager to handle, is that 100% of associations can become financially and physically stable if they are willing to effectively grapple with the harder truths.
Conversations surrounding reserve studies, adequate funding, and aging infrastructure rapidly accelerated after the Champlain Towers South tragic collapse in Surfside, Florida, and today there are only 10 states which do not have some form of legislation or statute in place to either require or guide the funding of reserves and conduction of reserve studies. Reserve studies are the tool that provides the truth, and luckily, you don’t need to be screamed at by Jack Nicholson in court, ala A Few Good Men, to uncover it. A comprehensive examination of a property’s physical components and financial needs and a 30-year capital plan to meet those needs, reserve studies tell associations where they are at, where they need to be, and how to get there.
Many associations worry most about the “how to get there” part of the equation, as raised fees, special assessments, and loans are not anyone’s favorite buzzwords. Luckily, there are multiple
The truth is, the amount an association should have in reserves differs year to year, and there isn’t a specific percentage at which reserves need to be consistently funded. Targeting an arbitrary balance relative to the fully funded balance does not offer a complete picture of overall financial health. While maintaining a 100% funded balance is generally a safe strategy, it typically results in over-funded reserves as it is incredibly rare that all projects would need to be completed at the same time.
associations are underfunded at the time of their first reserve study!
82% of
funding methods for associations to weigh, meaning associations do not have to adhere to a one-size-fits-all approach to attaining and maintaining adequate reserve funds. Before diving into the three funding methods, it’s important to touch on statutory funding. Defined by local or state jurisdictions, statutory funding does not dictate which funding method to use but does dictate minimum funding requirements. Currently, 18 states have legislation in place requiring reserve studies and/or specific funding requirements, four of which have updated their statutes in the last three years.
The first funding method is FULL FUNDING, which has the goal of maintaining a 100% funded reserve balance. In order to achieve this, an association would need to have the equivalent of the sum of the fully funded balance for each component in their schedule. The fully funded balance for a component is the replacement cost relative to the portion of the component’s life that is used up. For example, if a roof lasts 20 years and the roofing project will cost $100,000, at year 10, the fully funded balance would be $50,000. Full funding is the most conservative funding method, and while a healthy reserve balance is obviously desirable, 100 percent funded reserves are not generally necessary nor an indicator of health.
16 | COMMON INTEREST®
The second funding method, THRESHOLD FUNDING, is the most recommended strategy by reserve study providers. The goal is to keep the reserve balance above a minimum amount, so looking at cash inflows and outflows over time is key. Since most communities never replace everything at once, the balance can increase and decrease over time. The inflows can be set at an adequate and stable level that ensures the reserve balance never drops below the threshold, even in critical funding years when the balance is at its lowest due to capital-intensive projects. This goal is ideal for most communities as it involves stable funding, equitable contributions over time, and adequate funds for major repairs and replacements, which happen throughout the life of a community, but usually not all at once.
The third method is BASELINE FUNDING. This goal operates similarly to threshold funding, however, the reserve fund hits a $0 balance at some point over the length of the reserve study. This is a riskier strategy than both full funding and threshold funding and is generally only acceptable in situations of distress, as there is no cushion whatsoever on
the cash flow. If any capital project comes early or costs more than expected, this strategy could put the association in a funding deficit. This goal is not ideal but is better than deferring critical life safety issues or other expenses that will result in higher costs if ignored, such as roofing.
Associations suffering from inadequate reserve funds and those struggling to prioritize capital projects will benefit most from a current reserve study. While the truth about the status of the community may be hard to hear, the expertise and guidance received through reserve studies offers immediate support and alleviates many challenges associated with evaluating common property repair and replacement. There is always an element of unpredictability when managing a community (though hopefully you never find yourself in the middle of a murder investigation like Tom Cruise’s military movie character) and having a current reserve study and adequately funded reserves helps associations weather increasingly challenging times.
To ease any initial financial burdens, your reserve study provider can incorporate phased increases in annual reserve contributions to gradually increase fees over time. However, each stepped increase pushes the cost burden further down the line, so most providers will limit the amount of stepped
• Fall 2024 • A Publication of CAI-Illinois Chapter
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56
