Why Your HOA Reserve Funds Matter More Than You Think

What are Reserve Funds?

Reserves, in the context of homeowner associations (HOAs), refer to funds set aside for the repair and replacement of the association's major assets: those with limited, predictable life expectancies (Association Reserves).

These funds pay for planned replacements and large-scale repairs as they come due. Adequate reserves are crucial for the long-term financial health of an HOA and can help prevent the need for special assessments in the event of major repairs or capital improvements.

Effective reserve funds are generally built through continuous yearly, quarterly or monthly contributions from homeowners or property owners. Since reserve study requirements vary by state, it's crucial to consult your legal counsel or management company to make sure the community remains compliant.

Colorado is a good example of why that is worth checking rather than assuming. Colorado requires a reserve study policy, not a reserve study: section 38-33.3-209.5(1)(b)(IX) of the Colorado Common Interest Ownership Act obliges an association to adopt a written policy covering when it has a study prepared and whether there is a funding plan for the work the study identifies, which is a different obligation from having to commission one. Boards often read the two as the same thing.

Benefits of Adequate Reserve Funds

Having adequate reserve funds is crucial for a homeowners association's (HOA) or condominium association's financial health and stability. A well-funded reserve provides several benefits that help protect the community and its property values.

Firstly, reserve funds act as a safety net for unanticipated expenses. HOAs often face unexpected repairs or unforeseen capital improvements. With adequate reserve funds, the HOA can cover these costs without needing to rely on special assessments or other capital raising options. This ensures that the HOA's day-to-day functions, such as routine maintenance and regular operations, are not compromised.

Reserve funds also allow for the timely completion of deferred expenditures. Major repairs or capital improvements that are put off due to financial constraints can become even costlier over time. When our clients ask us if they should do part of the project today and part of it tomorrow, our answer is usually a resounding "Absolutely Not." If you need to repair the roofs on two buildings and you do one building now and the other one next year, chances are the same roofing project next year will cost more due to inflation and the ever rising cost of labor and supplies.

Additionally, having a well-funded reserve mitigates the financial burden on homeowners. Without sufficient funds, HOAs may resort to special assessments, which can be costly and burdensome for homeowners. By maintaining a healthy reserve fund, the HOA can avoid these sudden financial pit falls and instead spread the costs over time.

Lastly, a weak reserve fund exposes current and future owners to special assessments, loans or deferred maintenance (Association Reserves).

Operating Funds vs. Reserve Funds

Operating funds and reserve funds are two important accounts in managing the finances of a homeowners association (HOA). While both funds serve specific purposes, they differ in how they are used and the expenses they cover.

The operating fund is similar to a checking account and is used for day-to-day expenses that keep the association running smoothly. It covers routine maintenance, management fees, insurance premiums, and other regular recurring costs.

On the other hand, the reserve fund is more like a savings account. Its purpose is to save money for future, non-recurring expenses such as major repairs, capital improvements, or costly replacements. The reserve fund helps the HOA cover these unexpected or infrequent expenses without resorting to special assessments. For protecting reserve balances if a bank fails, see 9 HOA Strategies for Handling Bank Failures.

How Much Should Be Kept in Each Fund?

When it comes to determining how much money should be kept in each fund, several factors need to be considered to ensure the financial health of a homeowners association (HOA). The reserve fund, which is crucial for covering future repairs and replacements, requires careful planning.

Conducting a reserve study is essential in order to estimate the cost of potential repairs and replacements over the next 20 to 30 years. This study assesses the current condition of HOA assets and projects the expenses that may arise in the future. By understanding the expected costs, the HOA can set aside an appropriate amount in the reserve fund.

Important considerations that affect the necessary amount for each fund include the age and condition of the property, the size of the community, and the types of amenities and common elements that require maintenance. A thorough analysis can help determine how much should be allocated to the reserve fund versus the operating fund.

Reserve study professionals generally recommend an update every three to five years, and some states require it more often (Reserve Advisors). This allows the HOA to make informed financial decisions and ensures that the reserve fund remains adequate to cover future expenses.

The HOA Board's Role in Managing Reserves

HOA boards play a crucial role in managing reserves for the financial health of the community. Reserve accounts are established to ensure that funds are available for anticipated future expenses, such as major repairs or replacements of common area components. The HOA board along with the property manager have the responsibility of approving reserve accounts, creating budgets, and determining the components for which reserve funds are to be established.

Including reserve accounts in the budget is an essential part of effective reserve management. Just like with a personal budget, it's important to consider these reserve fund savings in the same context as any other fixed expense. They should be accounted for alongside other line items such as insurance, management fees and landscaping.

Someone once said to me "when you prioritize your savings, you can spend the leftovers without guilt."

The Importance of Balanced HOA Dues

HOA dues can be a contentious topic and there are often some extremely loud voices and wildly different opinions. We've heard it all from "our dues are way too high" to "our dues are so low we barely even notice them."

The truth is that if your dues are too high, you can cause major financial stress to the community members. If they are too low, you may hinder the community's ability to take care of future needs or emergencies. The goal is to strike some middle ground so you can cover today's expenses while also preparing for the future. This is much easier said than done and the results can have huge implications.

Unexpected Expenses, Special Assessments and HOA Loans

Unexpected expenses, special assessments and HOA Loans all play a crucial role within homeowners associations (HOAs). Unlike fixed expenses, which cover operational maintenance costs, unexpected expenses refer to unanticipated repair or replacement needs that arise in a community. These expenses are often unforeseen and require quick action to address them.

In such situations, HOAs may opt for special assessments to generate the necessary funds. Special assessments are additional fees imposed on homeowners to cover the costs of these unexpected expenses. These assessments are different from regular assessments because they are specific to a particular project or issue and are not part of the ongoing operational expenses of the HOA.

There are various scenarios that may necessitate special assessments. For instance, if the community pool requires major repairs or if the clubhouse roof needs replacement, the HOA may impose a special assessment to collect the funds needed to address these specific projects. Similarly, unexpected expenses can also arise due to major maintenance or infrastructure issues within the community.

Unfortunately, special assessments are often poorly executed, extremely burdensome and not as efficient at raising money as some might thing. A homeowners association loan or HOA loan might be a more sustainable option. With an HOA loan, a homeowners or condo association can ensure that these unexpected expenses are promptly addressed while minimizing the impact to homeowners. This approach allows for a fair distribution among residents, ensuring that the community remains well-maintained and the property values are preserved.

Final Thoughts

We know all of this sounds great on paper but putting into practice is much more difficult. Many associations have struggled through years of negligent boards or property management companies, catastrophic hurricanes or other climate related challenges. It's never too late to start working toward better practices.

It's important to hear opinions from the owners in the community, consult professionals and educate yourselves about other community associations in your area. The HOA board has a fiduciary responsibility to the rest of the community and it's their job to act in the best interest of their neighbors.

That being said, by living in a homeowners association or condo association, you also have a duty to educate yourself and to be involved when it's appropriate. We encourage all readers to learn about the reserve study and make sure the board is planning for the future and any upcoming major expenses.

Once you have the study in hand, a free planning tool will show you which year your reserves stop covering what is coming. Attend board meetings, make your voice heard in a civilized way and take the time to understand the budget and other financial aspects of the place you call home.

If you need help with community financials specifically related to raising money to cover large capital expenses, contact us now for more information. One of our specialists will be happy to help.