Recipe for Disaster

Planning for Reserve Funding

We’ve all driven past neighborhoods that have gone to seed. The pool is closed and empty. The tennis courts are cracked and weeds are growing up through the asphalt. The roof is caving in on the clubhouse, and the perimeter fence looks like it’s about ready to fall down. More than likely, these associations failed to create a reserve fund to replace and maintain the association’s common property.

Devastating Consequences

All too often, association budgets don’t include enough money for reserve funding. Some new association budgets don’t take reserve funding into consideration at all. Failure to plan for the inevitable maintenance of association property and amenities is a recipe for certain disaster that can take your development down a rocky road. The consequences for not adding reserve funding to the budget can be vast including the depreciation of property values, increased days on the market for new home inventory, increased or special assessments to homeowners and potential liability for developers and builders.

Fast Forward

Reserve funding is an area that is often unintentionally overlooked by developers who are more concerned with the imminent, day to day expenses instead of looking in the future towards eventual property maintenance and replacement. Ninety-nine percent of associations created today will require at least a minimal amount of reserve funding. Remember to fast forward and look ahead when creating the association budget. Even if the association merely has a monument at the front entrance, it will still require a budget line item for reserve funding. At some point, the monument will need repair or replacement, and even the most modest front entrance monument will have a replacement cost of at least $10,000.

Five Steps

Reserve funding has five essentials steps:

• Determine what items the association will need to repair/maintain/replace in the future
• Determine the approximate life span of the item
• Calculate a cost estimate for repair or replacement of that item in the future
• Divide the replacement cost of the item by the life span of the item to determine how much will need to be saved each year in order to pay for the item at the time of replacement
• Establish a separate, interest bearing bank account for reserve funding

For example, let’s say that an association has a large monument at the entrance that has a replacement value of $20,000 and a useful life span of 20 years. In order to have enough money in the bank to replace the monument in twenty years, the association would have to save one thousand dollars per year for twenty years.

A Reseve Study

After the amenities and common properties are constructed in a developing community, developers would be wise to commission a formal reserve study. This is performed by third party accounting professionals that will provide a detailed report on the funding needs of the association. A formal reserve study will include a physical and fiscal description of all property, calculation of useful life spans and/or remaining life spans and replacement costs for all association owned property. The reserve study also takes into account any inflation that may occur and includes that amount in the replacement values. A formal study such as this provides valuable information to the homeowners so that they can estimate what their expenses are going to be in the future and plan accordingly.