Making the appropriate decisions to adequately fund a reserve account is one of the most basic responsibilities of a Board. Reserve funds are utilized to pay for projected common area expenses like roof replacement, paint or asphalt overlays. Unfortunately for most condominium communities this basic community need is not being met as the majority of communities are severely underfunded, where reliance on special assessments and loans is highest. We have seen that the communities which have lower funding levels (ie. their reserve fund balance is significantly lower than an ideal amount) also have issues with financing units for sales/refinance, have marketability issues with Brokers & Buyers and are typically impacted most by deferred maintenance issues as these communities must defer projects in order find the funds for the projects.
The reason for the lack of adequate reserves is often attributed to a Board and/or Community Membership which seeks the lowest possible HOA dues. With many owners planning on being in the community for only a few years there is little incentive to budget for expenses that are many years into the future. Those Board Members and Property Managers who make a case for adequate reserve contributions and the usual higher corresponding HOA Dues can often be fighting an uphill battle against the majority of the community – the result of which can mean getting voted off the Board or fired as their property manager. What most of these dissenting members do not realize though is that by not adequately funding for projected expenses they are actually paying more in the way of more expensive projects, loans & interest and stagnant or falling home values. There is absolutely no free lunch when it comes to these expenses and playing hot potatoes with who gets stuck with the bill is irresponsible, opens up the Board to liability issues and results in a community atmosphere which is stressful and uncomfortable.
Additionally the most prevalent misconception regarding reserve funds is that they are to pay for some future expense – this is not the case as reserve funds are to offset current deterioration to the common areas. This means that if a member is a dues paying member they should be paying their fair share of the deterioration to the common areas. By pushing off the reserve funds they are piling them on someone else at a future date. This is unfair and opens the Board and Association up to all types of liability issues as these future members will not be very understanding as to why current members decided to not pay their fair share into the reserve account.
Unit Owners See the Benefit of Adequate Reserves
What may seem like just higher monthly dues to some is, to a trained eye, adequately funding the reserve account and in turn benefitting the community members. Those present and future members of a community will see less out of pocket expenses when a reserve account is adequately funded. We have seen this scenario repeat over and over again in the way of special assessments or loans which underfunded communities must rely on. Last minute scrambles for cash, trying to secure loans and find vendors last minute places the community in a position of relying on fewer bids, higher costs and the community does not benefit from compounding interest on the reserve account balance.
Condominium unit owners may scoff at higher monthly HOA dues but when they are presented with a special assessment of many thousands of dollars they are often placed in a position of having to sell, refinance or scramble for money from other sources. This is especially troublesome when there are economic downturns and people have lost their jobs, have reduced incomes and property values are falling. The sources for additional income like working more or refinancing are often off the table during these periods of times – this was prevalent I the 2006-2012 time period. A roof that fails during a period of economic downturn will not wait to start leaking until the economy returns; many communities found this out during this last economic downturn when special assessments were very common and many unit owners decided to just not pay them or walk away from their units leaving them to the Bank.
By adequately funding the reserve account unit owners are paying their fair share for the use of the common areas (deterioration to the common areas) and are doing so in a fair, stable and feasible manner. Instead of large expenses that can lead to financial insecurity they are able to pay a much lower amount rolled into the HOA dues on a monthly basis.
Additionally communities which have a stable and feasible financial strategy are more appealing to Buyers, Brokers and Lenders which in turn results in a higher level of marketability and protected property values (i.e. keep up with market trends).
A Reserve Study is a Valuable Tool
A reserve study completed in compliance with Washington State Law and National Reserve Study Standards is not just a document a community should order to comply with Washington State Laws. It’s actually a very valuable tool for a Board or Property Manager to utilize in their budgeting decisions and recommendations. Within a reserve study you will find the following:
- List of common area components that are the Association’s responsibility
- A projected replacement/repair schedule of the common areas
- Current and projected future costs related to these projects
- Current financial strength of the Association’s reserve account
- Recommendations as to how much should be set aside for reserves
- Numerous funding plans to comply with statutory and client goals
All of these items are extremely helpful for budgeting purposes and disclosure requirements to the community membership. Washington State requires annual disclosure to the membership of common interest communities like condominiums. Disclose as to the adequacy of the reserve account and what if any special assessments would be required to stay cash positive is required. This is regardless of whether a reserve study is completed or if the Board has made fiscally responsible decisions. Annual disclose to the community membership and all potential Buyers of Units in the Community is required with few exceptions. Without a reserve study a community will have an extremely difficult time complying with the laws that are set in place to protect the membership, buyers.
A Board which hires a reserve study company will then need to utilize the reserve study by disclosing and implementing the recommendations. There is little benefit in just knowing the expenses that are projected if nothing is to be done about it. By refusing to implement a financial strategy to meet these expenses head on you might as well remain with your head in the sand and pretend they will not happen as the end result will still be special assessments, loans, deferred maintenance and lower market appeal.
Most Communities Must Act Soon
In Washington State most condominium communities were built 20-30 years ago and most have not adequately budgeting for large expenses that typically arise after 20+ years. This means that the typical condominium community no longer has decades to delay or kick the can of expenses down the road. Deferring projects just lead to higher costs (inflation) and deferred maintenance issues (e.g. peeling paint, rot, leaking roof, potholes, etc.) which leads to lower market appeal. Essentially it’s a viscous cycle of too little money and too little time – which is most often met by ignoring the costs or wishful thinking that their community will somehow avoid them.
It is extremely difficult to watch, as reserve study providers, as communities and their membership fall into a position of a dysfunction. This scenario is unfortunately not uncommon but is completely avoidable. Utilize the services of a reserve study professional to place your community on a path of financial stability and prevent the common pitfalls of going it alone.
Additional Resources: WA State Reserve Study Laws / Washington State Reserve Study Guidebook