The primary reasons to perform a reserve study include:
• Helping to ensure that funds will be available to make necessary repairs and replacements when the time comes, which results in a well-maintained community continually in a good state of repair
• Protecting, maintaining, and even increasing property values
• Reducing the likelihood of special assessments or loans to fund repair and/or replacement projects
As defined by the Reserve Study Committee of the Community Association Institute (CAI), all reserve studies should consist of two parts: the Physical Analysis and the Financial Analysis.
The importance of the Physical Analysis cannot be understated because it determines the existing condition and actual expected life of the common area components.
The Physical Analysis includes:
o Identifying common elements and performing a component inventory
o Conducting an on-site condition assessment of those common elements
o Estimating the remaining useful life and replacement costs of components included in the assessment
Likewise, the Financial Analysis is critical to determine whether a community’s reserves are adequately funded to meet the projected expenditures determined by the Physical Analysis.
The Financial Analysis includes:
o The evaluation and analysis of the association’s reserve fund balance, income, and expenses
o A review of the current reserve fund status
o Recommendations for appropriate funding changes based upon the results of the physical assessment and funding analysis
What can you expect from a Reserve Study?
FEA has often found that the expectations of property managers, associations, and/or board members regarding the scope and results of a reserve study are not always consistent with what the reserve study provider will deliver. Therefore, we generally offer the following clarifications about the intent of a reserve study, and what the community can realistically expect.
A reserve study IS:
• A planning tool to determine the proper funding level to keep the community’s reserve funds at an adequate level to meet projected expenditures
• A guide for required or expected repairs and replacements
A reserve study IS NOT:
• The association budget. The reserve study may be used as a guide in the budget process. However, it may not be necessary to replace a common element at the time shown in the reserve study, and costs may differ from the opinions provided in the study. It is important to understand that the reserve tables represent a model and not a mandate.
• A comprehensive engineering evaluation of all components, or a mechanism to perform destructive testing, sampling, or evaluation of causes for deterioration or failure of common elements. In some instances, the reserve study may include recommendations for further evaluation of certain components.
• An evaluation of facility management and maintenance practices. The reserve study report may include discussion of the status of maintenance if it has an impact on the remaining useful life of the common element, but assessing or commenting on maintenance practices is not typically included as part of the reserve study.
• A report with recommendations for improvements, upgrades, and enhancements to existing common elements. The reserve study will typically project replacements in-kind. In general, it does not consider and evaluate all options for replacement of an element, which may be preferred due to changes in technology, performance, efficiency, etc. However, if a capital project for upgrading or improving certain reserve elements is known at the time of the study, the elements of the project and cost implications can be incorporated.
• An infallible document. Despite the best efforts of the reserve study provider to deliver accurate opinions of cost and timing of replacements, the actual costs and timing depend on many factors which are often difficult to predict and beyond the control of the reserve provider.
Reserve Funding Plan Methodology
When determining funding goals, there are two primary methods to analyze and evaluate a community’s reserve fund plan:
• The component method analysis, and
• The cash flow method
With component method analysis we look at each individual component to determine its useful life and replacement cost. The amount of money you need to reserve for that particular component is the replacement cost divided by the remaining useful life (interest and inflation can be considered in either scenario), i.e.:
Amount to reserve each year for Component A = RUL
EXAMPLE: A new roof was installed in 2014. The installation cost was $100,000, and the estimated useful life of the new roof is 20 years.
RUL = 20 years
Replacement cost = $100,000
Amount to reserve = $100,000/20 years = $5,000 per year
The component funding requirement and subsequent required annual contribution to reserves is determined by adding up the requirement for all components, i.e.:
In the component funding scenario above, the required annual contribution to the reserve fund is $103,875.
In general component method funding is conservative, presents a more complex accounting challenge, and is rarely followed in reality.
When using the cash flow method to analyze and evaluate a community’s reserve fund plan, we still have to look at each component, its remaining useful life and its replacement cost, but we look at it through a broader spectrum of what our total expenditures are every year. Using the same components from earlier, the reserve expenditures are sorted and displayed by year:
Boiler, Cooling Tower
Once we have the starting reserve fund balance, the current annual contribution to reserves, and the projected expenditures by year, then we can determine if the contribution level is sufficient to meet projected expenditures, and if not, what the contribution needs to be. For example, for each year of the study:
Starting Balance + Current Contribution - Expenditures = Reserve Cash Balance
In FEA’s experience the cash flow method is simpler than the component method analysis and more accurately reflects actual reserve accounting. With both methods, accurate determination of remaining useful life and replacement cost is key to an adequate funding plan.
The Reserve Study Standards issued by the Community Association Institute (CAI) and the Association of Professional Reserve Analysts (APRA) define a variety of different funding goals:
• Baseline Funding, which establishes a funding goal of keeping the reserve cash balance above zero.
• Full Funding, which sets a reserve funding goal of attaining and maintaining reserves at or near 100% funded which in essence means that the account for each component should contain the right amount of funds based on age of the component and the replacement cost.
• Statutory Funding, which establishes a reserve funding goal of setting aside the specific minimum amount of reserves required by local statutes.
• Threshold Funding, which establishes a reserve funding goal of keeping the reserve balance above a specified dollar or percent funded amount. Depending on the threshold, this may be more or less conservative than Full Funding.
How often should you do a reserve study and who does them?
Due to changing financial conditions and varying aging patterns of components, reserve studies should generally be performed or updated every three to five years. Interim reserve study updates without site visits can also performed as often as every 1 to 2 years to ensure the integrity of the reserve fund and the financial well-being of the community.
FEA recommends using CAI-certified ‘Reserve Specialists’ or APRA-certified ‘Professional Reserve Analysts’ to perform reserve studies. These designations are awarded to suitable individuals who have demonstrated experience and knowledge of reserve funding principles, and who have a general knowledge of construction and building systems and components. We also recommend checking references before selecting a reserve study provider, and always consider that the cheapest firm is not always the best one suited to perform your reserve study.