When thinking about funding for future capital projects such as re-roofing or replacing asphalt, Association Board members often ask the $64,000 question: How much should we budget for future capital projects? A Reserve Study is the only way to determine appropriate reserve contributions to ensure that capital projects can be conducted without the fear of special assessments. A Reserve Study is a physical analysis of the association’s common property (minimum 30 year forecast) and a financial analysis that determines appropriate homeowner contributions into a reserve fund to conduct capital projects when necessary.
Determining appropriate reserve contributions is no easy task. Professional Reserve Studies have been available to community associations for only about the last 15 years. The Association of Professional Reserve Analysts and CAI have issued standards and a designation program for Reserve Study providers.
An alternative to hiring a professional reserve consultant became available in recent years: reserve software. Software has been developed by a number of firms and marketed as a low cost alternative to using specialists.
Easily, the biggest advantage to using reserve software is the price, while investing in a professional Reserve Study offers many other advantages. The benefits of hiring a reserve professional include accuracy, independent third party opinion, consistency, reliability, and saving the Board valuable time in conducting the Reserve Study.
How would one conduct a Reserve Study using purchased software? The Board member or association representative who is going to conduct the Reserve Study internally with purchased software often gets more work than he anticipated. The individual must first identify all the common elements that the Board is responsible for maintaining such as exterior walls, roofs, asphalt pavement, clubhouse flooring and wall coverings, mechanical systems such as boilers and cooling towers, retaining walls, pool, sidewalks, to name a few. Associations generally will maintain anywhere from 10 common elements up to 100 elements that should be a part of the Reserve Study.
The second step is to quantify the common elements. This step includes taking measurements such as square feet of roofing, exterior walls (excluding windows), pavement, sidewalks, linear feet of curbing, or number of exterior lights. The association should make sure that those conducting the measurements are measuring in a consistent way.
Next is the condition analysis of the common elements – determining the remaining useful life or "how much longer before we need to repair or replace.” This analysis plays a very large role in determining the appropriate amount of reserve contributions by the homeowners. This is an area where the expertise of a specialist is extremely valuable. The individual who conducts the study with software should consider whether the development was constructed in phases and whether it makes sense to consider replacements in a phased manner or to project partial replacements. This is also where the individual must make judgment calls about such items as asphalt pavement or sidewalk deterioration. Issues one should consider include the soil conditions beneath the pavement, likelihood of tree roots displacing sections of sidewalk, etc., and the percent of the total square foot area that will require replacement earlier than is typical.
Should the association conduct replacements earlier than necessary due to aesthetics? Many Boards view lobbies and entry signage as reflective of the image of the association. In order to maintain a positive image, refurbishing and redecorating are conducted for aesthetic purposes rather than wear and tear. Additionally, specialists can often make engineering recommendations based on success stories observed at other associations that prolong the lives of the common elements and reduce the long term costs to the association.
Historical information, maintenance contracts and association records, if available, are helpful in identifying patterns of repairs and replacements. Another method of obtaining remaining useful life information is by asking qualified contractors. The individual should obtain a minimum of three bids. It is also recommended to check references of the bidders to ensure the level of quality that is consistent with the Association’s long range goals and objectives.
Some software programs will provide replacement costs of most common elements under normal conditions and average costs. These replacement costs are general in nature and do not consider factors that may reduce remaining lives such as extreme weather conditions like several consecutive harsh winters, poor workmanship, construction defects, lack of aggressive maintenance by previous boards, etc. Does the Board want to replace carpet with $20/yd. or $60/yd. carpet?
Upon completion of the physical analysis (30 year forecast of capital projects), one must then conduct the financial analysis to establish a funding plan. The individual should consider the current reserve balance, the rate of return on reserves invested, the inflation rate, and the anticipated future capital expenditures. Some software programs will include the construction inflation rate to project future costs while others ask the user to enter the U.S. inflation rate. The software enables the individual to conduct various scenarios to help determine a level of reserve funding that is consistent with the Board’s long term objectives.
Life is full of tradeoffs and the issue of software vs. investing in a Reserve Study conducted by a reserve professional is a great example of tradeoffs. A professional Reserve Study by a specialist offers better accuracy in condition assessment, an independent third party expert opinion, reduction of claims of financial mismanagement, compliance with state legislation and the AICPA (American Institute of Certified Public Accountants) Audit Guide for associations, and valuable time savings every year in budget meetings, and peace of mind for the homeowners.