The Importance of Reserve Studies

According to David Chesky, P.R.A., R.S., and Executive Vice President of The Falcon Group, headquartered in Warren, New Jersey, “Reserves are monies that community associations set aside as part of their monthly maintenance fees to save up for the replacement of their major common element components.” Establishing reserves allows associations to save up for the replacement of the common elements. By setting aside money for possible future major replacement projects, they save themselves from needing to assess the community or finance projects. Reserves are similar to emergency funds in general; they exist to fund major replacement projects. “A reserve study is a budgeting tool for management companies and boards to use in setting aside funds as part of their monthly maintenance fees for the planned replacement of the common elements of the community,” Chesky said.

In the event that the reserves are underfunded, the association has three options. It can assess for the project itself, it can assess to bring the reserves up to a sufficient level so that they are no longer underfunded, or it can finance the project in question. Associations should only use any of these options as a last resort, as they can have a negative impact on the community. Chesky underscored the importance of a reserve study to the financial health of an association.

The amount that should be held in reserves varies from association to association. That amount should be based on a reserve study performed by a professional, Chesky said, and thus it can change from association to association. The study from start to finish can take anywhere from thirty to sixty days. Larger associations typically take longer, while smaller associations can take less than thirty days. Studies very much depend on the type of association and the projects for which they must budget.

Reserves are crucial to well-maintained condominium and homeowners associations. What is their importance, and how does an association establish reserves? And once established, how does an association maintain a reserve account? A reserve study is perhaps the most important element when it comes to establishing reserves. Associations should know what to expect from a reserve study and from the professional who performs it. Going into the reserve study process with that knowledge can help associations achieve a successful reserve study as well as a comprehensive reserve account.

Chesky stated that associations should have a professional experienced in construction and cost estimating perform their reserve studies. A reserve study, he said, is not a generic study, as it directly affects whether or not an association has sufficient funds to go forward with a project.

Prior to a reserve study, the association will need to gather certain documents to provide the reserve professional. This typically includes the governing documents, reserve fund financial information (i.e. balances and current and past contribution levels to the reserve fund), project history, and a site map. “We use that information to generate satellite imagery of the community to get a better understanding before we go and do site inspections,” Chesky said. Governing documents tend to indicate what the common elements include. Only the common elements for which the association is responsible would be reviewed and included as part of the study. Providing maintenance and past project history allows the reserve specialist to factor in any past problems during the inspection.

The physical analysis portion of a reserve study is the inspection of the common elements to identify the lifecycle and condition of those elements. It analyzes any existing issues as well as any site variables that may affect the lifecycle of the component and the replacement cost of the component, Chesky said. The financial analysis is a review of the association’s reserve fund balance, along with contribution levels pertaining to the study’s calculated recommendations.

“The role of the association is to provide the necessary documentation to the professional performing the study, as well as the history of the community,” Chesky said. Reserve specialists may be on site for one to three days, depending on the size of the community, but board members and managers are involved in the community on an almost daily basis. Their extensive knowledge of the association makes them vital to the reserve specialist. They can communicate any past problems and help the inspector to focus on certain things.

Chesky noted that most communication is through management or board members, depending upon the association’s arrangement. Maintenance personnel or management may be interviewed for specific information on the association as a whole or on a specific building. “For example, if we’re doing a reserve study on a high-rise building, these buildings would typically have a full maintenance staff and a superintendent,” Chesky said. “We would normally arrange to interview the superintendent and tour the building together with the superintendent because they have a wealth of knowledge of the building, and that’s vital in preparing the study and making things accurate.” The completed report can then be used to advise the owners on what and why maintenance and replacement needs to occur.

What are some common reserve items that are typically overlooked by an association? Chesky provided a few examples: detention-basin components such as outflow/inflow structures and low flow channels in detention basins. In communities with lakes or ponds, they need to be aware that those bodies of water can fill up with silt or run-off from drainage structures, which would necessitate dredging. “Dredging is very expensive, and oftentimes that is overlooked in the community. Then they’re stuck with a two or three hundred thousand dollar project that they’re not ready for,” Chesky explained.

Associations should also keep an eye on chimney caps, which could be overlooked since they are high up and difficult to see. Chesky mentioned wood trim as another commonly overlooked element. Wood trim is often thought of either as part of the siding or as part of the building maintenance. “Some communities have extensive amounts of trim,” Chesky said. “If it all needs to be replaced at one time, it can be expensive, and if the association is not ready for this expense, it could be a big hit.”

Depending on the association, the largest expenses tend to be roof replacements, roads, and siding. High-rises must be approached differently, since their largest expenditures could be their mechanical systems, including elevators. High-rise buildings also have parking garages, extensive facade materials, balconies, and plazas, all of which could create large expenses for associations.

The cost of a reserve study varies greatly and depends on the association’s size and responsibilities. Smaller associations tend to spend less on a reserve study, while larger associations tend to spend more due to the extensive fieldwork required of the reserve specialist and to the greater responsibilities of the association.

The cost of the reserve study, from start to finish, generally includes a complete analysis of the association. That analysis includes a review of the documentation provided, an inspection of the common elements, and an interview with management and maintenance staff. The reserve specialist also performs quantity measurements in the field of all the relevant components of the association. “In order to properly estimate the cost of any one of the components, accurate quantities obtained from field measurements of that component are absolutely vital,” Chesky said. The study concludes with the report prepared by the reserve specialist along with the various funding strategies and recommendations for the association.

A reserve study, Chesky explained, provides an association with a professional assessment of the community with respect to the condition of the various common elements, the remaining life cycles, and cost estimates to replace those components. A study ensures that projects are funded properly and helps to avoid assessments or financing. Funds are set aside and projects are already planned out, reducing a lot of the risk of unexpected maintenance or failure. “For the homeowners, it provides a real benefit in that it maintains property values because, if associations are properly funded, and projects are done on time, nothing is left to deteriorate and nothing is left unsightly,” Chesky said. “For the property manager, it provides planned, scheduled replacement of components, rather than having to scrounge and find the money for things. The money should be there in a separate account.”

Further, a reserve study can enhance resale value by making the association as a whole more attractive to potential buyers. Common element replacements or maintenance is scheduled, and nothing is left to overgrow or deteriorate.
While some states require a reserve study, most do not, including New Jersey. Nothing mandates that an association must follow the recommendations in a reserve study. Reserve studies are meant to be used as guides, Chesky said. According to the general industry standard, reserve studies should be completed or updated every three to five years.

Chesky recommended that associations look for a reserve specialist with experience in the industry, qualifications in construction, and cost estimating. Companies that perform reserve studies and are also engineering and architecture firms can be helpful, especially since community associations assets can vary so widely. “You really need to have someone who understands all of the facets of construction, not just roof replacements and all the ancillary items that are included in that type of project but also mechanical systems and things of that nature, to properly assess the conditions and to provide accurate cost estimates,” Chesky said.

The relationship between an association and a reserve specialist typically extends beyond the initial study. Some firms assist clients with their scheduled future projects and provide consulting services. It can be beneficial to find a specialist who provides the association with future updates to the reserve study once projects are completed, as well as every three to five years.

What other professionals are involved in a reserve study? “Beyond the association manager providing documentation, the association’s accounting firm may provide financial information for the study. The association’s attorney may also need to clarify what the common elements are if the governing documents are unclear,” Chesky said.
Finding the right professional to perform a reserve study can make all the difference. The reserve study itself serves to secure an association’s future projects and helps it to fulfill its responsibilities to the common elements.

The four different methodologies or strategies commonly used for funding reserves are baseline funding, threshold funding, full-funding, and statutory funding.

“Statutory funding doesn’t really apply because that is funding based on statutory requirements, which we don’t have in New Jersey,” Chesky said.

“Full-funding methodologies are based on depreciation and sometimes referred to as ‘the component method,’” he said. This is the most conservative methodology of funding the reserves, with the goal being to have one hundred percent of the depreciation of all common elements for a community in the reserve fund at any given point in time.

“Threshold funding or baseline funding are cashflow funding methodologies where the goal of those funding methodologies is to have enough money to pay for expenditures based on the scheduled timeframe, while staying at or above the predetermined amount of money at any given point in time,” Chesky said.

In baseline funding, that predetermined amount of money would be zero dollars. In threshold funding, that predetermined amount of money would be some form of a threshold that the community would set, either an arbitrary number or 5% or 10% of their replacement cost values,” Chesky said.

While overfunding is uncommon, if it does occur, the contributions to the reserve fund should be adjusted downward. Reserve studies advise associations on the proper level of funding, and having that study updated on a regular basis can help to avoid overfunding. “The annual contribution recommendation is adjusted based on projects that have occurred and monies in hand,” Chesky said.