HOA boards are responsible for the well-being of the communities they oversee. Ultimately, their tasks are twofold: to protect and enhance the property’s value and to inspire a sense of community and belonging. Board planning decisions are focused on these goals, ostensibly to protect property values, enhance safety and comfort for residents, and generally ensure everyone has a safe, beautiful, and well-maintained place to live.
Monthly fees and various other funding initiatives support the above activities, either through the operating fund or reserve fund. Regular maintenance and upkeep are paid through the operating fund, while money for more significant projects comes from the reserve fund.
HOAs allocate a certain percentage of income to the reserve, a separate account held for unexpected expenses, like emergency repairs, or planned upgrades, like repaving the driveway, replacing windows, or reshingling the roof. The HOA’s governing documents provide details on how the reserve is funded, percentages, and what funds can be used for.
Financial planning for the reserve is essential to ensure the HOA allocates enough monthly income to cover projected expenses. However, mistakes can be made; if so, things can spiral quickly. Understanding where the risk lies is critical to avoiding reserve planning mistakes and the key to mitigating the impact.
What could happen if the HOA reserve fund is underfunded? An underfunded reserve will almost always result in unpleasant surprises in the form of frequent special assessments, which are never welcome. While we can’t predict every possible expense, many are anticipated well in advance. Most projects should be covered if the reserve is managed well, reducing assessment frequency.
Poor reserve planning almost always results in funding issues. Here are a few of the most common reserve budget planning mistakes HOAs make.
Top HOA Budget Planning Mistakes Boards Make
1. Draining the reserve fund
HOAs that continually drain the reserve for non-essential expenses, unplanned upgrades, or to transfer funds into the operating account risk having nothing left to cover unexpected costs or repairs when they arise. It’s not uncommon to have a few people on the board who are less concerned with the future and more with shiny things, but this mindset must be balanced with some pragmatism. Good planning might not solve this issue entirely, but it may substantiate the debate before funds are unnecessarily or frivolously spent.
2. Hoarding reserve funds
Boards can sometimes be too cautious with their reserve spending, leading to deteriorating property conditions and decreased property values. A scarcity mindset is often at the root, with some board members not wanting to spend for fear of depleting the reserve. However, inaction is potentially worse for the community than overspending, as it could reduce the useful lifespan of certain assets and result in the need for total replacement at a much higher cost.
3. Failing to anticipate or underestimating future expenses
Adding a buffer or cushion to the reserve is always recommended. Costs of repairs and services have risen to a shocking degree in recent years, meaning what you may have expected to pay just a few years ago could have more than doubled and would put the reserve in the red.
While predicting how much of a cushion you’ll need is challenging, frequent benchmarking can help you plan. Keep an eye on market values for services you expect, negotiate with suppliers, and fund the reserve with a buffer of at least 10% on top of your estimates.
Consider also whether there may be foreclosures or delinquencies. Although you may not expect it, changing economic times have shifted the status quo. Should the association face a swath of delinquencies or failures to pay, special assessments may be the only way to cover if the reserve is insufficient.
4. Indecision
When boards disagree or aren’t sure how to spend their reserve funds, it can result in overspending or failure to spend on essential needs. Either scenario can be damaging to the community. If the board tends to be indecisive, a reserve fund study can help (see next point).
5. Not doing reserve fund studies
Reserve fund studies are typically conducted by a third-party individual or company who is paid to assess the property and project its future needs. The resulting report looks at the community’s assets, estimates the life span of the roof, electrical and mechanical systems, and equipment, and indicates when repairs or replacements are needed. Comprehensive on-site reserve studies are generally conducted every few years but should be updated periodically, especially when changes have occurred. The reserve study is intended to inform reserve fund planning, though it does not set out specific costs, as these can change. With the reserve in hand, boards then have a basis for benchmarking costs, which should help them set percentages for the reserve.
How Much Should be Kept in the Reserve Fund?
As each community has unique needs and concerns, specific dollar amounts for the reserve can’t be specified. Instead, we look at the fund’s ability to cover major costs for a period of time. A reserve is considered fully funded when it is projected to cover 20-30 years’ worth of reserve-related costs.
Governing documents dictate funding percentages, and many set that bar as high as 85-90% of what the reserve study indicates. However, 70% is more common, though some manage with as little as 40%.
For example, if the study estimates $75,000 worth of expenses for the coming fiscal year, the HOA should plan for a reserve of $52,500 if funding is at 70%.
Good financial planning is always about balance. HOAs must weigh their spending decisions carefully and not be hindered by fear of depleting the budget. As always, the caveat is to be conservative while always putting the community’s well-being first. Planning a buffer over and above what’s required ensures the board is ready for whatever may come.
Speak to us today about HOA property management and how to implement reserve fund best practices.
