Every HOA has a reserve fund set aside for future expenses, both expected and unexpected. These could include building repairs, equipment replacements, major landscaping projects, new construction, renovations, roof replacements, or periodic upgrades of the HOA-controlled common areas.
The reserve is separate from the operating fund and used for day-to-day expenses, ongoing maintenance, upkeep, admin costs, etc. Without adequate reserve funds, homeowners would be subject to frequent special assessments every time an issue crops up. Obviously, nobody enjoys that kind of surprise.
So, we can think of the reserve as an emergency fund to be used only when needed. A well-funded reserve provides a cushion and can help the HOA pay for projected future projects based on periodic reserve studies. Because reserve funds are liquid, they can be accessed in emergencies, enabling the association to act when needed. An example might be repairing earthquake or storm damage after a major event.
Today, we’ll dive into HOA reserve funds, how they are funded, and best practices for maintaining an adequate reserve.
Where Does the Money Come from to Fund the Reserve?
The reserve comes from monthly assessment fees, split between operating and reserve funds. There is no set standard for what percentage that might be, but it’s usually between 15-40%. That money is then allocated to the reserve to save for future costs, some of which are expected.
For example, the HOA may know that the pool will require a new enclosure and roof for the pool house, which is estimated to cost $150,000. With that money in reserve, the HOA can avoid issuing special assessments when it’s time to do the work. Other examples could be installing EV chargers, solar panels, or other desirable upgrades.
The homeowner pays into the fund, but the HOA is responsible for fund management and preparing for what’s ahead.
Reserve Fund Planning Best Practice: Review Studies
One of the ways that boards plan and manage reserve funds is by conducting review studies. Review studies provide insight into future costs and are crucial to HOA financial planning as they inform the board what to prepare for. The goal is to have enough money in reserve for expected expenses, with some left over to cover the unexpected.
Review studies are typically conducted every three to five years and are often performed by a third-party property management company and/or an engineering specialist.
Sometimes, a site visit might not be necessary for the study. For example, if significant work has recently been completed and expected work is known, a review can be done between board members, vendors, and staff, sparing the expense of a site visit review.
However, the most accurate and responsible planning requires an inspector on the property at regular intervals. These types of reviews are more costly but can help HOAs avoid expensive oversights and ensure their reserve fund practices are sufficient to carry them to the next review.
In addition to the site visit, review studies also include a financial review component in which the association’s assets and income are analyzed against the reserve fund. If the study reveals any potential shortfalls, the strategy can be adjusted to ensure funds are available when the expense is expected.
Ultimately, you don’t want to empty the reserve fund to pay for a repair or end up in the red. Doing so disadvantages the association and may require unplanned special assessments.
Regular on-site assessments and financial reviews are essential best practices, especially considering inflation and the rising costs of construction work today.
Accounting for Change to Avoid Reserve Underfunding
With the review study in hand, boards have a blueprint to help them plan. Still, it’s vital to mitigate costs if possible, and reserve funds can help with that, too.
Reserve funds can be used for preventative maintenance to minimize the impact of a major repair and extend the lifespan of certain assets. For example, the association may own an old riding mower, but meticulous maintenance and upkeep can extend the engine’s life and delay the purchase of a new one for several years in some cases. It’s the same with roofing. Inspections should be triggered following storm or wind events to ensure there are no missing shingles or leak-causing damages.
Boards must also consider and plan for rising costs of services, insurance, and repairs, including inspections. Adding 10% to the projected expenses is recommended to protect against inflation.
An underfunded reserve forces the board to scramble to cover unexpected costs via special assessments, increased dues, or borrowing from an outside source—all of which can be avoided by maintaining a fully funded reserve.
Ideally, you want your reserve to be funded 100%. However, many HOAs manage well at 70%, though dropping below that is not recommended.
Reserve Fund Management Best Practices
Here are a few tips for HOAs to ensure reserves are funded adequately and that funds are well-managed.
Conduct review studies every three to five years.
Hire an experienced professional from a third-party management company to complete the study.
Work with finance professionals who understand the HOA model.
Adjust the budget periodically as needed. Small increases are more manageable for everyone, vs. assessments requiring a large lump sum.
Be transparent with homeowners about how reserve funds are managed. When the community understands reserve levels and how money is spent, they will be more understanding when increases occur.
Prioritize preventative and seasonal maintenance of all HOA-controlled areas. Perform regular inspections to identify needed repairs before they become significant.
Final Thoughts on Reserve Fund Management
Reserve funds are integral to the value of the community. An adequate reserve fund ensures repairs, maintenance, and upgrades are completed over time and helps boards avoid unexpected expenses.
Working with an experienced HOA management company like Belwood Properties ensures you the unbiased expertise and informed assessments you need to plan. Speak to us today to find out how we can help.
