Homeowners Association Boards (HOAs) have a fiduciary responsibility to make decisions that are in the best interests of their homeowners. They act on behalf of the association, must put the community’s needs first, and always act in good faith.
Operating funds and reserve funds are equally crucial to the community’s health, and the HOA board is responsible for managing both responsibly and with integrity. Homeowners pay monthly fees to the HOA to cover maintenance, everyday expenses, repairs, replacements, and various other short and long-term projects.
The HOA board governs how fees are used. They manage the community’s budget, much like homeowners manage their household finances. Generally, one account pays daily expenses (operating funds) and another (reserve funds) pays for bigger, more long-term projects, future repairs, replacements, or disaster recovery.
In best practice, the two accounts are kept separate. Of course, not all HOAs manage their reserve funds adequately enough to cover big expenses when situations arise. In a perfect world, as in life, something is always put aside in case of unexpected events.
But what is the difference between operating funds and reserve funds? And how are they allocated? Let’s find out!
What Are HOA Operating Funds?
Operating funds are the day-to-day expenses of running and maintaining the property. These include landscaping, common area maintenance, security, utilities, staffing, office expenses, insurance, accounting, and legal fees.
Projected costs are typically based on the previous year’s expenses plus any additional fees based on new services to be launched.
The operating budget is set for each year, and the expense breakdown is typically approved by the board or officers of the HOA. Homeowner’s fees are collected, and the funds go directly into the operating account. The funds are then spent as necessary to ensure the association runs smoothly and all essential services are provided as expected.
Ideally, the HOA strives to keep operating costs to a minimum. This may involve renegotiating contracts when they’re up for renewal, discontinuing services the community no longer requires or finding ways to value-engineer certain aspects of daily property management.
For example, when trying to trim the budget, the board might choose to eliminate some contracted services, downsize roles that have become redundant, or implement technology to optimize communication and make some jobs more efficient.
What Are HOA Reserve Funds?
Unlike operating funds, reserve funds are set aside for specific purposes. These funds are used for large-scale repairs, replacements, or other capital improvement projects.
Examples of projects that reserve funds would cover might include:
- A new roof for the clubhouse
- Repaving the roadways
- A new pool installation
- New windows
- Replacing or installing fencing
- A new playground
- Painting of community buildings
- Major landscaping
- Major renovations
- Upgrade HVAC systems
- Install EV chargers in the parking garage
It’s always a good idea to check governing documents to see what types of projects the HOA board is responsible for, as there may be more.
Reserve funds are typically required by law, and the amount of money an HOA must set aside depends on the size of the association and the types of assets it owns. The reserve fund account usually pays for long-term expenses, and each year, depending on its forecast, the board sets aside a certain amount of money to fund the future replacement or renovation of these assets.
Much like having a household emergency account to cover unexpected expenses, the reserve fund is built up over time to protect the community in case of disaster or unforeseen issues. For example, if crime becomes an issue in the neighborhood, the board may choose to install more CCTV cameras, a new gate on the underground parking, or beef up security by hiring a live guard.
Why a Reserve Fund is Important
Without an adequate reserve fund, HOA boards risk raising association fees without much notice. Operating funds are usually fairly consistent, but if there is nothing in the reserve fund, it may become a financial burden should significant repairs need to happen. Damage from extreme weather, natural disasters, earthquakes, fires, or equipment breakdown can be costly.
Reserve funds are also used to cover the cost of major upgrades, such as installing solar panels, EV chargers, and other things that represent significant improvements for the community. A well-funded reserve means that the board has the resources to complete these projects without any additional need for fundraising or having to take on debt.
What is an HOA Reserve Study?
HOA reserve studies are conducted as a way of projecting anticipated future expenses so they can be budgeted.
For example, if you know you’ll need the main driveways repaved, or a new roof is required within three years, the board can start building up reserve funds for that specific purpose.
A lot of guesswork goes into reserve studies, too, as there is no way to anticipate everything that could happen or go wrong. In best practice, HOA boards will conduct a study every three to five years, which will include comprehensive inspections, evaluations, and some analysis of the association’s financial health. With these facts in hand, the board can then adjust budgets and see where they need to trim costs or prepare to raise fees.
Since not all boards have specialized expertise on staff, professional technicians and inspectors are usually brought in to advise and inform the way forward. No decisions are made lightly, and as stated above, the board must act in the community’s best interests, avoiding self-serving activities or conflicts of interest.
What Happens When Reserve Funds Are In Shortfall?
The HOA’s lack of reserve funds can spell trouble for the community.
In an extreme example, we saw a disaster strike in Florida with the Champlain Tower collapse in 2021. Needed structural repairs were not completed, and as a result, many people lost their lives. Those who survived lost their homes. Had the HOA prioritized proactive maintenance, retrofitting, and repairs, perhaps this could have been avoided.
Nevertheless, shortfalls sometimes occur despite all best efforts, but conducting periodic studies and staying on top of needs are the best ways to get ahead of it. It may be necessary to raise association dues, collect a special assessment (a one-time additional fee above and beyond customary HOA fees), or seek external financing, such as through a line of credit.
Do you have questions about how your HOA fees are or should be allocated? Connect with us today.