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Which Components Belong in Your Reserve Study?

by Robert M. Nordlund, P.E., R.S.
President
Association Reserves, Inc.

To avoid collecting too much or too little Reserves, it is important to make sure the association has correctly established the list of components for which Reserve funds will be set aside. Neglecting a key component or including items not appropriate for Reserve funding is typically the greatest source of Reserve Study errors. These types of errors greatly overshadow errors in life or cost estimates for individual components. Fortunately, there are some basic principles to apply that help you craft a Reserve Component List that will successfully meet the needs of the property, the Board, the Owners, and Management.

The primary tool to use is the four-part test found in national Reserve Study standards. With it, you sift through the list of potential Reserve Components to determine which ones are appropriate. For a component to be appropriate for Reserve funding, one needs to be able to answer “yes” to all of the following four questions:

For resort properties, one of the first steps is therefore to correctly divide administrative or sales areas and assets into the proper areas of responsibility: association, hotel operations, management, or developer/sales. Here you identify which assets are not the responsibility of the resort to maintain, and these assets are then clearly not common area maintenance responsibilities (failing test #1). In addition, one needs to set proper expectations for scope of the analysis. Some vacation ownership resorts have different budgets and bank accounts for villa interior assets and other common area assets. In these cases, the end result of a Reserve Study might be two completely separate reports: one for the Interior Owners Association (IOA) and one for the condominium Home Owners Association (HOA).

The next step is to begin with the end in mind. This means assembling the report so it can be most useful to the Board and Management. If the resort was built in phases, there is a strong chance that Reserve projects will occur in the same phases. In these cases, it would be logical and most effective to group assets together by phase (Buildings 1 and 2 and the central pool area in the Phase I grouping, Buildings 3 and 4 in the Phase II grouping, etc.). Other common ways to assemble the document are to divide the assets into administrative, recreation, and villa type (1-bdrm, 2-bdrm, etc.) groupings. This way information will be easier to find when Reserve expenditure decisions need to be made.

In assembling the Reserve Component List, the appropriate time and effort should be spent correctly establishing life and cost estimates for critical components. This means one should spend more time on the important assets, and less on the small and relatively insignificant assets. In vacation ownership resorts, the interior assets typically dominate the Reserve Study, making up 60% - 75% of the total value of Reserve assets. Completely ignoring villa interior assets in the Reserve Study as “handled with the ongoing housekeeping budget,” as we have sometimes seen done, is a critical mistake. After the villa interior assets, the largest assets are typically painting, roofing, interior common spaces (hallway paint/carpet, lobby, exercise room, etc…), major mechanical (cooling towers, boilers, elevators, etc.), and roadway/parking surfaces.

Turning our attention back to the most significant component, villa interior assets, there is yet another rule of thumb. Approximately 60 – 75% of Reserve expenses for villa interior assets typically are attributed to soft goods and case goods replacement. Kitchen and bathroom refurbishing follow, with “other” items typically well under 10% of the value of villa Reserve assets. Therefore don’t commission a blue-ribbon committee to perform an in-depth analysis to estimate the life and cost estimates for the TV and VCR assets! Spend your time establishing good price and life estimates for the soft goods and case goods. Note that it is best to establish “coordinated” or “logical” replacement cycles, where the soft goods have a Useful Life one half or one third that of the case goods. For example, if you expect to replace your soft goods every four years, it is best to plan on replacing case goods every eight or twelve years. Thus every-other, or every-third soft good replacement cycle you have an opportunity to change the entire decorative style of the room, and you never have to take the room out of service for case goods (only) replacement.


Conclusion:

So what should one expect as the bottom line? Typically the results of a Reserve Study are described as threefold:

The Reserve Component List is therefore one of the three primary results of a Reserve Study, and arguably the most important. The Reserve Component List forms the foundation for the other two results, for all financial computations stem from the Reserve Component List. The Percent Funded (the parameter that measures the relative strength/weakness of the Reserve Fund) and an appropriate Reserve contribution rate are dependant on the accuracy of the Reserve Component List. Many people focus on the Reserve contribution rate as the primary result of a Reserve Study, but any Reserve contribution rate based on a hastily assembled Reserve Component List that neglects key components or contains inappropriate components will be a false or misleading number. The Reserve Component List is that important!