- 
What to Expect from Your Reserve Study
by Robert M. Nordlund, P.E., R.S.
President
Association Reserves, Inc.
An ancient Chinese Proverb says "Projections are very difficult, especially about the future!" While a year-end review by a CPA looks backwards at the prior year, a Reserve Study tackles the difficult task of projecting forward into the future, attempting to prepare the association for anticipated major common are repair and replacement expenses.
Fundamentally, it is all pretty simple. No advanced training is necessary to do the most basic Reserve planning: anticipating a future cost, subtracting the funds currently available, and dividing the amount to be collected over the time remaining until the expense occurs. That is Reserve planning at its simplest. But once you begin to examine the subject more closely, many more questions develop: what type of Reserve Study to perform, what information to compute and show, how to allocate the funds, and when to perform the Reserve Study.
It is a big help to understand there are three types of Reserve Studies: the Full Reserve Study, Update With-Site-Visit, and Update-No-Site-Visit Reserve Study. All are Reserve Studies, but they differ in the amount of investigative field work done. Once a Full Reserve Study has been done to inventory all components and develop the Reserve Component List, in future years the association can choose between the two less expensive update options. The Update With-Site-Visit is for associations in need of on-site observations to evaluate the physical changes of the components, while the less expensive Update No-Site-Visit is for associations where the physical assets have experienced only minor changes. You will find some Reserve Study companies offering mail-order workbook "kits", some sell software products, and some provide the software for free with a completed Reserve Study.
All Reserve Studies will provide the user with three results: the Reserve Component List, an evaluation of the current status of the Reserve Fund, and a recommended Reserve contribution rate. The Component List is valuable for understanding and planning the cyclical replacements of the association's major assets. Strength of the Reserve Fund is measured by "Percent Funded," which shows how well prepared the association is financially for its upcoming Reserve projects. Approximately 1/3 of all associations fall into the 0-30% "weak" range, where special assessments or deferred maintenance should be expected. The 30-70% range is a mid-range status (approximately 50% of associations fall into this range), and associations over 70% Funded typically enjoy sufficient funds for capital projects and an absence of special assessments. The Reserve contribution rate is part of the multi-year Funding Plan, created based on the association's beginning Percent Funded, future array of expenses, and conservative or aggressive funding strategy.
If the Reserve Component List is developed according to National Reserve Study Standards, for a component to be included for funding in the Reserve Study it must pass a four-part test:
1) It needs to be a common area maintenance responsibility;
2) It must have a limited life expectancy;
3) It must have a reasonably predictable remaining useful life, and;
4) The cost must be above a minimum threshold of significance (typically around 1% of an association's annual budget).
Such a Reserve Component List means that association Board members, managers, and Reserve Study professionals all use the same decision process to develop a stable, reasonable Reserve Component List. Thus Reserve Component typically do not include permanent assets (not life limited), assets more appropriately covered by insurance (no predictable life limit), and assets small enough to be absorbed by the Operating Budget.
Standard disclosures to appear in the Reserve Study include such simple things as the quantities of the components (42,000 Sq Ft of asphalt, etc.) and the assumptions used for interest and inflation. Note that Interest cannot be assumed to cancel out the effects of inflation, because interest is only earned on the funds actually on deposit, while inflation works its effect on the entire replacement cost of the component. Most importantly, the Reserve Study should show at least 20 years of income and expense cash flow projections (30-years is typical among professional Reserve Study providers), to show what happens under the assumed expense scenario and the recommended Funding Plan.
Since one of the primary results of a Reserve Study is the recommended Funding Plan, Reserve Studies are typically prepared in the middle or second half of a Fiscal Year period. This allows the Board or management time to review the Report, compare their Percent Funded status to the prior year, and incorporate the findings and recommended contribution rate into the budget for the following Fiscal Year. Thus preparing Reserve Studies is a seasonal business, with most providers busy in the summer and fall preparing Reserve Studies for the majority of associations with Fiscal Year cycles that end on 12/31.
Having a Reserve Study prepared is a wise decision for associations of all ages. A Reserve Study is helpful for new associations, because it ensures that the association establishes appropriate precedents of setting aside sufficient funds for the future. A Reserve Study is also helpful for mature associations, helping them negotiate a financial path through a maze of significant capital expenditures and special assessments. Many mature associations have a Reserve Study prepared "too late" after experiencing a special assessment, as the Board members swear that they will never get themselves into a similar financial jam in the future!
The practical reasons for a Reserve Study are driven by the information needs of the Board and management staff, attempting to pilot this multi-million dollar privately owned Real Estate partnership successfully into the future, making accurate disclosures to current and prospective owners all along the way. In addition, the Governing Documents of most associations (check yours!) mandate an "adequate" amount of Reserves be set aside to provide for the future capital Reserve needs of the association. Outside factors are also involved. Many states now require formal or information Reserve Studies or Reserve disclosures to association members or prospective home-buyers, and since 1991 American Institute of Certified Public Accountants (AICPA) has recommended annual Reserve Studies for all community associations as a primary way to ensure the future physical and financial health of the association.
The bottom line is that Reserve expenses are inevitable, and it is the Board's responsibility to prepare the association for those expenses. Reserve expenses can, and should be, confronted and controlled as part of running an association in a fiscally responsible manner. A well executed Reserve Study, based on and containing the fundamentals stated above, will help the Board successfully meet their primary responsibility which is to maintain, protect, and enhance the assets of the corporation.