Reserve Funds vs. Special Assessments
Reserve funds are designed to allow the association to repair or replace community property controlled by the association as that property wears out or becomes obsolete over time. By collecting sufficient reserve funds HOAs avoid resorting to special assessments. This spreads the cost of HOA upkeep out over time and more equitably shares those costs across all members as they use the property.
In contrast, special assessments unfairly put the entire cost of the project on the homeowners who happen to own at the time the repair is needed. Current homeowners pay for years—even decades—of enjoyment of HOA property by their predecessors.
Robert Nordlund, a reserve expert with Association Reserves Inc., recommends HOA leaders ensure reserves are 100 percent funded. Yet, you aren’t alone if you suspect your reserves are underfunded. A 2003 survey of 687 associations by the Executive Council of Homeowners found that associations on average had only 54 percent of the reserve funds currently needed.
Recent State Laws
States have recently started to mandate reserve studies and disclosures. As a result, what once were simply best practices are now the law in some states. Here’s a rundown of recent laws covering HOA reserve management you should be aware of:
In Washington, Senate Bill 6215 was signed into law on March 21, 2008. The law “encourages” but doesn’t require an association to establish a reserve account to “fund major maintenance, repair and replacement of common elements, including limited common elements that will require major maintenance, repair, or replacement in more than one and fewer than thirty years.”
The law requires the following:
- An association must prepare a reserve study and update it annually.
- The initial study must be conducted by a reserve study professional and based on a visual site inspection.
- The study must be updated by a professional at least every third year. These third-year updates must be based on a visual inspection.
- The current reserve study must be included in all public offering statements and seller’s disclosures.
If an HOA can prove that an annual update would create “an unreasonable hardship” it can update the reserve study every three years instead of annually. An association can claim an unreasonable hardship if the study would cost more than 10% of its annual budget.
California already has a law similar to the one just enacted by Washington requiring reserve studies. In addition, California HOAs will soon have to comply with new reserve account-related requirements, which are set out in AB 2100. AB 2100 goes beyond requiring reserve studies—it requires HOAs to create a plan to fund reserve obligations.
Some parts of AB 2100 relating to reserves are already in effect. Additional requirements will take effect Jan. 1, 2009.
The following requirements are already in effect:
- HOAs must adopt a reserve funding plan every three years indicating how the association will fund the reserve account to pay for maintenance and repair obligations. The funding plan must be adopted in an open meeting of the board.
- HOAs must provide an annual operating budget to members that includes a statement as to whether the board will defer repair or replacement of any major components.
- Associations must state in their operating budget any current deficiencies in reserve funding, expressed in a per unit basis. tarting Jan. 1, 2009, the HOA must also distribute a summary of the reserve funding plan to members of the HOA, and state in the summary that the full plan is available to all members upon request.
In Florida, SB 902, which was signed into law last year, adds several new requirements for the way HOAs calculate and disclose their reserve funds. Among other things, the new law stipulates that an HOA must prepare an annual budget that sets out the association’s reserve accounts. If the association’s budget doesn’t provide for reserve accounts, and certain other criteria are met, the association must publish a statement in its financial report announcing the lack of reserve accounts. The law also dictates the annual process an HOA must follow if it decides to underfund their reserves accounts. More details are available on the Florida state website.
Virginia HOAs had until July 1, 2007, to comply with reserve funding provisions contained in two laws created in 2002: the Condominium Act and Property Owners’ Association Act. These require that HOAs conduct a reserve study at least every five years to determine necessity and cost of repairs. The same legislation requires associations to review those results annually to assess whether the reserve funds are adequate to finance the repairs, replacement or restoration of capital components and make adjustments to the reserve funds. HOAs must provide a copy or summary of the reserve study report to prospective purchasers.