Although our expertise is in community association collections our team are experts in financial management, and after all when we recover association funds there are things you should know. So here are some commonly asked questions and answers that we get from boards of directors regarding reserves:
1) What types of bank accounts are operating funds and reserve funds held in, respectively?
Answer: Association funds should be held in financially stable, federally or state-chartered banks and/or savings and loans that provide government guarantee on deposits. Also, the financial institution that the association utilizes should have appropriate control procedures available to the association to make sure at minimum two active board members are involved with any transfers out OR between their bank accounts. If your association bank account allows for just one signature to be able to pay bills or move funds then the community is in harm’s way. Don’t ever let that be the case.
2) How much money should a building or association hold in reserve at any given time? How is that figure determined?
Answer: This can change dramatically from association to association. In fact, there is an entire industry support area around reserve study analytics for communities. However, conceptually, this is like the community saving up the funds equal to depreciation of major capital equipment so that when the time comes to replace a capital item, they have the money needed already there. Major items include but are not limited to: air conditioner/chillers, boilers, driveways/parking structures, balcony and/or steel frame maintenance, roofs, social common area maintenance (ie lobbies, walkways, meeting rooms/game rooms/media rooms, pools, and many others.
3) Aside from not being able to complete necessary repair/replacement projects, what are some other possible ramifications of inadequate reserve funding?
Answer: The association may need to pass a special assessment to raise money when needed. This may result in a disproportionate burden for repairs and maintenance being borne by current residents/owners rather than having properly raised the funds from people who have owned units in an association’s past when it had the opportunity to have them pay into reserve accounts.
For example, in some states, members must actively waive funding reserves from their budgets in a vote of the entire community membership. It is not a good idea to NOT fund reserves and partially funding is not optimal but this is an important decision.
Depending on the urgency of a repair/replacement and specific financial parameters for the community association.
- May be forced to borrow funds at higher interest rates than may be offered by traditional banks.
- If repairs/replacements are not done in a timely manner, the association may be exposed to fines/violations from the town/city/community in which they are located.
- At some extremes, and likely very rarely, certificates of use/occupancy may be pulled/revoked requiring the building to be abandoned until the situation is rectified. For example, this could happen if there was a functional problem with fire safety or other life safety issues in a building.
4) What are the most common ways condos or HOAs can beef up their reserves?
Answer: – Increase the amount they set aside on an annual basis to help catch up on prior year amounts that were not funded. Pass special assessment (one time or on going for a specified limited time) to catch up on funding reserves. Another way is to look into your books and see if the association has lost any money from bad debt write offs in the last five years. This money may be collectible and should not be automatically written off as bad debt.
5) What are some reasons why raising fees or special assessments might not be appealing to a board looking to increase their reserve fund?
Answer: These are not always politically popular. Board members may not want to be viewed by their neighbors as the one raising maintenance fees. Just like in our government entities, sometimes the answer involves cutting spending but that is not a smart move in the real estate business. The object is to increase property value and cutting necessary expenses in a community association is a sure way to reduce the properties’ appeal.
In community associations, depending on the financial situation (which vary dramatically), raising revenue by increasing maintenance and/or passing special assessments may be a necessary hardship to balance the budget and maintain or increase property values. Its all too easy for a board to kick the can down the road but when something needs repair or replacement do it right away.
6) Please discuss alternatives to common reserve funding strategies — different loan products? bonds? investments?
Answer: We can’t think of a circumstance where it would make sense in today’s markets to borrow funds to fund a reserve account. This is because the likely returns on any reserve account would be very low single digit returns while the cost of borrowing such funds would be higher. Therefore, saving for reserve funds is important. If an association must later borrow to fund a capital improvement for which they haven’t saved already, the overall cost to the association’s members will be higher due to the need to pay interest on a loan.
So, there you have it. Some important information on Reserves that every board of director and community association manager should know.