By Bryan Farley, RS, President, Association Reserves - Colorado
On my tenth birthday I was given the greatest gift a kid could ever ask for. That gift, which every adolescent looks forward to, was of course… braces. Not only did I look silly (my grandma affectionately called me ‘train-tracks’ since my teeth looked like they could support a steam engine), they also required ongoing upkeep and maintenance. One of the daily maintenance tasks was to hook these small rubber bands into the braces to improve my overbite. The problem was that I found the bands to be a nuisance and preferred not to wear them. My thought was that the orthodontist wouldn’t notice my lack of discipline. Unfortunately he did notice, but in my infinite wisdom I still thought that it wouldn’t make much of a difference whether or not I wore the bands. Finally after a year, the orthodontist told me that the more consistent I was with my daily maintenance, the sooner the braces and bands would come off.
Just as I assumed that my daily maintenance negligence would go unnoticed, many Boards assume their annual Reserve Study maintenance will go unnoticed. A Board may assume that Reserves are something that a future Board may need to think about. Or, the Board may assume that the owners may not notice that the association is lacking proper funding for the upcoming summer projects. The lack of Reserve Study updates is an issue that many Board members fail to realize. Because the physical condition of the association’s assets and the size of the Reserve Fund change on an annual basis, Board members need to know how much to budget for their Reserve contributions each year.
The problems that occur when a Board does not update their Reserve Study include; higher special assessment risk, increased dues, deferred maintenance, and cash flow deficiencies:
Special Assessments – Based on a analysis of over 19,111 of our most recently completed Reserve Studies, we found that when clients only updated their Reserve Study every five years, the risk of special assessment increased by 35% when compared to a client that had updated their report every year. If a client updated their Reserve Study every three years, the risk of special assessment increased by 28% when compared to a client that updated their report every year. Why does special assessment risk decrease when the Reserve Study is updated regularly? One factor could be that it is harder for a Board to ignore an upcoming project when the Reserve Study is constantly reminding them each year of their annual fiduciary responsibility.
Increased Dues – Increased special assessment risk will also require higher reserve contributions, which will affect the overall dues assessment. On average, reserve contributions should make up anywhere from 15%-40% of the total annual budget for a well-run association. When an association falls behind in their funding, they will need to increase their contribution rate to catch up with the ongoing deterioration of their property. When a client updates their Reserve Study annually, the year-to-year variation in Reserve contributions will, on average, drop by 9%.
Deferred Maintenance – When an association neglects to update their Reserve Study, scheduled projects tend to be deferred, and deferred maintenance will only become more expensive. For example, suppose an association completed a Reserve Study in early 2013 but the Reserve Study has not yet been updated since. Since 2013 there have been at least two major hailstorms, one catastrophic flood, and countless wind storms. The unexpected surprises may cause an association to defer the expected, inevitable projects such as exterior painting. However, by deferring these projects, the costs of the routine painting maintenance may increase by 50% due to wood rot or other carpentry issues.
Cash Flow Deficiencies – An association that has not updated their Reserve Study will be unprepared for inevitable expenses of expected deterioration. How will a Board know how to set their annual reserve budget unless they know what their annual reserve costs are? It would be like packing for a vacation but not knowing if you are going to Hawaii or Iceland (unless you can handle a bikini in the snow). A budget must be set with the end in mind; what is the projected roof replacement cost, what is the projected asphalt sealing expense? If an association does not know what the inevitable costs will be, the most likely scenario will be that the Board will underfund the reserve account.
Updating a Reserve Study requires that a Board be disciplined, however this discipline today will bring financial freedom for years to come.
Once I had understood that my daily routing of rubber band wearing would eventually bring me freedom, I became driven to be the best rubber band braces-wearer I could be. At the wise old age of eleven, I had finally realized that positive results require diligent routine and discipline. Similarly, boards that pay attention to their financial situation have demonstrably fewer special assessments and more stability to their budget. They tend to be on-track, setting the right amount aside towards Reserves, with owners all paying their fair share (the true cost of home ownership). The result is their property is significantlymorelikely to have the necessary Reserve funds on-hand when they are needed to perform those major, predictable common area repair and replacement projects.
Bryan has completed over 1,500 Reserve Studies and earned the Community Associations Institute (CAI) designation of Reserve Specialist (RS #260). His experience includes all types of condominium and homeowners’ associations throughout the United States, ranging from international high-rises to historical monuments.