To any community, HOA reserve funds are critical in ensuring financial health. Unfortunately, far too many associations have underfunded or no reserves. The first step is understanding the purpose of a reserve fund and its requirements.
Homeowners associations operate in much the same way as corporations. While it is not the primary purpose of an HOA to generate profit, associations rely on revenue to fund various expenses. This revenue mostly comes from HOA dues, which homeowners pay regularly. The board then splits these dues into two funds: the operating fund and the reserve fund.
The operating fund covers the day-to-day or more recurring expenses of the association. Meanwhile, the reserve fund covers non-recurring expenses, particularly the cost of future major repairs and replacements.
A homeowners association is responsible for maintaining common areas and elements. Over time, these elements deteriorate and will require repairing or replacing. An HOA taps into its reserve fund to pay for this, which contains monies set aside over time. Some may wonder about the difference between a reserve and a reserve fund, but they are the same.
The purpose of a reserve fund is to prevent undue financial burdens on the HOA and individual homeowners. The association’s assets will experience wear and tear, and there will come a time when they will need repairs or replacements. The cost of repairs or replacements doesn’t come cheap.
If an HOA were to collect funds from homeowners in one go, it would need to be an excessive amount. Setting aside money over time, little by little, in an HOA reserve account eliminates this financial burden.
Typically, an association’s reserve fund covers the cost of major repairs and replacements of common elements. For example, when the roof of a clubhouse eventually requires replacing after 10 years, the HOA’s reserves can pay for that replacement.
That being said, some associations have strict rules about reserve spending. An association’s governing documents should shed more light on the expenditures that reserves can cover. These documents bind board members and their decisions. Therefore, the board should only use the reserves for their designated purpose.
In some cases, an HOA board may be able to borrow from the reserve fund to pay for unbudgeted expenses. However, that will still depend on the association’s governing documents.
While the reserve fund plays a vital role in the financial health of a community, not all associations maintain one. Additionally, not all associations are required to do so.
There are two things to consider regarding HOA reserve fund requirements: state laws and the governing documents. The law mandates HOAs to establish and maintain a reserve fund in some states. If the law is silent, associations should turn to their governing documents for guidance.
In Florida, a new law requires condominium associations to maintain reserve funds. This legislation came to fruition after the tragedy that struck the Champlain Towers South condominium in Surfside, FL. Investigations found that the condo building needed repairs and maintenance, but the association had insufficient reserve funding.
The HOA board is in charge of calculating annual or monthly dues. The board typically accomplishes this by creating a budget consisting of anticipated expenses. From there, the board tacks on reserve fund contributions based on calculations and projections from the HOA reserve study. Homeowners then pay their reserve fund contributions as part of their regular dues.
The HOA board then deposits the allocated collected fees into the homeowners association reserve fund. This fund is kept in a separate bank account from the operating fund of the HOA. While internal controls and procedures can differ from one association to another, boards usually require two signatories to withdraw from the reserve account.
Concerning money management, weighing the pros and cons is common practice. For HOA reserve funds, the pros are as follows:
As for the cons associated with reserve funding, the only thing that comes to mind is monetary contributions. An HOA’s reserves can’t fund itself. It relies on contributions from homeowners. Since such contributions are included in the computation for regular dues, homeowners are less likely to feel the impact of this financial obligation.
It is difficult to set a dollar amount that would constitute adequate reserve funding. How much an association should keep in its reserves will depend on several factors, including the type of association, the number and nature of its common elements, and the cost of replacing or repairing them.
In general, a good HOA reserves rule of thumb to go by is 70% of the required amount at any time. While it is best to be 100% fully funded, this is not always possible. As such, the HOA board should aim to cover at least most of the association’s reserve requirement.
An HOA should conduct a reserve study to come up with a more concrete amount. This study involves an inspection of the association's common elements and an estimation of the remaining useful life of each element. From there, the study calculates how much it will cost to repair or replace each element and how much an HOA should have in its reserves to meet that cost.
HOA reserve funds help keep associations in the green in the event of major repairs or replacements. Even if state laws and governing documents don’t require reserve funding, associations should establish and maintain one anyway.
Vanguard Management Group offers exceptional HOA management services, including help with reserve funds. Call us today at 813-930-8036 or contact us online to learn more!