HOA Reserve Studies: What You Need to Know
Just what is a reserve study? What should it include, and how often should it be done? We've got answers.
Reserve Study Definition
"A reserve study is a study made of all the major capital systems in the association," explains Robert Galvin, a partner at Davis, Malm & D'Agostine PC in Boston who specializes in representing condos and co-ops. "It evaluates how much life they have left and how much they're likely to cost when they wear out. From that, you can calculate how much money the association has to set aside each year to have enough to replace those items when they do wear out."
How do you do that calculation? You take the estimated replacement cost and divide it by the number of years the item is estimated to last. That number is the amount you should reserve each year.
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Some states require that associations have reserve studies, others don't. Here's a sampling:
- California requires associations to perform reserve studies. "You have to get it updated on an annual basis," says Duane McPherson, division president at RealManage, a San Rafael, Calif., association management firm that oversees properties in Arizona, California, Colorado, Florida, Louisiana, Nevada, and Texas. "And every third year, you have to arrange for an on-site visit by the reserve study people so they can really see what's there."
- "Reserve studies aren't required in Massachusetts," says Galvin. "Our law states that a condo has to have a reserve fund, but it doesn't state how much has to be in it or mention anything about reserve studies."
- Minnesota doesn't currently require associations to perform reserve studies, but that may change. "In Minnesota, a reserve study isn't required," says Matthew A. Drewes, a partner at Thomsen & Nybeck PA in Edina, Minn., who represents associations. "But I'm aware that there's a push for it in the legislature."
Why You Should Do a Reserve Study Even If Not Mandated
Even if your state doesn't mandate that your association do a formal reserve study every so often, it may indirectly—and strongly—suggest that you meet that standard. "Under Minnesota law, the reserve requirement is that the annual budget shall provide from year to year for adequate reserve funds to provide for those things the association is required to replace," says Drewes. "If you're not bringing those funds into based on a calculation of when those thing should be replaced, you're failing in your efforts to adhere to the statute."
Drewes also advocates doing a reserve study to protect board members from liability. "It's a recommended procedure if for no other reason than to cover the board to ensure that somewhere down the line they're not subject to potential liability," says Drewes. "The standard for nonprofit boards, especially those that aren't compensated, is set fairly low in terms of competence. They need to act in good faith. But it's not too far of a cry to argue that a board is failing even that standard if it isn't making some effort to make sure adequate reserves are maintained. Whether they have to do a reserve study to meet that standard is debatable." It, however, would certainly go a long way toward providing the board protection if its competence were ever challenged.
Hire the Right Reserve Expert
Reserve studies can be costly, but McPherson advocates that you pay the necessary fees to get as detailed a study as possible. "The reserve study should contain every single component the association has," he says, "and it should be as detailed as it can possibly get."
How much will a study cost? "The cost depends on how complex the association is," says McPherson. "I've seen them cost as little $500-$600 a year and then as high as $5,000-$10,000 a year. They can get complex when you get into condos, where the association owns some walls and you have to assess the roof. There are a ton of different components in condos that make a reserve study more complex. Or if you're in an association that's gated and has its own roads, or if you've got a golf course, it's going to cost much more. But the vast majority of associations don't have those amenities. They'll have a park, a basketball court, or things like that are relatively easily evaluated."
Reserve studies aren't perfect, either. "There are problems with reserve studies," says Galvin. "If you ask someone, 'How many years does my roof have left?' Or, 'How many years until I have to replace elevators or the swimming pool, and how much is it going to cost?' the answers are only estimates. But you have to start someplace."
That's why McPherson advocates that you hire an expert who knows exactly what to include in a study by searching for one who does association reserve studies for a living. "There are a number of people certified by the Community Associations Institute to do them," says McPherson. "They have software to calculate the useful life of every aspect of the structure, including roofs, siding, water heaters, and so on."
The bottom line may be that unless your board has expertise in building components, it's just not qualified to evaluate the useful life of each. "The average layperson doesn't typically have an understanding of the useful life of and the cost to replace building components," says Drewes. "So the board needs to understand that a reserve study may be an important aspect of their responsibilities, and not doing one could have pretty significant consequences down the road."