Reserve Studies: Planning for the Bills You Know Are Coming

There is a simple question every community association eventually has to answer:

What are we going to do when something really expensive needs to be replaced?

Not repaired. Not patched. Not put off for another year.

Replaced.

The roof. The parking lot. The boiler. The siding. The elevator. The pool equipment. The windows. The electrical system.

Every community has expensive components that will eventually reach the end of their useful lives. The question isn't whether those bills are coming. It's whether you'll have the money when they arrive.

That's what a reserve study is really about.

A reserve study is a plan for the future

A reserve study is a long-range financial plan for the major components a community is responsible for maintaining and eventually replacing.

It usually has two parts.

The first is the physical analysis: What do we have? How old is it? What condition is it in? How long is it likely to last?

The second is the financial analysis: What will those components cost to repair or replace, when are those expenses likely to occur, and how much should we be putting aside now to prepare for them?

That sounds straightforward, but there's an important point here:

A reserve study isn't a prediction. It's a plan based on reasonable assumptions.

Nobody knows exactly when a roof will fail or what a replacement will cost 15 years from now. A good reserve study recognizes that uncertainty and builds a financial strategy around it.

Without that kind of planning, boards often end up doing something very human: looking at the current budget and asking, "How much can we afford to put into reserves this year?"

That's the wrong question.

The better question is:

"What will we need, and what do we need to do today to be ready for it?"

The problem with waiting

"Let's deal with it when it happens" sounds reasonable until you think about what happens when it actually happens.

Suppose a community suddenly needs a $1 million roof replacement and has only $250,000 in reserves.

The $750,000 difference doesn't disappear.

Someone has to pay it.

The association might impose a special assessment. It might borrow the money. It might delay the project. Or it might try some combination of those approaches.

None is particularly attractive.

And the timing is usually terrible.

A major capital project doesn't arrive because the board has decided it's a convenient year to spend money. It arrives because something has reached the end of its useful life.

That's precisely why reserves exist.

You don't save for the things you expect to happen next year. You save for the things you know will happen eventually.

The hidden cost of underfunding

Underfunding reserves can make an association look financially healthier than it really is.

Imagine two communities with identical annual budgets.

Community A is putting $300,000 a year into reserves.

Community B is putting $100,000 a year into reserves.

On the surface, Community B looks better. Its assessments are lower. It has more money available for current expenses. Owners may be happier with the budget.

But if Community B has the same roofs, pavement, buildings, and equipment as Community A, those future expenses haven't gone away.

Community B has simply made a different choice:

Let today's owners pay less and leave more of the bill for future owners.

Sometimes that choice may be intentional and reasonable. The important thing is that the board understands it.

That's one of the most valuable things a reserve study can do: make the consequences of today's decisions visible.

What a good reserve study actually looks at

A good reserve study starts with the physical property.

Someone should identify the major components that the association is responsible for and estimate:

• How old each component is
• Its current condition
• Its expected useful life
• Its remaining useful life
• The likely cost of replacement or major repair
• When the expenditure is likely to occur

The study then turns all of those individual pieces into a long-term financial picture.

And that is where things get interesting.

A roof replacement might be ten years away. A parking lot might be five years away. A boiler might last another 15 years. Several smaller projects may occur along the way.

The reserve study puts all of those future obligations onto one timeline.

Suddenly, the board can see something that isn't obvious from an annual budget:

The community isn't just managing this year's expenses. It's managing decades of expenses.

What does "percent funded" actually mean?

If you've ever looked at a reserve study, you've probably encountered the term percent funded.

It can sound more complicated than it really is.

In simple terms, it asks:

Given the age and condition of everything we own, how much money have we accumulated compared with how much we ideally should have accumulated by now?

Suppose a component is expected to last 20 years and has already used half of its expected life.

The association doesn't necessarily need to have 50% of the eventual replacement cost sitting in the bank — there are many variables involved — but the association should have accumulated a meaningful portion of the money needed for that future expense.

Percent funded gives the board a way to see whether it is roughly on track or falling behind.

And here's an important point:

100% funded isn't necessarily the goal for every community.

There are different funding strategies, and reasonable experts can disagree about the appropriate level of reserves.

The important thing is understanding the risk.

A community with relatively low reserves has less room for surprises. A component may fail earlier than expected. Construction costs may rise. An unexpected project may compete for the same reserve dollars.

The lower the reserves, the less margin for error.

A reserve study isn't the same thing as a maintenance plan

This distinction is easy to miss.

Your reserve study shouldn't become an excuse to neglect maintenance.

In fact, the opposite is true.

Regular maintenance can extend the useful life of expensive components.

Cleaning and maintaining a roof may help it last longer. Servicing mechanical equipment can postpone replacement. Maintaining pavement can delay more expensive reconstruction.

A reserve study asks:

When are we likely to need a major repair or replacement, and how much should we plan to spend?

A maintenance plan asks:

What do we need to do to keep those components functioning properly in the meantime?

You need both.

The reserve study is only as good as its assumptions

This is where boards need to be careful.

A reserve study can contain impressive-looking tables and graphs and still be based on poor assumptions.

How was the useful life of the roof determined?

When was the property actually inspected?

Where did the replacement-cost estimates come from?

Are those costs based on current local construction prices?

What inflation rate is being assumed?

Are major components missing?

Are components being assigned a remaining life based solely on their age rather than their actual condition?

These questions matter.

A 20-year-old roof that's been carefully maintained may have several good years left.

A 10-year-old roof that has been neglected may be approaching the end of its life.

That's why a physical inspection is so important.

If someone can prepare your entire reserve study without ever setting foot on your property, you should at least ask some questions about how they determined the condition and remaining life of your major components.

Don't just buy the study. Understand it.

One of my biggest frustrations with reserve studies is that they can become very expensive documents that nobody actually uses.

The board receives a 100-page report.

Everyone looks at the colorful charts.

Someone says, "Looks good."

The report gets saved somewhere.

And then the next year's budget is prepared exactly the way it was prepared the year before.

That's a waste.

The board should understand the important assumptions and conclusions.

Which projects are coming in the next five years?

Which ones are coming in the next ten?

How much money will be needed?

Are our current contributions sufficient?

What happens if we contribute less?

What happens if construction costs increase faster than expected?

What happens if a component fails earlier than predicted?

Those are the conversations a reserve study should generate.

There isn't necessarily one "right" funding level

This is probably the most important thing for boards and owners to understand.

A reserve study may recommend a particular contribution level, but the board still has to make a decision.

Maybe the recommended contribution would require a substantial increase in assessments.

Maybe the community has unusually strong reserves already.

Maybe a major project is coming sooner than expected.

Maybe the board believes the community can reasonably accept some additional financial risk.

There can be legitimate reasons for choosing a different funding strategy.

But there is a big difference between choosing to underfund reserves and not realizing that you are underfunding them.

The first is a conscious financial decision.

The second is simply poor planning.

Reserves are really about fairness

There's another way to think about reserve funding.

It's about fairness between owners.

Consider a roof that costs $1 million and is expected to last 20 years.

If the association saves nothing for 19 years and then imposes a $1 million special assessment when the roof fails, the owners living there in year 20 are effectively paying for a component that provided benefits to the community for the previous two decades.

Some of those owners may have moved in only a few years earlier.

A reserve system spreads that cost over the life of the component.

Owners contribute while they're using and benefiting from the property.

That's a much more logical way to pay for something that everyone knows will eventually need to be replaced.

What happens when reality doesn't match the study?

It won't.

At least not perfectly.

The roof may last three years longer than predicted.

The parking lot may need replacement three years sooner.

The new boiler may cost 30% more than estimated.

A construction project may come in under budget.

That's normal.

The answer isn't to declare the reserve study wrong.

It's to update the plan.

A reserve study should be treated as a living financial model.

When a major project is completed, enter the actual cost.

When a component lasts longer than expected, update its remaining life.

When construction costs change dramatically, revisit the estimates.

And when the board makes a conscious decision to contribute more or less than the study recommends, understand what that does to the long-term picture.

Make the reserve study part of the annual budget

The reserve study shouldn't come out once every few years and then disappear.

It should be part of the annual budgeting process.

Every year, the board should be able to answer a few basic questions:

What major expenses are coming?

How much do we currently have saved?

How much should we be contributing?

Are we still comfortable with the risks in our funding plan?

Those questions turn reserve planning from an occasional exercise into an ongoing part of responsible governance.

The bottom line

A reserve study isn't really about roofs, pavement, boilers, elevators, or swimming pools.

It's about something much simpler:

Being honest about the future.

Every community has a long list of things that will eventually wear out.

You can ignore that fact.

You can hope that the next board will deal with it.

You can wait for the emergency.

Or you can acknowledge that the bills are coming and start planning for them now.

A good reserve study doesn't eliminate those expenses.

It doesn't guarantee that there will never be a special assessment.

And it certainly doesn't predict the future perfectly.

What it does is give the board something enormously valuable:

a way to see the future coming.

And when you can see the future coming, you have a much better chance of being ready when it gets here.