How much money does your condo or homeowners association (HOA) have in its reserve fund? If you're puzzled by this question, our HOA could be in for an unpleasant surprise when a major repair – such as replacing the roof – is needed and your association doesn't have the funds to pay for it.
Not only do most statutes legally require HOAs to have a reserve fund, saving for future capital repairs is also a critical risk management tool to protect homeowners' shared investment in the community. Associations that save money avoid having to pay interest on bank loans and avoid claims after requiring homeowners to pay unexpected lump-sum special assessments.
Homeowners may grumble about paying an increase in monthly assessments for reserves, but they can appreciate the increased value a healthy reserve fund brings to their homes, as it reflects the sound financial management of the association and increases their property's ability to be bought and sold.
What is a reserve fund?
A reserve fund is money set aside by an HOA to purchase, repair or replace big-ticket items, including the roof, elevators, parking lots, pool maintenance and more. A number of factors – including the size of the HOA, the number of shared amenities, and how often the amenities must be repaired and replaced – affect how much money is needed in the fund.
The optimum scenario is that a percentage of each homeowner's monthly assessment is put into the reserve fund. The money is then invested until it is needed for a major repair, with the hope that there is enough in reserves to pay for expenses without having to take out a loan from the bank or demand homeowners to pay a large special assessment.
Each state has its own laws about HOA reserve funds and how that fund can be used. Some states even have laws requiring a specific percentage of the association's annual budget must be allocated and have a cap for how much money can be put into a reserve fund.
What is the Board's Fiduciary Duty?
The HOA's bylaws and applicable state laws dictate the structure of the association's reserves, but it's also the board's fiduciary responsibility to ensure there is adequate funding to protect the value of the assets and legally operate the HOA.
The board treasurer usually manages the reserve funds; however, it's the entire board's responsibility to ensure the fund is established, invested and managed with care. Board members are personally liable when they don't property fund the reserves or invest negligently. If reserves aren't managed with care, the board is likely to encounter breach of fiduciary duty lawsuits from homeowners.
How to Start a Reserve Fund
Establishing and maintaining a reserve fund takes planning to be effective. There should be a long-term schedule for the reserve fund in the annual budget. It's also important to plan ahead – there will be some homeowners who are delinquent or will default on paying their fees.
A reserve study is an effective tool to help set up the reserve fund. Even if your association conducted a reserve study years ago, it should be updated consistently to make sure the association is still on track.
To conduct a reserve study, complete the following steps:
- Identify repairs – Identify the common elements in the HOA that will need repairs or replacement over time. The life of each of those elements is considered. This includes elevators, the roof, parking lots, swimming pools, boilers and more.
- Obtain cost information – Compile cost information from local contractors to determine how much you'll have to spend to repair or replace each common item. Check to see if any of the maintenance is covered under a service contract.
- Determine how much money is needed in the fund – Using the price for each repair or replacement, divide it by the number of years of life left for the element to determine how much you should set aside each year in the reserve fund. Knowing the total amount needed will help you plan the annual budget and determine how much to assess homeowners on a monthly basis.
Investing Reserve Funds
HOAs must conservatively invest their reserve fund to get the maximum return while protecting the principal amount. Safety and liquidity of assets are key; many associations choose to invest their reserves in certificates of deposit or federally insured bank accounts. Many times, HOAs need assistance from financial advisors and investment experts to obtain advice on how best to manage their funds.
Before investing, it's important to check your bylaws to make sure there are no limitations on investments.
Also, given that HOAs are nonprofit organizations, it's critical to ensure that investing doesn't jeopardize your nonprofit status. There may be a tax liability for interest earned on investments, and it's crucial to obtain advice from an investment expert so you can make the best financial decisions for your HOA.
Collecting assessments from homeowners can be challenging, especially if you have to collect a special lump-sum assessment or if monthly fees will increase. Many times, property managers are in charge of collecting assessments and monitoring those who are late with payments. In all circumstances, your HOA must be fair and consistent and you must make sure that both your board and the property manager use legal procedures when collecting assessments from homeowners.
Borrowing from the Reserve Fund
When unexpected expenses arise, some HOAs decide to borrow from their reserve fund to cover the expenses. It's usually not wise to draw from the reserve funds for expenses they were not intended to cover; but if you must, come up with a plan to quickly replenish the funds.
Before drawing from the fund, check your state's statutes regarding legal restrictions on borrowing from HOA reserves. Some states allow HOA boards to borrow from reserve funds to meet short-term cash-flow problems, but they require that the funds be replaced within a certain time period from the date of the withdraw. Other states restrict borrowing from reserve funds.
Keeping Homeowners Informed about Reserves
Communicating updates to homeowners about the reserve fund will keep them informed about why saving is necessary and updated on the financial affairs of the HOA. Homeowners should be reminded that funding the reserve will increase the resale values of their homes and minimize the need for lump-sum special assessments.
A reserve fund is a critical risk management tool for your HOA. Contact Deeley Insurance Group today to find out more about reserve funds and how to manage your association's risks.