In Part I of this blog series, we “got a grip” on reserve funding with the help of our guest contributor, David Schwindt. David covered what reserve studies are, how they’re developed, and what it means for your finances.
As you know, homeowners and community associations absolutely need to put money aside for future expenditures and repairs. But the fact is, funding a 100% contingency is a conservative approach and, in many cases, can be wasteful.
In this post, David dives further into best practices for reducing the risk of “surprises” and painful special assessments to ensure that you’re not overfunding your contingency.
This concludes David’s contribution to our blog series on reserve funding & risk mitigation. Feel free to post any questions in the comments section below, and be sure to check back for my follow up post, where I’ll add my two cents and discuss the importance of comprehensive physical analysis in striking and maintaining a sensible contingency balance.
Thanks for reading!
Reserve Funding and Risk Mitigation, Part II: Best Practices
By David T. Schwindt, CPA RS PRA, Guest Blogger
Risk of Special Assessment
Many reserve study professionals present statistics that show the risk of a special assessment based on the percent funded. For instance, if an association is 50% funded, these statistics indicate there would be an 11.6% chance of a special assessment. The higher the percent funded, the lower the potential for a special assessment.
Please be aware that these statistics have been compiled by a reserve study provider and not vetted by CAI. However, if the contention is that the more extra cash an association has in the bank, the less likely the association will be to special assess due to surprises, then the underlying theory appears reasonable.
If our funding goal is to fund for all expected expenditures and to allow funding for surprises, how can we mitigate the risk of surprises thus lowering the contingency amount?
Many reserve study providers recommend a percent funded of at least 70%. Figure 2 shows that if associations follow a set of best practices in maintaining common area components, the percent funded could be much lower because the likelihood of a surprise is diminished. Note that this matrix addresses the fully-funded percentage but can also be used as a tool to determine the required threshold using the threshold method.
Let’s revisit Figure 2, which illustrates the relationship between a number of reserve study best practices and the probability of surprises.
Let’s examine these best practices through the lens of some of the surprises that associations experience. The following list includes but is not limited to events that may require additional cash:
The design, materials or workmanship on original construction is not adequate thus requiring repairs, remediation or this may result in a significant reduction in the estimated useful life of components. A complete building envelope inspection by a construction professional may catch issues early on that may reduce the cost of repairs and may allow the association to bring an action against the developer or contractor. This investigation may include intrusive openings around decks, windows, roofs and siding.
The association does not adequately maintain the components which may lead to unexpected repairs or significantly reduced estimated useful lives. A written maintenance plan consistently followed by the association may help components last longer with fewer repairs.
The association does not perform ongoing inspections of components. Ongoing inspections may catch issues before they become worse and cost more to repair.
The reserve study does not include all components that need to be funded. Missing components may include plumbing and irrigation systems, water/sewer lines, rot, windows and doors, deck assemblies, asphalt, major landscaping projects, concrete issues including spalling/rusted rebar and replacement of siding and trim. Failure to include all components in the reserve study will likely lead to a special assessment to pay for unbudgeted repairs.
The reserve study is not updated annually to account for increase in prices, changes in cash reserves, application of adjusted inflation in funding model and/or change in estimated useful lives. Failure to update the reserve study on an annual basis may lead to unbudgeted expenditures.
The RFP (request for proposal) for repair and replacement projects is not written correctly resulting in specifications that are either inadequate or do not address issues. Using a construction professional to assist with RFPs can help assure that repair/replacement projects are performed by qualified professionals and includes all needed costs and procedures.
The association does not use a construction consultant on major projects to assure that work is performed properly. The danger of not using a consultant increases the chance of substandard materials and workmanship and the possibility of requiring re-repairing/replacing the components or may significantly reduce estimated useful lives.
The Bottom Line
Associations that adopt best practice procedures and spend a little more each year on maintenance, inspections, reserve study updates and construction oversight can reduce the amount that is assessed to overfund the replacement reserve bank account to pay for unexpected costs.
As always, associations should look to the credentialed reserve study provider for guidance.
David T. Schwindt is a CPA and credentialed reserve study provider and is the owner of Schwindt & Co. Schwindt & Co provides accounting, tax and reserve study services to over 500 Associations in the Pacific Northwest. To learn more, visit www.schwindtco.com
Ready to eliminate surprises and overfunding?
Pete Fowler Construction Services (PFCS) can help get you there. Our team of expert consultants specializes in creating real, practical solutions for owners, associations and managers. We help you make intelligent decisions by examining your property, diagnosing problems, specifying the right maintenance and repairs, and applying construction management discipline to your project (including bidding and writing contracts to protect the owners, performing quality control inspections, managing change orders and processing invoices). We provide actionable insight and expertise to right your project, and clear up any messes that others may have created along the way.
To learn more, visit our website or give us a call at our Southern California Office (949) 240-9971 or Portland Office (503) 660-8670.
THE RESERVE FUNDING SERIES
Part I: Getting a Grip on Reserve Funding Jan 8, 2014
Reserve Funding & Risk Mitigation: The Bottom Line Feb 13, 2014