What are the Risks of Insufficient HOA Reserve Funds?

So it looks like your homeowner’s association has some projects to be done. The roof on a common building is on year 15 of its 20-year lifespan. The pool house needs painting. And hasn’t there been talk of building some new walkways in the greenspace?

How do you know if your HOA has the money to fund these big projects? The place to look is at the reserve fund.

What is a Reserve Fund?

A reserve fund is one of two funds your HOA uses to pay for its expenses. The other is the operating fund. Think of the operating fund as a checking account. That’s how regular, often recurring, expenses get paid.

Utilities, landscaping, office supplies, and regular maintenance come out of the operating fund.

The reserve fund is like a savings account. This is where the HOA saves up for those large expenses that happen infrequently. Like replacing a roof or painting a building.

The fees paid by homeowners are split into those two funds based on estimates from short and long-term budgets. The HOA board uses a reserve study to predict major projects, when they will need to be done, and how much they will cost.

The reserve study also helps them determine how much money should be in the reserve fund for unexpected events. Storm damage, earthquakes, and accidents are just a few of the many possible expenses that might arise. The reserve study bases its estimates on the likelihood of those types of events in your community.

So the reserve fund is how your HOA plans ahead. Ideally, it should be funded at 100%, all the time. That means that the HOA is regularly contributing all the funds recommended in the reserve study.

For example, the reserve study indicates that a roof will last 20 years. The estimated replacement cost is divided by 20 and that is the portion of homeowner’s fees that gets deposited into the reserve fund for that project each year.

In the real world, an HOA with a reserve fund at 75-80% is doing very well and at a low risk of requiring a special assessment.

Depending on the size and nature of your association, you may have a few reserve fund projects on the books or many.

Inadequate Reserve Funds

But sometimes, the reserve fund falls short. Either it hasn’t been funded at the level recommended by the reserve study or the study did not accurately estimate costs or allocate enough money for unexpected expenses. Maybe inflation increased higher than anticipated and the cost of projects rose exponentially.

Some HOAs don’t fund their reserve account fully because the board doesn’t want to raise fees or dues. That is penny wise and pound-foolish board thinking. The maintenance and repairs don’t go away. They become a community-wide hazard.

Insufficient reserve funds can lead to serious consequences.

• Special Assessments. Homeowners may be asked to contribute large sums to cover costs that should have been in the reserve fund. Homeowners will be angry, and rightfully so. They rely on the HOA board to fulfill its responsibility to fund the association over time. Some members will be unable to pay and others will suffer significant financial difficulty in doing so.
• Decreased Property Values. The common areas maintained by the HOA contribute to the value of the homes in the community. Neglected common areas are both unsightly and unsafe, decreasing the value of every home in the association.
• Real Estate Reality Check. A poorly functioning HOA makes it harder to sell a home. Through no fault of their own, homeowners will wait longer to find a buyer willing to take on the risk of a failing HOA.
• Deferred Maintenance. This is a big issue. Not replacing an asset at the end of its recommended lifespan leads to more repairs and more costs against the operating budget. It’s wasteful and can lead to unsafe conditions in your community. The Surfside, Florida building collapse is an extreme example of the consequences that may occur when an HOA defers maintenance projects past their recommended replacement date.
• HOA liability. When repairs aren’t made, accidents happen. That can leave your association at risk for legal action. Unsatisfied homeowners may pursue complaints against a board for not fulfilling its responsibilities.

What to Do if Your HOA Has Insufficient Reserve Funds

If your HOA reserve funds are inadequate, it’s time to get serious about long-term planning. The first step is to make sure you have a current and updated reserve study. Examine the recommendations. If they have not been followed, find out why.

If you aren’t on the board, ask questions. This issue directly affects you as a homeowner. If you are on the board, take a hard look at why the reserve study hasn’t been applied in the budget process.

In some cases, there may have been a large, unexpected expense that drained the reserve fund. It takes time to recover and not everything can be anticipated. If we’ve learned anything in the past few years it’s that estimates aren’t promises.

If this is the case, a small increase in assessments might be enough, combined with established funding levels, to get things back on track. But don’t guess. Hire a professional. Someone with experience can help you figure out the best way to recover after a large loss.

For other HOAs, the culprit might be inexperience. Not listening to the professionals who prepare the reserve study is a rookie mistake. You can remind your HOA board that these studies are done for good reason. The consequences to your community of ignoring them can be severe.

There are also software tools available to help HOAs model and forecast different long-term reserve plans to determine the most appropriate plan for your community. Homey’s long-term reserve modeling feature allows board members to adjust their current reserve plan in real-time to account for actual replacement costs and funding rates. If your HOA board decides to adjust to the reserve plan, use Homey’s visual modeling tool and financial presentations to show homeowners how raising fees over time will save them money in the long term and keep the community safer.

When you approach your board with solutions in hand, problems become easier to address. HOA boards are obligated to manage the finances of their organization in good faith and in accordance with regulations. That isn’t happening if the reserve funds are insufficient.

We’ve come a long way from legal pads and pencils. Use the technology at hand to make long-term planning and reserve funding easier and more accurate. Contact Homey today to get started.