What is a Reserve Study?
One of the primary business duties of Community Associations is maintaining and preserving property values of the Associations common property. To do this properly, Associations must develop funding plans for future repair or replacement of major common-area components. A Reserve Study is a budget-planning tool that identifies the current status of the Reserve fund and establishes a stable and equitable funding plan to offset the anticipated future major common-area expenditures. The Reserve Study consists of two parts: the physical analysis and the financial analysis.
There are many benefits to having a Reserve Study done. First, it meets legal, fiduciary and professional requirements. It provides for the planned replacement of major items that must, at some point in time, be replaced, as major items deteriorate during use. It minimizes the need for special assessments. And lastly, a replacement fund enhances resale values. Following are things to keep in mind when planning your Reserve Study.
Until just a few years ago, most Reserve Studies included a list of all of the components, their replacement cost and remaining useful life in order to determine what the next years funding should be. After many years of discussion and development by the Reserves Committee of the Community Associations Institute, it was agreed by the leading Reserve Study Providers from across the United States that all Reserve Studies should include not only this “Physical Analysis” but also a comprehensive “Financial Analysis.” This is now the standard. The physical analysis is important because it determines the existing condition of the common elements. The financial analysis, which includes a cash flow projection of the Reserve Fund over a 20 to 30 year period, is even more important because it focuses on the planning and budgeting of replacing these common elements based on the specific needs of the Association. A Financial Analysis enables the Association to consider long term planning decisions, rather than focusing only on the next year’s replacement items. By providing this projection, the Association is better able to make an informed decision in regards to how much money should be set aside each year into the Reserve Fund and still feel comfortable that a special assessment will not be required over the life of the projection.
The actual cost of performing the replacement work when it occurs will generally vary from the costs included within the Study. In preparing the Reserve Study, the replacement costs, which are used, are based upon both estimating standards as well as the actual cost of similar projects, which have been performed. The replacement costs are typically based upon current dollars and are not based upon the preparation of specifications and bidding of the work to actual contractors. It is intended to be used as a budget-planning tool. In order to keep the replacement costs as well as the anticipated useful lives current the Reserve Study should be updated (including a site visit) on a regular basis AS WASHINGTON LAW.
The replacement costs included within a Reserve Study should not always be based upon a replacement with the exact same component. In many instances the original component, which is being replaced, either is no longer available or has become outdated since it was first installed. By making recommendations for alternatives to the initial installation, the Association may be able to install a replacement with a significantly longer life such as a new type roofing system, or something which is much more energy efficient such as a new HVAC system. In both cases, this will result in either a reduction in the recommended contributions to the Reserve Fund or a reduction in the client’s energy costs. At Pacific Crest all Reserve Studies are prepared under the direction of experienced professionals whose expertise in not only estimated life valuations and cost estimating but also in design. Pacific Crest also provides alternative recommendations and the required design services when the replacements become necessary.
The Reserve Study can be used for much more than just estimating the Associations contributions to the Reserve Fund. The Reserve Study cash flow analysis can also be used as a tool for determining how the Associations Reserve Funds can be invested. They give the Association the ability to plan for the actual replacements, therefore making it easier to negotiate more effectively with contractors. The cash flow analysis will show how much money will be in the Reserve Fund and over what period of time. By reviewing this information with the Associations investment advisor, an investment plan can be established to maximize the return on these funds based upon when they will be needed. In addition, by reviewing the anticipated replacements in the coming year on a regular basis, the Association can plan to have the required work performed before the actual conditions deteriorate to the point that remedial work will be required as part of the replacement, which can cause a significant increase in the actual cost of doing the work. A common example of this occurs with pavement seal coating and overlays. If the application of the seal coating is not performed on the recommended schedule, even if the pavement looks good, it can result in additional deterioration of the pavement which must be corrected prior to the application of the overlay. This can reduce the anticipated time period before the overlay is needed, but also increase the cost of the work when it is done. At Pacific Crest our expertise in both the analysis of existing conditions and the ability to answer technical questions specifically related to the conditions at your site can help prevent this from occurring.
The Reserve Study will not be the only funding the Association will need for the upkeep of the common elements. The Reserve Study is only for the major repair or replacement of the common and limited common elements that are the Associations responsibility. In all cases the cost of ongoing maintenance should also be budgeted for separately, as this is not included within the Reserve Study. If the proper maintenance is not performed, it can result in a significant loss of useful life for the reserve components. This will result in their replacement occurring sooner than anticipated when adequate funds have not yet been accumulated.
Full Funding of a Reserve Study may mean that you are over funded. Based upon the National Reserve Study Standards of the Community Associations Institute, there are a number of different “Funding Goals” which are recommended to be utilized as the basis for your Associations future reserve fund planning. “Baseline Funding” is when the cash flow projection reaches $0 at some time over the projection period. “Component Full Funding” is based on keeping every individual component within the Study 100% funded. In most instances, this will result in a significant amount of funds, which are never used during the cash flow projection period. “Threshold Funding” is when the amount in the fund during the cash flow projection period is based upon keeping a minimum balance within the fund. This is generally less than “Full Funding.” At Pacific Crest, we work with the client to establish the funding goals ahead of time and then concentrate on strategies to achieve that objective. We also present multiple projections so the Association can immediately see the result of continuing their present funding as well as the range of funding plans which can be selected.
- Level 1 Reserve Study – This is the starting point for associations who have never had a study or let their study lapse. This is the creation of the reserve study, involving creation of the component list, measuring/quantifying all reserve components, and development of the Useful Life, Remaining Useful Life, and Current Replacement Cost based on a diligent, visual on-site inspection). Note that for most associations, a Level 1 reserve study only needs to be done once. After a Level 1 reserve study has been done, in subsequent years the association goes into a rotating cycle of Level 2’s and Level 3’s.
- Level 2 Reserve Study – This is an update with an onsite inspection reserve study. The purpose of this study is to see how components are wearing and where they are in there life cycle. Typically the reserve specialist will meet with the board or the maintenance committee and walk the property with them. Typically reserve components that are coming up for repair or replacement will be scrutinized. This type of update is often performed every 3 years.
- Level 3 Reserve Study – This is a financial update. We will collect information on what major maintenance has occurred and the costs, how much was actually contributed to reserves and what the balances are in the reserve accounts. The Level 3 study is done in the two years after the Level 1 study and then on the three year rotating cycle with Level 2.
In Washington State associations are required to maintain their reserve studies. After creating the initial reserve study or the Level 1 study, associations will follow a 3 year cycle consisting of two Level 3 studies and on the third year a Level 2.