One of the most important aspects of serving on the homeowner’s association Board of Directors is understanding your fiduciary responsibility. What this means is that Board members are tasked with doing everything in their power to ensure that the homeowners association remains financially healthy. In order to fulfill this important obligation, Board members should have a good handle on the HOA reserve funds. This includes knowing what reserve funds are used for, where the reserve account is kept, and when a reserve study is required.
In this article, we’ll try to hit on all the major issues related to the HOA reserve fund.
What’s the Difference Between Reserve Funds and Operating Funds?
The first thing to know is that HOAs have two major accounts: the operating fund and the reserve fund. The operating fund – as its name states – is used for keeping up with day-to-day expenses and maintenance of the association’s assets. This is where most transactions take place. The reserve fund is essentially a savings account. It is where the HOA saves money for more costly repairs and replacements.
Unfortunately, many HOAs have underfunded reserves. They don’t have enough money put back to cover estimated expenses in the future. Not every state has laws requiring reserve studies, but it is a good idea for every HOA, regardless of the laws, to have a professional reserve study conducted at least every few years. A reserve study evaluates the condition of major assets and amenities, estimates when they will need to be repaired or replaced, and how much that will cost.
How Much Money Do You Need in Your Reserve Fund?
Ideally, your community wants to have a 100 percent funded HOA reserve account, meaning that it has enough money to cover all anticipated costs. In lieu of a fully-funded reserve, even 70 percent is pretty decent. Anything below 70 percent, however, and the HOA faces the likelihood of needing to leverage special assessments or increase association dues in order to cover costs. (We’ll cover this shortly.) This can be unwelcoming among the members who must come up with this money without any advance warning.
What is the HOA’s Reserve Fund Used For?
As you think about your HOA reserve fund and think about how much money it needs, it may be helpful to know more about the potential uses of the reserve account.
As a rule of thumb, HOA reserve funds are used to cover any expenses that do not occur regularly. There are any number of unusual or unexpected expenses that could arise in your homeowner’s association, but some of the most common uses of HOA reserve funds include:
- Completing major landscaping projects
- Constructing a new community playground or assembling a new playground for your community
- Replacing the pump for your HOA’s pool (or completing other costly, unexpected pool repairs)
- Replacing the roof of your clubhouse or another common area
- Painting the clubhouse or other common areas/structures within your HOA
- Replacing or making significant repairs to fencing
- Other major construction or repair projects in your HOA, including sidewalks, etc.
Hopefully, these examples are instructive as you think about when you’d need to use HOA reserve funds, and when you’d simply draw from your normal operating fund.
What Makes HOA Reserve Funds So Important?
What makes it so essential for your HOA to have a solid, healthy reserve fund in place? Simply put, those who serve on the HOA Board are responsible for the upkeep and maintenance of the community, including all common areas. This means handling day-to-day operations, but it also means being prepared for unexpected expenses, or urgent projects that may arise in the future.
So, for example, what happens if the roof over your clubhouse suddenly springs a leak? Or if the pump blows out on your community pool, right as swimming season starts? These and similar issues can impede the quality of life for the entire community, and residents will rightly expect these problems to be fixed right away. HOA Board members must be prepared for the financial burden associated with these repairs. That’s where HOA reserve funds come into play.
Additionally, reserve funds can be useful for handling any sudden repair needs that arise due to hurricanes, tornadoes, flooding, etc. Depending on the geographic location of your community, this may or may not be a major point of concern.
It’s also important to keep in mind that HOA reserve funds aren’t only for emergency repairs. For example, your Board may approve to use HOA reserve funds to make major upgrades or improvements to common areas. These enhancements can benefit everyone who lives in the community.
These types of projects tend to have fairly high price tags, so they often can’t be covered with the normal, day-to-day operating funds. By having homeowner’s association reserve funds in place, the Board can handle these projects without the need for a fundraising effort, without incurring debt, etc.
What is an HOA Reserve Study?
Again, your reserve account should have enough money in it to handle all anticipated expenses; if you know for a fact that the clubhouse roof will need replacement within the next couple of years, that’s certainly an anticipated expense.
But of course, there’s no way your HOA can anticipate every single emergency repair need or maintenance problem that will arise. As such, there is no clear, definite answer to how much should be in your HOA reserve funds. You’ll need to make some educated guesses.
We also recommend conducting HOA reserve studies. A reserve study allows the Board to have a better grasp on how much money they need in the reserve account. We typically advise conducting a reserve study once every three to five years.
Reserve studies usually include thorough inspections of all HOA infrastructure and features. A physical evaluation of the property helps with anticipating future repair needs. This physical evaluation should be combined with a financial assessment, providing some insight into the HOA’s current fiscal health and the stability of HOA reserve funds.
It’s crucial to note that reserve studies require a lot of technical expertise, and frankly, most HOA Board members aren’t going to have that kind of expertise. As such, studies into reserve funding are usually carried out by external professionals. The best way to find someone qualified to assess your HOA reserve fund is to talk with a representative from your property management company. Here at Southern Property Management Group, we are always happy to chat about HOA reserve funds, and to answer any questions your Board has about reserve funding.
What Happens When Homeowners Association Reserve Funds are Insufficient?
Given the significance of HOA reserve funds, it might almost go without saying that having an underfunded HOA reserve can be dangerous.
We would certainly urge HOAs to keep their reserve funds as fully funded as possible; as we noted above, a 100 percent funded reserve fund is ideal, but even HOA reserve funds that are 70 percent funded can be viable.
If you don’t have a full reserve fund in place, and if emergency repair needs do arise (again, think freak storms or other inclement weather), then the HOA will need to scramble to find a way to pay for the repairs. There are a number of options available to HOA Boards that get caught without sufficient reserve funds, and none of them are pretty.
What to Do When Your HOA Lacks Reserve Funds?
Among those bad options, an HOA might try any of the following:
- You can increase dues in your HOA. This can be problematic for a couple of reasons. One, homeowners are obviously going to be displeased about it, and some may even ask why the HOA was remiss in cultivating healthy reserve funds. Additionally, an incremental increase in dues may take a while to yield the funds you need for a capital improvement or emergency repairs project. In other words, you won’t be able to make up for a fully-funded reserve fund overnight.
- Another option is to collect a special assessment. Special assessments are basically a one-time collection of fees, above and beyond what homeowners are already paying with their dues. Special assessments aren’t the end of the world, but they can definitely cause disharmony among homeowners. They can be a real pain to collect. And, they may lead to some skeptical questions about how your Board has managed its cash reserves.
- Finally, your HOA can make up for inadequate reserve funds by seeking external financing. Taking on additional debts is really never a good idea for HOAs, unless it’s literally the only viable option. Accruing new debts isn’t going to solve your problems in the long run. You’ll still be short on your reserve funds, and you’ll also have less wiggle-room in your operating budget, as you’ll need to make loan repayments. Often, seeking external funding is a precursor to a special assessment or an uptick in member dues.
The bottom lines? It’s crucial for your HOA reserve funds to be fully funded, which is why we recommend studying the reserve fund on a regular basis. Again, if you have any questions about how to do this, we’d recommend talking with your property manager.
HOA Reserve Funds: Some General Tips
If you’re only now thinking seriously about HOA reserve funds, you may have some questions about how to handle the process in a thoughtful, strategic, and efficient way.
Here are a few general tips and guidelines we’d offer with regard to HOA reserve funds.
- Don’t be afraid to ask for help. We’ve mentioned this already, but it really is important to note the level of expertise required when working with reserve funds. If there’s nobody on your Board who has real-world experience dealing with this issue, we would highly recommend seeking the help of a professional. Your association management company is usually the best place to turn.
- Think about reserve funds when hiring a management company. Along the same lines, remember the importance of HOA reserves when you hire a property management company. During the initial interview process, ask about their experience with fund reserves, and inquire as to how they can help you ensure an adequate reserve fund within your HOA.
- Focus on incremental changes whenever you can. Whether you’re tweaking your operating budget or increasing dues, remember that smaller changes, made over time, tend to be more effective than big, all-at-once changes. Your members will be much keener to pitch in an extra $10 monthly than to shell out hundreds or thousands of dollars at once.
- Be transparent. When dealing with HOA reserves, communication is key. Remember that this money belongs to the members of your community, and they have a right to know how much is currently in the fund and what that fund is being used for.
- Monitor common areas. While you can’t always predict if and when repairs will be needed, you can certainly keep an eye on common areas, and make notes as to any places where you anticipate a problem.
- Be vigilant about preventative maintenance. An investment in basic, routine maintenance can often help you delay or even eliminate the need for more expensive repairs or replacement costs. Make sure your HOA community has a preventative maintenance program in place; this is something that goes hand in hand with regular reserve studies.
With these basic tips, you’re well on your way to making prudent decisions about your community’s HOA reserves.
Questions About Reserve Money? Ask Your HOA Management Company
Adequate reserves are vital to any healthy community association. If you have any questions or concerns about your reserve accounts, operating fund, or general financial health, we invite you to contact Southern Property Management Group.
Our HOA management company works with communities in Alabama, as well as community associations in the Tennessee area. We’d love to provide the guidance you need in the area of HOA reserve funds, and to help your Board uphold its fiduciary responsibilities on behalf of the entire community.
To schedule a time to talk with Southern Property Management Group, contact our office at your next opportunity. We’re here to help in any way we can!