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Reserve Funding: Condo and HOA Unknowns
The benefits of a reserve study have been well documented and universally accepted. Reserve studies highlight the scope of predictable repair and replacement an association will face over a predefined period, providing not only a roadmap of anticipated costs but a clear plan as to how to navigate and prepare for them. However in spite of its acceptance as a good means of management and financial planning, a reserve study must also be understood for its inherent limitations.
By definition, reserve components are items “whose infrequent and significant nature make them impractical to be included in the annual budget” (RCW 64.34.382). Determination of what constitutes a reserve component is dependent on a number of factors. Unless explicitly determined otherwise, a four-part test is generally used to distinguish a reserve expense from that of an operational or maintenance expense.
A reserve component will generally satisfy the following criteria:
- The component is part of the Association’s common or limited common area responsibilities.
- The component has a predictable useful service life.
- The component’s useful life fits within the projection period (30 years).
- The component’s cost for repair and replacement is too high to be included as part of the operating or maintenance budgets.
The above four part test should serve as a reminder to associations that not every aspect of a development is necessarily accounted for in a reserve study. Many reserve components, such as roofs, sidings and windows fit well within the framework above. However there are components of a property, some very long-lasting others not readily visible, that are generally not included in a reserve study. It is important that associations do not lose sight of these latter items, such as electrical or drainage systems. These “known unknowns” are items which still constitute part of the association’s common area responsibility, but are often omitted from the reserve study because of the difficulty in establishing their useful or remaining useful life.
Impact On Associations
This means of categorization of reserve and non-reserve components is both beneficial and prudent, as it does not unfairly burden an association with repair and replacement costs that may not eventuate. Many would agree that it makes little sense to reserve for a building component that has an unpredictable service life and cannot be accurately quantified.
Of course, such “life of the property” items sometimes begin to fail prematurely. In these instances, the reserve study framework can be a convenient tool that will allow for the inclusion of a schedule for replacement of such an item. This is especially helpful if the unexpected replacements must be phased in over time. So in certain instances “known unknowns” can be quantified and, based upon competent investigation of conditions, a manageable replacement and repair schedule can be developed and incorporated into the regular reserve study framework.
Every Community is Unique
Every community is different by design. Each community has to deal with its own unique challenges and conditions. A reserve study has the flexibility to incorporate these unique needs and address the individual challenges faced by each community. In this context awareness of these “known unknowns” can be viewed simply as good governance.
Good governance requires associations to prepare for the future and in doing so they should be aware of the scope of a reserve study. They need to be aware of what elements of their common areas are addressed within the report. Understanding why certain items are included, and why others are not, is important. Associations need to recognize that in some circumstances the task of selecting reserve components needs, on occasion, to extend beyond the accepted framework. However this is more the exception than the rule.
Stuart Wilkinson, RS
Reserve Study Group – Seattle