Condo Media - July 2013 - 35

Reserve Funding Options

Using the useful life and replacement
cost projections in the reserve study,
boards can develop a reserve funding
schedule for each major component,
creating a timeline ensuring that the
required funds will be available when
replacements are required. Cozby describes several funding strategies boards
can consider:
• Baseline funding, which maintains
the reserve balance at some specified level above zero every year. This
approach ensures funding for projects
planned for the budget year, but lacks
a “safety net” assuring funding for
components that have to be replaced
sooner than expected.
• Threshold funding, which
provides the reserve cushion baseline
funding lacks. But depending on the
threshold established, Cozby points
out, this amount could fall short of the
minimum 10 percent annual budget
allocation the FHA certification rules
require.
• Full funding, which, as the name
suggests, requires annual contributions
that will fully fund the replacement of
all components at their projected replacement dates. For simplicity, assume
a current reserve balance of zero and
three components:

1
2
3

Roof replacement in 20 years at
a projected cost of $200,000,
would require an annual reserve
allocation of $10,000;
HVAC replacement in 10 years
at a projected cost of $100,000
would require another $10,000;
Repaving the parking lot in five
years at a cost of $20,000 would
require $4,000 annually.

Fully funding the reserves required
for these components would require
an annual allocation of $24,000.
Few communities will actually do
this, and most industry professionals say it isn’t necessary. Industry
studies have found that associations

maintaining their reserve funding
levels in the 50-60 percent range
have only a slight (5.5 percent) risk
of lacking the funds they will need to
finance the capital projects required
in any year.
What boards should do, indus-

try executives say, is think seriously
about their capital repair and replacement needs and put in place
a realistic plan for financing them.
(The sidebar on this page suggests
some “best practices” for reserve
planning.)

Managing Reserves: A Few Best Practices

Update the reserve study periodically. A reserve study is based on assumptions, and
those assumptions can change. The climate, weather, soil conditions, maintenance,
construction quality, and even luck all play a role in the aging process, causing some
components to age more rapidly or more slowly than expected. The financial climate is also
variable. You can’t project replacement costs or investment earnings based on the interest
rates you see today; the inflation rate could be higher or much lower five years from now.
Industry professionals suggest updating the study every three to five years, depending on the
age and condition of the community. Newer communities might be comfortable at the longer
end of that range; older communities or those with identified infrastructure problems might
need more frequent updates.

Fund the reserves adequately, but don’t over-fund them. Excess reserves could
raise questions in an IRS audit, Bloom says. But he acknowledges that this concern is
more theoretical than real. “The question has been raised at CAI conferences and no
one has had an answer for it,” primarily, he says, because “no one has ever actually encountered the problem.”

3
4

Establish a strategy for investing the reserves. The strategy should be in writing,
it should define the association’s investment goals, and it should emphasize that the
priority is safety — preserving principal, not maximizing return. “You don’t want to be
the one who tells owners that you’ve lost their money,” Cozby says.
Recognize that avoiding risks doesn’t mean avoiding all income-generating
investments. Communities shouldn’t invest their reserves in the stock market, Bloom
agrees, but they shouldn’t put them in non-interest-bearing bank accounts, either. Bank
certificates of deposit, bank money market accounts, U.S. Treasury securities, and possibly
municipal bonds are higher-return but still conservative investment alternatives that many
investment advisors recommend for community associations. A few other points related to the
investment policy:
• Consider working with an investment professional; it’s not essential, but depending on the
expertise and comfort level of board members, it can be helpful.
• Make sure the board’s investment decisions are well-documented and approved by the association’s attorney, accountant, or investment advisor.
• Diversify the investments. That standard advice for individual investors applies to community associations as well.
• Focus on liquidity. Industry experts recommend holding a small portion of the reserves (about
5 percent) in cash for emergencies, another 10 percent to 15 percent in extremely short (six
months or less) securities, and the rest spread among varied investments with varied maturities.
• Don’t overlook the earnings potential of your operating funds. If they aren’t in an interestearning checking account, they should be.
• Review your investment strategies periodically — annually is a good idea — to make sure
they still match your near-term and long-term financial goals. But don’t let cyclical changes in
the market alter your investment perspective, which should remain long-term.

Condo Media • July 2013

Condo Media - July 2013

Table of Contents for the Digital Edition of Condo Media - July 2013