Okay, how do we establish a funding plan for our HOA’s Reserves? (Part 2 of a 3 part series on Reserves)
Once an association has obtained a reserve study, two questions arise: 1) Do we have to fund a reserve account? and 2) If so, how do we fund a reserve account?
The statutes for condominiums and property owners associations require an association’s budget to include, among other things, an annual amount to fund the reserve account that is consistent with the obligations in the reserve study. This means that an association should be placing funds into the reserve account that permits it to meet is obligations to repair, replace and restore capital components based on the estimated replacement cost, the estimated remaining life and the estimated useful life of the capital component.
There are three methods of funding a reserve account: baseline funding, full funding and threshold funding.
- Baseline funding – the board sets the reserve contributions at a level that ensures that the reserve account never falls below a zero balance. This type of funding is most risky for an association because there is less margin for error to avoid special assessments to fund major capital replacement or repair.
- Threshold funding – similar to Baseline Funding, the board sets the reserve contributions at some predetermined dollar level above zero balance. This type of funding is more of a middle ground between baseline and full funding.
- Full funding – the objective of full funding is to keep the reserves at or near 100% fully funded. The board analyzes separately each capital component. The replacement cost of each component is divided by the remaining years of useful life. The results of each of those calculations are added to determine the annual amount of funding for the capital components. Clearly, this funding plan requires the association to set aside in reserves the most amount of funds, but it is also the safest funding plan because the association will be financially prepared to make any capital repair or replacement.
If a board of directors does not adequately fund the association’s reserve account, an association will not have sufficient funds to meet its obligations unless the association borrows money to make the necessary repairs or replacement, or unless the association imposes a special assessment on the owners. If the association does not borrow money or levy a special assessment to make the necessary repairs or replacements, the property values in the community will suffer.
Proper reserve funding protects the property values in your community. By establishing a reasoned funding plan based upon a professional reserve study, the board can best ensure that major capital repairs and replacements can be done without imposing a “surprise” special assessment on homeowners, and without delaying the needed repairs.
In our third installment in this series, we will discuss the process of hiring a reserve study specialist.
Tarley Robinson, PLC, Attorneys and Counsellors at Law
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