The Reserve Account is Not for Future Expenses
It’s an important concept when completing reserve studies that the recommended allocation rate to a reserve account is not for the future; instead it’s to offset the current deterioration of common areas.
Example: The community, noted above, which had in fact replaced their roof the year prior still suffers from ongoing deterioration of the components; including this new roof which will likely last 25 years and now has used up 1/25th of its useful life. At this point the community would ideally have set aside 1/25th the future cost of the roof replacement.
Unfortunately the Board has likely now moved onto other more pressing issues in the community so they do not discuss or consider things like a roof replacement in another 25 years. This is obviously very easy to do as Board members will not likely be on the Board, in the community or perhaps even alive.
However this is the exact time the above community can benefit the most from this discussion. Adequately allocating enough to the reserve account now will be most fair to the community membership (current and future) and have the benefit of interest being collected on the balance over a 25 year period.
Fairness to the membership
By spreading out the costs to the community members on an annual basis the Board ensures that the costs are adequately spread out to the community which would include current and future members. Each year as the roof deteriorates the amount placed in the reserve account should be equal to an estimated amount of the deterioration (monetized) so that at the end of the useful life of the component there is an adequate amount in the reserve account to pay for the replacement expense.
Additionally due to significant inflationary factors and a much higher future cost by distributing the costs over time the Board is ensuring the community members pay their fair share of the costs which are inflation adjusted annually. Just as the cost of purchasing a house or vehicle will be much higher in the furture so to will the cost of construction projects.
Example: I’ll again use the above community with the roof. Their roof had a cost of $130,000 as of last year but in 25 years this costs will have more than doubled to $272,000 based on a historical 3% inflation rate. So the community members in 5, 10 or 24 years will be paying a higher amount to the reserve account as the costs of the roof replacement will have had significant periods of time too inflate; and not a flat 3% per year but suffer from compounding inflation.
Sound confusing ? Well that’s why we do reserve studies. What appears to be simple math in fact can become quite complicated with respects to splitting up the costs equally over time, across many Members and doing so in a fair fashion and with many components.
What to do now?
To set up an appropriate reserve allocation rate now requires discussion and a financial strategy. This is also why completing a reserve study right after large common area projects such as asphalt, roofing, siding, windows, decks and paint is so beneficial. The reserve study company completing the the work for the HOA can incorporate actual costs into the study and has a much wider timeframe to base the recommendations on. Both of which will result in a study which is most catered to the community and which is most accurate.
Reserve Analyst Tip: During the discussion for the roof replacement incorporate into the discussion the allocation to the reserve account which may need to be adjusted after a large project like the above roof replacement. If you’re not comfortable explaining the benefits of this to them contact your reserve study company to provide some literature on the subject or to make a presentation. If your reserve study company isn’t helpful find one that is.