Reserve Study StandardsBy Mike Price CMCA, AMS, RS
Reserve studies are required by Hawaii State Law, HRS 514A and HRS514B-148 for Condominiums and Time Share property under HRS 514E-10.3. Reserve studies provide a tool to manage timely replacement of major physical assets, referred to as "components". The reserve study recommends a budget plan to collect enough money to properly fund replacement of deteriorated components without the need for loans or large Special Assessments. Deterioration of components like roofs, exterior paint, mechanical equipment and asphalt is inevitable due to wear and effects of this tropical climate. The Board of Directors is responsible for maintaining these components for the good of all owners. An adequate Reserve Fund to replace components at the end of their "useful life" is the goal. Objectives of an adequate reserve fund plan are:
- Sufficient cash on hand
- Stable contribution rate
- Spreading cost fairly and evenly over present and future owners
- Fiscally responsible plan meeting legal, industry and property declarations requirements
The recent recession has resulted in stricter requirements for condominium mortgage loan approval. FHA requires a recent reserve study using the Percent Funding Method in order for a mortgage to be backed by the FHA. Fannie Mae requires that 10% of the budgeted Maintenance Fee be deposited in a reserve fund. Private lenders are verifying the condominium property association has an adequate reserve fund to maintain the property and that component replacement is not deferred.
A reliable reserve study is important. The consequences of an inadequate reserve study are budget mistakes, unexpected expenses and deferred maintenance. The Community Association Institute (CAI) developed a National Reserve Study Standard for credentialed Reserve Specialists (RS) along with the better known Property Manager credentials CMCA, AMS, and PCAM. Most associations understand the importance of having at least a CMCA professional managing their property operations. A credentialed Reserve Specialist providing the reserve study is just as important. A listing of Reserve Specialists can be found on the CAI ------website National Directory at http://www.caionline.org/info/directory/Pages/default.aspx ------Enter Designation: RS and State: Hawaii. Also a list of providers practicing in Hawaii and experienced with the unique conditions and related higher costs of construction and procurement can be found at http://www.caihawaii.org/Service-Providers---Reserve-Studies~5061~249.htm .
The reserve study provider selection process is no different than selecting a painting contractor or an auditor. Obtain a written proposal and compare it to National Reserve Study Standards for completeness and full disclosure of what will be provided. Ask to review a sample reserve study report. If you do not understand the sample study report and plan recommendations, then neither will the owners when you try justifying the recommendations. The reserve study report needs to provide a clear plan you can follow. The reserve study needs to clearly state the following important information:
- Current Reserve Fund status
- Methods and objectives utilized in computing or evaluating the association's Reserve Fund status
- Type of report: Full study with site inspection (Level I), Update with site inspection (Level II) or Update without site inspection (Level III)
- Starting balance for report period
- Report period covered
- List of reserve components requiring funding
- Listing of component quantities or descriptions, and current replacement cost.
- Methods and goals of the funding plan using National Standard terminology
This is a partial list of what is required by National Reserve Study Standards. The National Reserve Study Standards provides a check list of items required in the report. Download and use the checklist and information to evaluate sample reports. Make sure the reserve study that the Board is currently using meets these standards. It is important that all reserve components requiring funding are disclosed in a report. Many large components can be predicted to last for 25 to 30 years. Budget plans of less than 30 years need to disclose how the 30 year and longer reserve components are being handled. Is the deteriorated value of the long term component collected each year or will there be a large "make-up" contribution required after the component has 20 years expected remaining life? Hawaii HAR 16-107 allows an option where the first ten years deterioration of the 30 year life component is not funded. The owners in the first ten years use the component, but do not pay for the deterioration of the component. The deterioration cost is pushed out onto future owners. This is not "equally spreading cost over present and future owners".
Conflicts of interest need to be avoided and good judgment applied in the process. Decide whether the reserve provider has another relationship with the association that will bias the reserve study results. Because the reserve study results are important to the well being of the association, selection of a reserve study provider based solely on price is not "good business judgment". Remember the fiduciary responsibility in this process is borne by the Board of Directors, not the Professional Reserve Specialist, the Managing Agent, or well intentioned volunteers.
Summary: State law requires an annual review of the reserve fund and reserve study plan. Ability of future buyers to obtain mortgage financing depends on the adequacy of the reserve study. Reserve studies are a powerful managing tool if followed. Strong plans avoid cash flow problems, need for loans and Special Assessments. The Board of Directors has a duty to maintain and protect the property components in order to protect the owners' safety and property values. The goal of the reserve study is adequate Reserve Fund cash to replace components at the end of their "useful life". Any reserve plan is a prediction based on current costs and conditions of future events that may not occur as planned. Having a strong fund with a margin for future expensive unpredictable events like the current recession delinquency rate, and other catastrophic economic events is recommended. The goal should never be to minimize the reserve contribution portion of the Maintenance Fee. A weak fund or under funded plan exposes future owners to high risk of Special Assessments, large loans, deferred maintenance which result in loss of property market value. A reserve study prepared according to National Reserve Study Standards avoids these problems. Again these standards are found at www.caionline.org
About the Author: Mike Price - CAI Reserve Specialist #164 and former President of Association Reserves Hawaii LLC, provides independent third party comprehensive reserve studies for all Islands. Mr. Price has a bachelor degree from Eastern Washington University and over 30 years experience in construction and project management. He holds the CMCA and AMS designations as a past condominium Site Manager and General Manager. Mr. Price can be contacted at firstname.lastname@example.org or (808) 936-4789.