Managing Your Hoa Reserve Funds
Proper management of your HOA reserve funds can make or break your community. The last thing you want is to discover a major expense you cant afford to fix.
To help you better manage your HOA reserve funds, heres a list of tips to take into consideration:
- Adjust the budget when needed. Increasing fees incrementally over time is better than asking for a lump sum amount.
- Transparency is key. Keep homeowners up to date on your HOA reserve fund. If you need to increase fees, your homeowners will know why .
- Stay on top of maintenance. Its easier to fix smaller problems today than to deal with a big problem tomorrow.
- Conduct regular inspections and keep track of general wear and tear. This will help you to estimate when you might need to repair or replace equipment .
- Hire a professional company to run an HOA reserve study. This will help you to determine the correct amount to budget.
Why Do You Need Reserve Funds
The main purpose of an HOA is to operate, maintain, repair, and replace the communitys shared areas. The board will not be able to do this without adequate operating and reserve funds.
Apart from large-scale maintenance and repair projects, HOA reserve funds are also useful in case of unexpected damage or emergencies. For example, if a powerful storm wrecks your water pipes, you will need to repair them immediately. Given the urgency of these matters, the HOA will likely not have enough time to come up with the money for repairs. If you have a reserve fund, you can use this money for the repairs.
If you do not have a reserve fund, the HOA may have no other option than to significantly raise HOA dues or levy a special assessment. This scenario also places a lot of financial stress and burden on homeowners.
Consult With An Experienced Advisor Or Cpa
Youll want to consult a qualified and experienced advisor to review your reserve study and reserve account, and make recommendations for the best type, amount, and term of investments. Property management companies are a good source of information, as are CPAs with HOA experience. If theres any risk to the investment principal, avoid that investment and keep it safe!
Neal Bach, CPA
Have Adequate Insurance Coverage
Make sure that your associations insurance covers any money that you may lose to theft. Too often, HOAs think that their managements fidelity insurance protects them it doesnt. It only protects the management company if an employee steals from them. So, whether its fidelity and crime insurance or directors & officers insurance, make sure you are covered for any loss no matter who is lining their pockets.
What Are The Different Reserve Funding Methods
There are numerous methods for funding a reserve account, each with its own benefits and drawbacks. The reserve funding method you choose depends on your objectives for repair and replacement tasks, as well as your annual budget.
The two primary methods for increasing HOA reserve funds are the cash flow method and the component or straight line method. The method you choose is determined by your reserve funding objective for covering replacement costs, large-scale costs, and other unexpected costs for extending the useful life of common area assets.
The cash flow method for funding HOA reserves involves making regular contributions to a designated financial account for HOA reserve funds. Any money spent on improving the HOA property through repair and replacement costs comes from these financial reserves.
The component method, on the other hand, involves setting up different accounts for each of your HOAs assets. When repairs and replacements are needed for each of the assets, the cost is covered by pulling money from the designated account for each asset.
Click here to learn more about the methods used to fund HOA reserves.
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What Is A Special Assessment
When there isnt enough money in a reserve fund, an HOA has to conduct a special assessment. An HOAs governing board will assess the cost of a needed repair or replacement and then divvy that cost up among residents. Some HOAs require all residents to pay an equal share, while others base the portion a resident pays on the square footage of their unit.
When and how the HOA can call for a special assessment should be laid out in its governing laws. For example, the association may need to vote on whether a special assessment should be levied beforehand.
Keeping Homeowners Informed About Reserves
Communicating updates to homeowners about the reserve fund will keep them informed about why saving is necessary and updated on the financial affairs of the HOA. Homeowners should be reminded that funding the reserve will increase the resale values of their homes and minimize the need for lump-sum special assessments.
A reserve fund is a critical risk management tool for your HOA. Contact Valent Group today to find out more about reserve funds and how to manage your associations risks.
What Makes Hoa Reserve Funds So Important
What makes it so essential for your HOA to have a solid, healthy reserve fund in place? Simply put, those who serve on the HOA Board are responsible for the upkeep and maintenance of the community, including all common areas. This means handling day-to-day operations, but it also means being prepared for unexpected expenses, or urgent projects that may arise in the future.
So, for example, what happens if the roof over your clubhouse suddenly springs a leak? Or if the pump blows out on your community pool, right as swimming season starts? These and similar issues can impede the quality of life for the entire community, and residents will rightly expect these problems to be fixed right away. HOA Board members must be prepared for the financial burden associated with these repairs. Thats where HOA reserve funds come into play.
Additionally, reserve funds can be useful for handling any sudden repair needs that arise due to hurricanes, tornadoes, flooding, etc. Depending on the geographic location of your community, this may or may not be a major point of concern.
Its also important to keep in mind that HOA reserve funds arent only for emergency repairs. For example, your Board may approve to use HOA reserve funds to make major upgrades or improvements to common areas. These enhancements can benefit everyone who lives in the community.
Is The Project Long
If the project will take longer than a few days, its likely considered long-term. Long-term projects that dont fall under capital improvement typically use HOA reserve funds.
Some examples of the types of long-term projects generally paid for with HOA reserve funds include:
- Major landscaping work
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Hoa Reserves Calculation Example
For instance, if an association expects to pay $20,000 in 10 years for the repaving of all community roads, then the board should collect $2,000 in reserve fund contributions every year. That way, when the time comes to repave the roads, your HOA will have enough money to pay for it without charging homeowners a lump sum of $20,000.
Of course, your association will probably have more than one project to fund than just a simple repaving. Therefore, you will likely need to set more money aside than just $2,000.
Hoa Reserve Fund Laws
Can HOA invest money? It depends on what state laws and your governing documents have to say. Some states have certain restrictions on what investments HOAs are permitted to take advantage of.
For instance, in California, Civil Code Section 5515 requires HOA boards to exercise prudent fiscal management when it comes to their reserves. This includes making investment decisions. A similar law exists in Oregon, thereby limiting associations to government-insured investments such as treasuries and certificates of deposit, among others.
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Hoa Reserve Funds Vs Hoa Operating Funds
In addition to reserve funds, an HOA also manages operating funds. Both the reserve and operating funds require homeowners within the HOA to pay fees. These fees support the community by paying for various expenses.
This is why proper management of HOA reserve and operating funds is so crucial. A well-funded reserve can help you make sure that any long-term improvements are fully funded, without dipping into your day-to-day operating funds.
Its for this reason that its essential to recognize the differences between HOA reserve funds and HOA operating funds as itll help you understand when you should use HOA reserve funds.
How To Manage The Reserve Funds Of The Hoa
Theft, fraud, or embezzlement can create major damage to your associations finances. Even if the HOA has adequate insurance coverage, there is no guarantee that you will be able to recover the money completely. In some cases, it may even take years to recover stolen HOA funds.
Nevertheless, the community needs to keep running. It will be up to the board to find ways to replenish reserves. This can be a major headache. As a precaution, its important to establish safeguards that will deter or eliminate fraudulent activity in your community.
Here are ways to manage HOA reserve funds and deter fraud:
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Is This Expense Going Toward A Capital Improvement
If the answer to this question is yes, you cannot use your HOAs reserve funds. Adding a new community feature or facility is considered a capital improvement.
HOA reserve funds only cover repairs, replacements, and unforeseen expenses. Something like a new building requires planning. Therefore, it requires a different fund to cover the cost.
Set Your Investment Strategy Goals
When investing reserve funds, there are several factors you need to consider:
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Learn Hoa Investment Fundamentals
While board members should avoid overstepping their roles or taking on too many responsibilities when it comes to reserve fund investments, they should have a basic understanding of HOA financials. Along with understanding your responsibility as a fiduciary, its important to be informed about HOA investments and your financial obligations. Even if you are working with a financial services company, make sure your association is choosing safe and time-tested investments . Additionally, your association should also be following state legislation in terms of individual requirements for managing and reviewing reserve funds.
Dont Take Risks With Your Communitys Funds
There are a variety of reasons why community association boards shouldnt make risky investments, but to me the main one is that this isnt your money. It belongs to the other homeowners, and as a board member its your fiduciary responsibility to manage that money wisely. Safety should be your main objective, then liquidity. Interest and returns should be at the bottom of the priority list. That said, there are still ways to generate a return with no risk.
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No Reserves Here Are The Alternatives
When you lack money in your HOA reserves, there are three possible alternatives none of which are particularly agreeable to homeowners.
- Special Assessments. A shortage of reserve funds will force you to impose special assessments on all homeowners. Due to the nature of the expenses that reserves cover, this usually means charging expensive assessments.
- Loans. If you have a steady source of revenue and little-to-no debt, you will find it easy to apply for a loan. Though, loans typically require you to pay interest and offer up collateral.
- Delay of Expenditures. If you dont have the money for it, you might consider postponing major repairs or replacements. This, of course, will inevitably affect curb appeal, property values, and homeowner satisfaction.
Check Your Governing Documents
If your documents already outline an investment strategy, you are ahead of the game. Set aside a time at your next board meeting to review the strategy and discuss any amendments needed, or ways in which the community is not currently in compliance with the policy.
If your governing documents do not currently outline an investment strategy, its time for the board to create an investment policy. Your investment policy should outline how funds are to be invested, what insurances are required, who is responsible for making investment decisions, and any other special considerations. Remember that your investment policy is the safeguard to your communitys future, so its importance cannot be underestimated. Well talk more about crafting your investment policy later in this series.
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Is It Possible To Invest Your Hoa Reserves
In a word, yes. You can invest your reserves, and many HOA boards do this as a way to earn more income for the association. But, you must exercise caution.
Remember that your duty as a board member is to maintain the community and that includes its assets. Every decision you make should be within the associations best interests.
Therefore, you must choose your HOAs investments wisely. Go for an investment that offers growth but will not put the principal amount in jeopardy. It is generally ideal to stay away from riskier investments. Though these offer more growth, there is also a higher chance of loss. In choosing this route, you might incite anger from the community and even invite potential lawsuits.
When using your reserve fund to invest, it is always best to follow the provisions outlined in your governing documents. Not all associations have an investment philosophy written in their CC& Rs, though. In that case, turn to an accountant, an attorney, or an HOA management company for advice.
How Do Reserve Funds Differ From Operating Funds
Before discussing ways to protect your associations finances, its important to know the difference between operating funds vs reserve funds. You should also know why these accounts are important to your association.
Most associations have two accounts: reserve funds and operating funds.
As previously defined, homeowners association reserve funds are designated for major replacements, repairs, and maintenance. Meanwhile, an operating fund is used to pay for the day-to-day expenses of the community. This would include maintenance services, security, landscaping, utilities, management fees, taxes, and insurance.
Reserve funds and operating funds are usually respectively kept in a savings account and a checking account. Ideally, HOAs should have about 1 to 3 months worth of operating funds in their account.
Both reserve funds and operating funds are important to an association. Without the latter, the community would not be able to operate properly on a daily basis. And without a sufficient reserve fund, the community wont be able to pursue projects that lead to scalability and growth.
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Understand When To Use Your Reserves
The purpose of a reserve fund is to provide the HOA with a financial safety net in case of emergencies or unforeseen occurrences. Its not for the maintenance of community properties rather, its for the repair and replacement of such things.
If you use it for maintenance or other unnecessary expenditures, then youre doing your association and fellow members a disservice.
As a board member, you must always act within the communitys best interests. Misuse of funds is a great abuse of power and, even worse, can be legally held against you. When in doubt, ask yourself these questions to determine whether you must use your reserve funds or not:
- Is this a recurring expense? If the same expense is going to come up in the next month or so, then its likely an operating expense. As such, you must use your HOAs operating fund to cover the cost instead of the reserve fund.
- Is this a capital improvement? If youre adding a new facility or feature to your community, then thats a capital improvement. In that case, you mustnt use the reserves to pay for it. Remember: reserves are only for replacements, repairs, and other unforeseen expenditures. A new addition to the community wouldve likely involved planning and, therefore, a separate budget or fund to cover it.
Four Hoa Reserve Fund Investment Hurdles
HOA boards are faced with a challenge. They have limited time and resources, yet must meet the financial obligations of the reserve study by following a funding plan that provides adequate member contributions and additional revenue from prudent investment of reserve funds that reduce those member contributions. Here are four hurdles the board must jump when tackling reserves investment.
Hurdle #1: Failure to use the Reserve Study or not having one in the first place. Homeowner association boards have the duty to conduct long range planning to identify common elements, their current condition, their useful lives and current cost of repair or replacement. This exercise is called a Reserve Study. Some boards believe that a reserve study provides little benefit except to point out the obvious.
These same boards either elect not to pay the cost of one or put the one they have in a file to gather dust. Both approaches are foolish because without a clear road map to follow, the board is bound to get lost in the maze. Properly funding reserves for the standard 30 year projection period could amount to many hundreds of thousands of dollars. Larger HOAs with extensive common elements should reserve millions.
Failure to fund reserves adequately results in unfair and sometimes uncollectible special assessments. Prudent investment of reserve funds could partially offset member contributions and reduce the risk of special assessments.
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