Reserve Funds

Hello

I am the President of an Association of 270 single family residences located in South Carolina.

I am interested in hearing from anyone regarding the use of Association Reserve funds. Our declaration and By Laws are silent on the issue of Reserves, how they can be spent, etc.

One of our Board Members is looking to use some of our reserves to fund a capital project (clubhouse expansion), using some of the Association Reserves.

Our reserves appear to be in pretty good shape at the moment, at a level of about 20% of our operating budget. However, we are presently in the process of completing a reserves study to tell us exactly what our reserves position is.

My interpretation of Reserves is funds set aside for the replacement of our Associations assets only and should not, and perhaps cannot be used to fund a capital project. Our Board is of mixed opinion in the matter and I would appreciate any input.

Thanks,

Bill in SC

Hi Bill,

Regarding Paragraph #1: Your operating budget covers the expenses of monthly bills and regular repairs of everything on your property. When it's time to replace an object (like a roof on that clubhouse or pool replastering), that money would come from the Reserve Fund. Also, it's a good idea to make a deposit into the reserve fund and note it as an "Expense" on the operating budget. Reserve Funds are somewhat related to operating budgets but you don't dip your hand into Reserves for general repairs and bill-paying NOR is it leftover money......what lesser informed people would consider excess revenue or "profit."

Regarding Paragraph #2: It would be appropriate to use Reserve Funds to expand your clubhouse in my opinion because you'd be replacing "usage" of the clubhouse, replacing walls, etc.

Regarding Paragraph #3: Await results of your Reserve Study to learn which items on your property will need replacing in the coming years. If you will have plenty of savings to pay cash as these projects come due - which is on a schedule of sorts - then you can discuss renovating the clubhouse. Since I have no clue of your operating budget, I'd venture to say 20% of your operating budget, in cash holdings, while a large amount to most anyone, is not a strong position for a community. A rule of thumb (and loose rule at that) is to keep a rock bottom minimum of 10% in reserves and save like crazy to increase. There's a fair chance the cost of your property needs will exceed, in dollars, your operating budget amount. Of course, not all things "come due" at the same time, so you'll be fine.

In my opinion, the appropriateness of the clubhouse expansion would revolve around timing and your HOA's cash position with Reserve Funds in relation to what needs replacing in the community in the near-future. My argument would be to NOT expand the clubhouse until all the other items on your Reserve Fund have money saved to replace them. It's a high hurdle for most HOAs to reach the coveted "Full Funding" status.

Otherwise, you build a new building wing and four other "old" amenities break down, need replacing and thus bankrupt your Reserve Fund - sparking a special assessment. HOAs do this a lot, not realizing the harm they've caused by adding new amenities while ignoring existing ones.

Bill,

As you know, Reserves are for the schedule maintenance, repair and replacement of existing capital components. Therefore, if you use Reserve funds to expand or add new capital components you will need to defer the maintenance, repair or replacement of the existing components.

To put it another way: If your putting money aside to repair both the roof and your deck and you decide to use the roof funds to expand the deck, how will you pay to repair the roof when it leaks?

Typically, the Board may "borrow" from the reserves (sort of an interest free loan). However, plans should be in place to repay the borrowed funds in a timely manner. DO NOT simply borrow the funds without a plan to pay back the Reserves.

To build on Tim and John's advice....

Unless you are fully funded and prepared to replace your other amenities as they naturally "die" and need replacing (without special assessment), then do not expand the clubhouse. To the expand the clubhouse, your board needs to offer a special assessment to fund the clubhouse work since it jumps the line in reserve fund priority. With a front-side special assessment, the membership can determine if it wants to raise dues or special assess to add the amenity as they will be willing to fund it.

To operate in the reverse fashion is to handcuff your members if the reserve fund runs dry trying to replace an amenity under emergency as a special assessment would be involuntary.

It's a transparency thing.

Borrowing from reserve funds is the same as using existing reserve funds for capital expense. I've always seen this as a gimmick in practice though voting to "borrow" from the HOA's own reserves is transparent in that it announces that such funds will be funding an expansion into new amenities.

If money is no objective, I'd say the expansion qualifies for Reserve Funds as the clubhouse is an existing amenity and there's no rule against replacing the amenity with a newer one offering higher and better use, which could include renovation and expansion. It's hair-splitting, I know. I'd want to know if the HOA has enough savings now and will have enough savings in the future.....when that's established and confirmed, then proceed within reason.

At day's end, the members will support the effort or they won't. Big projects, if announced early in the planning process, will help the board vet the proposal at the grassroots level for support, opposition or apathy (which is a form of support).

An HOA with few amenities would likely never have any discussion of amenity creation, but and existing clubhouse would be a worthy topic for expansion if there's a need or the clubhouse is functionally "obsolete." I think a mini-world war would start in your neighborhood!

At day's end, a good community needs competent and engaged board members to weigh the financial situations. The larger the community, the more the residents must delegate to an elected board. With 236 properties, it would be cumbersome to petition for scheduled Reserve Fund items. Nothing would likely get done.