Reserve Fund or Operating Account?

Started by DavidW5 • 8 replies • 1706 views

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DavidW5 (North Carolina)
Posts: 565

Posted:

I would like to hear some opinions from the folks here on this question:

At my former HOA if a common element that was not included in the most recent Reserve Study needed to be repaired/replaced we funded it from the operating account. In the next reserve study update the item in question was then added to the reserve inventory and subsequent repair/replacement was charged to the reserve fund. If this necessitated an increase to reserve contributions, so be it.

At my new HOA the practice has been to use reserve funds even if the common element is not covered in the current reserve study. I have concerns with this practice as it seems to compromise the methodology of the study. It strikes me as a practice that should be avoided if at all possible. An analogy would be the strong advice by financial planners not to borrow funds from a 401K as this may solve a short term problem but may also compromise eventual retirement security.

How do you handle this? Is it worth fighting over?

KerryL1 (California)
Posts: 14,550

Posted:

Do your governing documents or state laws offer any guidance, David? Maybe you can find some ammunition for your point of view and put up a good fight!

Per CA statutes, for instance, we must do it as you did in your former HOA. Or, alternatively, we are permitted to borrow the cost of the new item from reserves, but must write to inform homeowners we've done that and explain how we'll pay it back.

I agree with you that it's a sketchy practice--your board should plan ahead and budget for components that it wants.

TimB4 (Tennessee)
Posts: 21,062

Posted:

David,

I agree with you on how the Reserves should be handled.

Previous Boards in my Association saw our Reserve funds as one big pot of money. They did not see how it was allocated to different items. When I became Treasurer, I created reports showing how much money was allocated to each item. I also created a maintenance/repair/replace calendar based on the Reserve study to indicate when we needed to spend from the Reserves.

Now when something not identified as a Reserve item, or if a reserve item requires additional funds to repair, I simply reply "no problem, what payment plan does the Board wish to adopt to repay those funds or does the Board desire to delay/defer the planned maintenance/repair/replacement of the other item?

I then use those reports and calendar to help illustrate that if we take funds from one line item for another line item, we need to pay that line item back (and have a plan in place to do so) or defer/delay the required maintenance/replacement of that item.

I didn't argue where the funds should come from, I let the Board decide that. I simply insisted if funds were taken from the reserves that we need to repay the reserves either by using funds from the operating account, adopt a special assessment or increase assessments next year above any inflationary increase that would be required.

What you have isn't a fight, it's an education issue. You need to develop the tools (like my line item Reserve reporting) needed to help educated the rest of the Board. Over time, things will change. However, if you approach the issue as a fight vs. a learning opportunity, you may place individuals on the defensive and risk them not listening to you.

Hope this helps,

Tim

DavidC (North Carolina)
Posts: 5

Posted:

Hello,

I have a little different point of view. I think it is impossible to anticipate with certainty which items will need to be repaired or replaced. If an item needs to be replaced that the HOA is obligated to replace, and it is not specifically named in the reserve study, you still can use reserve funds. You then need to decide on the next reserve study whether to include those items. The reserves will be "more underfunded" because of the extra expense. But many HOA's do not require "full funding" of reserves, rather use the "cash flow" method and determine a "threshold funding level." This method results in having one "pot of money," with no need to create a separate funding plan for each over-expense. The goal is to always have a positive balance in the reserve fund.

A good example of items which may not be in the reserve study but are anticipated to be paid from reserves is sidewalks and foundations. In our HOA, these are outside the range of the reserve study (30 years). But we had one section of sidewalk that had to be replaced, and took the funds from reserves. The next time the reserve study was redone (we do this yearly), the reserve fund assessments went up somewhat to pay for this. In my opinion, doing it this way was much better than having a special assessment. A special assessment in this situation is unfair to the owners who live here this year but move next year. This is an expense that should be spread over years.

Re this statement: "I also created a maintenance/repair/replace calendar based on the Reserve study to indicate when we needed to spend from the Reserves." This sounds like what I sometimes hear, that "we have to spend the money this year because it is in the reserve study for this year." I would say rather that the reserve study is not so much a "budget" or plan for spending as a prediction. We hope that the components will last longer than predicted. If they do, great, we win. Some component will last longer than predicted, others will fail sooner than predicted. You spend the money when it is needed to be spent, rather than when the reserve study predicts.

Best,

David

KellyM3 (North Carolina)
Posts: 2,239

Posted:

David,

These are technical points.

I would certainly approve replacing a common element using Reserve Funds if the Reserve Study doesn't list it (but it's clear that the Reserve Study should include it). Deferring the replacement can only make things more expensive.

To your point, such situations should be avoided when they can but your 2nd HOA doesn't seem to be acting against the community's interest; it just needs to update its Reserve Study amenity list.

To me, the Reserve Fund is not similiar to a 401K. It's a basic savings account and, more importantly, a form of insurance policy or pre-paid maintenance account. It's meant to keep the amenities replaced or in top-shelf shape.

DavidW5 (North Carolina)
Posts: 565

Posted:

Thanks for all of your responses. Perhaps I should have been more specific about the expenditure that led to this question:

We have had a drainage issue at the front of our Clubhouse that had caused water leakage into the game room. The facilities committee proposed to the board that a french drain be installed to move the water away from the clubhouse. The finance committee concurred with this proposal and recommended that the expense be charged to replacement reserves. When this came to the Board for approval I objected to the use of the replacement reserve funds for the creation of a new capital item as this was not a repair or replacement of an existing common element. My experience had been that this was precisely the type of unexpected and unpredictable expense for which we maintain an operating contingency as recommended in our annual audit reports. The other board members disagreed.

If these specifics affect your opinion, please respond.

KerryL1 (California)
Posts: 14,550

Posted:

My opinion based on CA statues remands the same. In this case, if you don't have enough in your operating contingency line item, borrow from reserves for the french drain and place the drain on your reserves list. Have your next year's op. budget repay the funds you borrowed from reserves.

right, we cannot always anticipate for certain when reserve components might reach their lives' ends prematurely. WE have one here right now that I'm suggesting on next month's agenda web replaced if it cannot be repaired.

SueH4 (Pennsylvania)
Posts: 1

Posted:

Your message caught my eye and wonder if you would be willing to share a copy of your maintenance/repair/replace calendar? I want to create one for my HOA as well. If you feel more comfortable, please forward to [email protected].

TimB4 (Tennessee)
Posts: 21,062

Posted:

Hi Sue,

I have no problem sharing. Again, this was based on our Reserve Study (which was also our first Reserve Study) and past history (i.e. we painted curbs every 3 years).

As DavidC said, it should be used as a guide and not an absolute.

See attached word document.

Tim

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