CA HOA - How low can Reserves go in the two years following a $3 Million underlay project?

Started by SusanO3 • 9 replies • 52 views

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SusanO3 (California)
Posts: 167

Posted:

I have done some research on how low a HOA can go in terms of Reserve Fund money. It seems that Davis Sterling does not specify the lowest amount of dollars that should be in the reserve account (provide you fulfill the requirement of having a study etc etc), obviously good practice suggests you should have some. Would you say that going down to $200,000 in reserves with a plan to raise rates by 3-5% in the years following a major project ($3M underlay) is an acceptable (but not ideal thing to do).

I also read that Fannie Mae requires 15% of budget to go into Reserves, we are currently putting 50% of our operating budget into reserves to top up Reserves to do the underlay project in 2033, with no Special Assessment, so I think meeting Fannie Mae's 15% threshold will not be a problem. Anyone see a problem with my thinking?

Any wisdom and/or experience is appreciated. Sue

TimB4 (Virginia)
Posts: 20,986

Posted:

This issue tends to come up with Associations that utilize a cashflow methodology for reserves. Yes, the cashflow method can lower the amount of money to set aside (as not everything will have to be replaced at one time). The minimum balance is set by the Board and may or may not be an educated and informed guess.

The component method requires more money to be set aside, but you don't have to worry about not having enough left in the account if two major items need to be replaced at the same time (one expected and one unexpected).

From the AI response (which can summarize easier than I can):

Cash Flow Method (Pooled Reserves)

How it works: Collects money into one general reserve account and matches the total income stream against all combined future project costs.

Pros: Keeps initial homeowner contributions lower and creates a smoother, more stable long-term funding plan.

Cons: Can lead to a depleted balance if unexpected big expenses hit or if the board underfunds the account.

Component Method (Straight-Line Method)

How it works: Calculates a specific funding amount for every single item (like roofs or elevators) based on its individual lifespan.

Pros: Offers extreme financial security and absolute transparency for where every dollar goes.

Cons: Often causes a "cost shock" with much higher initial contributions in the first few years.

Most modern reserve study professionals recommend the cash flow method because it keeps annual dues lower and balances out costs over time. However, in my opinion, the component method is better and you wouldn't have the question you are now asking.

TimB4 (Virginia)
Posts: 20,986

Posted:

I did a quick search and it is recommended that the reserves should, ideally, not go below 30% of the fully funded balance.

Using your example that $3 million was spent (and that was the largest expense in the reserves), the recommended (not required) remaining amount should be around $900,000. Again, this is a recommendation not a requirement. The actual minimum threshold amount would have been set by your Board.

ElleN (Idaho)
Posts: 1,394

Posted:

It seems that Davis Sterling does not specify the lowest amount of dollars that should be in the reserve account (provide you fulfill the requirement of having a study etc etc), obviously good practice suggests you should have some.

Good practices says to maintain the reserve's "percent funded" value at at least 70% at all times. Why? One main purpose of budgeting for reserves is to spread costs of replacement of major infrastructure and amenities over all owners over all the years, as evenly as possible. If the percent funded figure gets too low, then some owners at some time will be treated fairly.

Would you say that going down to $200,000 in reserves with a plan to raise rates by 3-5% in the years following a major project ($3M underlay) is an acceptable (but not ideal thing to do).

It depends on what the percent funded value would be at $200,000. Granted if your board estimates there are going to be reserve expenses after 2033, and the board does not want to implement what your Reserve study professionals recommends when it comes to assessment increases and special assessments, then the board is consciously saying it wants to make future owners pay a disproportionate share compared to present owners. The latter is unfair.

Note that Fannie Mae offers an exception to the 15% rule. This exception is this: if a condominium association has a reserve study that has been conducted or updated within the last three years and the association is following the highest recommended level of funding (baseline is not allowed), then it does not have to comply with the 15% requirement. This should be important to your board. It is saying that the board should use the reserve study as its guidance as much as anything else. Why? Because by definition, a reserve study aims to spread costs over all owners over all time as evenly as possible. If your board follows the reserve study guidance, then it will fulfill this goal.

I get the feeling you are maybe trying to avoid raising assessments and/or a special assessment. Is this so? If yes, then know this: The numbers in a reserve study do not lie. Yes they are estimates, but that's simply because no crystal ball is available. If the reserve study says to raise the assessment now (or impose a special assessment), then your board should do it.

ElleN (Idaho)
Posts: 1,394

Posted:

If the percent funded figure gets too low, then some owners at some time will be treated fairly.

Post-o. Change "fairly" to "unfairly."

SusanO3 (California)
Posts: 167

Posted:

Thanks everyone for your replies. Just to add some information. The Board has increased annual reserve funding by 10% for last two years and has 10% in for the next 5 years for the very reason you mention, previous Boards did not increase funding more than 2.5% and sometimes not at all. That is history now, but I understand the issue because now we are playing catch up.

Our 2027 Reserve Study has the underlay replacement in 2033, and with the 10% increases to Reserves in the next 5 years we should just get to fully funding the project ( so we don't have to get community approval), however it will leave our Reserves pretty short but I'm thinking that is the best option given the cards we have been dealt. Nothing in your replies tells me the strategy the board is discussing is forbidden by statute. So that is good to know. Have also asked our Reserve Analyst the same question but this forum is just so much quicker to respond. I appreciate you all.

BryonW (Massachusetts)
Posts: 69

Posted:

I would say the bare minimum levels that you should never fall below are:

1) the deductible on your master insurance for a total loss
and/or
2) the largest reserve component that could fail unexpectedly, and if it failed, would demand immediate replacement (for example, the central boiler at a property in a cold climate. If it fails, you cannot wait. Replacement is an emergency).

At your property, is $200,000 enough to cover both of these?

Also note that, your "fully funded balance" in dollar terms, varies over time. For example, if your property has only 1 reserve component, that costs $10,000 and gets replaced every 10 years, then in year #1 your fully funded balance is only $1,000. By year #9 your fully funded balance should be $9,000. Thus, right after a large project is completed, it can be normal for your reserve to be low in dollar terms, but still fully funded in percentage terms.

TimB4 (Virginia)
Posts: 20,986

Posted:

The percent funded is not the same as the minimum balance in a reserve account.

The percent funded means the reserve balance matches the fraction of useful life "used up" on each asset. This should be between 70 and 100%. Hopefully 100%

The minimal balance would be the lowest amount that should ever be in the reserves. Reserve studies using a cash flow method (or Pooled Reserves) will look at a $0 baseline (meaning that the reserve account balance could drop to zero). The Board of Directors can instruct the reserve specialist to set the minimum balance to any amount they feel is safe. Utilizing a $0 baseline leaves no margin for error and if something occurs that was unplanned, a special assessment might be needed.

SusanO3 (California)
Posts: 167

Posted:

Thanks BryonW, good to raise the issue of deductibles. Our policy has $5,000 and $10,000 for water. Our biggest spend is roof leaks on the townhomes, which we are already covering, with an annual budget of $30,000 in our Reserves. So, I think we are OK to go down to $200,000 in Reserves and then build them back up from the underlay project in 2033. I appreciate your input.

SusanO3 (California)
Posts: 167

Posted:

HOA Forum folks are good, still not heard back from Reserve Analyst on this topic and we pay him!

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