RESERVES & RESERVE STUDY TERMINOLOGY
Editors Note: The information below comes from various sources that we deem reliable and true. We have also added and expanded on some topics based on our knowledge and experiences. There are also certain areas within these sections that are unique to the State of Nevada which we have, of course, elaborated on. A good part of the foundation for this page is found in the Preface section of the Advanced Reserve Solutions "Winreserve" Report. This report is, by far, one of the easiest to understand in the industry and provides all of the necessary components for a solid reserve analysis. It also provides properties with flexible solutions to their funding needs. We are grateful to have this information available for this section of our website. To further see what ARS has to offer see Advanced Reserve Solutions ... www.arsinc.com. ARS offers a wide menu of solutions for residential and commercial Common Interest Developments. Check out the website. There are, of course a number of other reputable reserve companies doing business in Nevada that provide solutions to the needs of HOAs. We will refer to and provide reference to these companies as well.
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INTRODUCTION TO RESERVE BUDGETING
The Board of Directors of an association has a legal and fiduciary duty to maintain the community in a good state of repair. Individual unit property values are significantly impacted by the level of maintenance and upkeep provided by the association as well as the amount of the regular assessment charged to each owner.
A prudent plan must be implemented to address the issues of ongoing preventive maintenance as well as long-range maintenance, repair and replacement of the common elements. Additionally, the plan should recognize that the value of each unit is affected by the amount of the regular assessment charged to each unit.
There is a fine line between “not enough,” “just right” and “too much.” Each member of an association should contribute to the reserve fund for their proportionate amount of “depreciation” (or “use”) of the reserve components. Through time, if each owner contributes his “fair share” into the reserve fund for the depreciation of the reserve components, then the possibility of large increases in regular assessments or special assessments will be minimized.
An accurate reserve analysis and a “healthy” reserve fund are essential to protect and maintain the association's common areas and the property values of the individual unit owners. A comprehensive reserve analysis is one of the most significant elements of any association's long-range plan and provides the critical link between sound business judgment and good fiscal planning. The reserve analysis along with the operating and reserve budgets provide a “financial blueprint” for the future of an association.
Who should/can perform reserve studies? In many states where there are minimal laws governing Common Interest Communities just about anyone can perform a reserve study as long as they have the appropriate knowledge and tools. This doesn't mean it's right or smart for a board to choose someone that does not carry some nationally recognized credentials qualifying them to do this.
As a general rule, a candidate should possess one of the two nationally recognized designations provided by two national trade organizations. The designations are CAI (RS - Reserve Specialist) and APRA (Professional Reserve Analyst). Unfortunately neither requires proof of an applicants abilities, education or experience. No testing is involved. Both organizations do however subscribe to a set of ethical standards and guidelines and at least provide some standards for terminology and methodology. However, a study from one company is likely to bear no semblance to a study from another company even if on the same property. In addition to these, Nevada requires anyone desiring to provide reserve studies in Nevada to register with the state. They are than provided with a Reserve Study Specialist number such as RSS-045. This provides the state with the ability to monitor and if necessary discipline an RSS who fails to follow Nevada Statutes regarding reserves, reserve studies and any other matter pertaining to a reserve study specialist.
Maintenance Responsibility - It is important to discuss maintenance responsibilities as it is critical to the ongoing condition of the common elements.
Most important to remember is that ongoing preventive maintenance funded by the operating budget is
equally if not more important that the reserve budget. If preventive maintenance is not funded and performed, long term maintenance will be adversely affected. Long term costs will increase and life expectancies will decrease
Long term maintenance usually equates to maintenance described in the Reserve Study. It handles components having a life of more than one year (not an annual maintenance item). Example being street maintenance.
Both types of maintenance are critical to maintaining the appearance and value of the community.
Typical Common Elements found in Common Interest Communities (a new section in development)
UNDERSTANDING THE RESERVE ANALYSIS ...
In order for the reserve analysis to be useful, it must be understandable by a variety of individuals. Board members (from seasoned, experienced Board members to new Board members), community managers, accountants, attorneys and even homeowners may ultimately review the reserve analysis. The reserve analysis must be detailed enough to provide a comprehensive analysis, yet simple enough to enable less experienced individuals to understand the results. There are four key bits of information that a comprehensive reserve analysis should provide. These items include:
Amount recommended to be transferred into the reserve account each month of the fiscal year for which the reserve analysis was prepared. In some cases, the reserve analysis may present two or more funding plans based on different calculation models. Typically one calculation method is presented. If others are presented in the reserve study, it is critical that the Board must have a clear understanding of the pros and cons of each of these funding models prior to implementing one of them in the annual budget.
Measure of the reserve fund “health” (expressed as a percentage) as of the beginning of the fiscal year for which the reserve analysis was prepared. Remember, “100% funded” means the association has accumulated the proportionately correct amount of money, to date, for the reserve components it maintains (can only be achieved through use of or reference to the Full Funding (or Component) method.
Projections and Annual Expenditure Detail
Indicate the “level of service” the association will provide the membership as well as a “road map” for the fiscal future of the association. The projections define the timetables for repairs and replacements, such as when the buildings will be painted or when the asphalt will be seal coated. The projections also show the financial plan for the association – when an under funded association will “catch up” or how a properly funded association will remain fiscally “healthy.”
Complete listing of the reserve components. Key bits of information are available for each reserve component, including placed-in-service date, useful life, remaining life, replacement year, quantity, current cost of replacement, future cost of replacement and analyst’s comments.
In this section, a description of most of the summary or report sections are provided along with comments regarding what to look for and how to use each section. All reserve analyses may not include all of the summaries or report formats described herein.
In some cases, the reserve analysis may be a lengthy document of one hundred pages or more. A complete and thorough review of the reserve analysis is always a good idea. However, if time is limited, it is suggested that a thorough review of the summary pages be made. If a “red flag” is raised in this review, the reader should then check the detail information, of the component in question, for all relevant information.
Provides general information about the client, global parameters used in the calculation of the reserve analysis as well as the core results of the reserve analysis.
TYPES OF RESERVE STUDIES ...
Terminology for the different types of reserve studies is simple. There are three types and in Nevada they are the only standard terminology acceptable by Nevada Law ...
Full Study - I like to call this the "zero base study" not unlike the zero base budget where you basically begin with a blank slate. This type of study is typically performed as the first study for a development, where law or documents require it, or where the association changes reserve providers and wants a fresh new look and evaluation of the property and it common elements. This type of study includes a complete site inventory of the common elements along with the application of life cycles and cost estimates. Finally, it generates a series of reports, disclosures and conclusions as a formal reserve study report.
Update with Site Visit - This type of study differs from a Full Study in that a new inventory is not performed. The initial inventory is updated with condition assessments along with the inclusion of any new components and any changes in the existing. Beyond the change in the site visit, the remainder of the steps listed above are a part of this type of study.
Update without Site Visit - I like to call this a "financial update". Essentially that what it is. The reserve provider typically provides forms to the client which request updates to financials, any available information regarding the common elements such as copies of contracts, proposals, invoices, etc for work that has recently been performed or is expected to be performed in the coming year. Basically any information which will or might have an impact on the reserve maintenance projections for the year of the study will be used to update the current reserve study and its projections.
Nevada has a 5 year requirement for reserve studies. This means that minimally every 5 years every HOA in Nevada (there are a few exceptions) is required to have a reserve study update. The Update with Site Visit meets that 5 year requirement if done properly. It should be noted that we feel it only meets the requirement IF the person who performed the Full Study is performing the update and reviews all components as stated above in the description of the Update with Site Visit. If a new provider is brought in to take over the process, we feel that a new Full Study (inventory) needs to be performed as no legitimate provider is going to accept the current inventory gathered by someone else without a disclaimer stating that he/she does not accept responsibility for the resulting numbers.
CALCULATION METHODS ...
This is the one single area where reserve providers vary in their methodology and terminology. Clients and managers agree that they are confused by the different methodology and terminology presented in the various types of reports from the different companies. Nevada has accepted the following terminology as the standard for the State.
Full Funding Method (or Component Calculation Method)
There are only a few true reserve funding calculation methods used by reserve analysis firms. Some articles in trade publications seem to indicate that there are dozens of “unique” and different reserve calculation methods (i.e. component, cash flow, pooling, front-loading, splitting, etc.). Most “unique” calculation methods are actually hybrid derivatives of either the Full Funding (Component) method or the Baseline Funding method.
This calculation method develops a funding plan for each individual reserve component included in the reserve analysis. The sum of the funding plans for each component equal the total funding plan for the association.
This calculation method is typically the most conservative. This method structures a funding plan that enables the association to pay all reserve expenditures as they come due, enables the association to achieve the ideal (Full Funding) level of reserves in time, and then enables the association to maintain the ideal level of reserves through time.
One of the major benefits of using this calculation method is that for any single component (or group of components), the accumulated balance and reserve funding can be reported. For example, using this calculation method, the reserve analysis can indicate the amount of current reserve funds “in the bank” for the roofs and the amount of money being funded towards the roofs each month. Using other calculation methods, this information cannot be calculated and therefore, cannot be reported.
This parameter is used to develop a funding plan only; it does not necessarily mean that the reserve contributions must be raised each year. There are far more significant factors that will contribute to a Total Reserve Contribution increase or decrease from year to year than this parameter.
Baseline Funding Method
This calculation method develops a funding plan based on current reserve funds and projected expenditures during a “window,” typically 30 years.
This calculation method is not conservative and will typically produce a lower monthly reserve contribution. This method structures a funding plan that tries to enable the association to pay for all reserve expenditures as they come due, but is not concerned with the ideal (Full Funding) level of reserves through time. Consequently, this funding method can allow an association to become increasingly under funded, while never running completely out of money during the “window”, assuming everything in the assumptions and estimates don’t change.
This calculation method structures a funding plan that is the “bare” minimum required to pay for all reserve expenditures as they come due during the “window.” This method disregards components that do not have an expenditure associated with them during the “window.” This method tests reserve contributions to determine the minimum contribution necessary, based on the association's beginning reserve balance and anticipated expenses through time, so that the reserve balance in any one year does not drop below $0. This method allows for no margin of error. If any factor used in the calculations changes (ie; costs, timing of maintenance, etc.) the association could find itself short of funds.
Threshold Funding Method
This calculation method is a hybrid of the Baseline Funding Method which enables the development of “custom” or “non-traditional” funding plans which may include deferred contributions or special assessments. It is easy to establish percent funded goals as well as funding plans which set a minimum dollar amount for the reserve fund to remain above.
This calculation method can be used to calculate a reserve contribution that enables the association to become "ideally (or fully) funded" in time. It is very helpful where associations may be seriously underfunded and owners may not have the ability to pay large assessments in the short term. It can enable for lower short term funding goals and give the association time to build sufficient funds to bring the reserve fund up to acceptable levels.
TERMINOLOGY IN THE HOA RESERVE STUDY INDUSTRY
by Don Barry RS RSS (PCAM 1994-2014)
Sara Barry PCAM CCAM CAM Paralegal
Community Managers and board members are frequently coming to us with questions regarding the use of terminology in the reserve studies of different reserve companies. There is frequent confusion and lack of understanding as to how to even read different studies and find the important relevant data. Nevada does have standards for certain terms, but companies outside of Nevada and some within, use different terms mostly because their software is locked in to certain terminology depending on who and where the software was developed. There are basically two national industry group which have also settled on standards which may differ. Nevada's standards do differ from some of these standards but are written in to law and are simple to understand.
Much of this terminology is basic to understanding the industry itself. Community Association professionals and related service industry professionals must learn and apply correct terminology when developing and presenting important information such as a reserve study. If the professionals differ in their methods of presentation and terminology, how can the members of the Boards and home owners understand and interpret the data?
GLOSSARY OF KEY TERMS
COMMON TERMS RELATING TO RESERVES & RESERVE STUDIES ...
Annual Contribution Increase Parameter
The rate used in the calculation of the funding plan developed by the Full Funding (Component Calculation) Method and Baseline Method. This rate is used on an annual compounding basis. This rate represents, in theory, the rate the association expects to increase contributions each year.
In most cases, this rate should match the Inflation Parameter. Matching the Annual Contribution Increase Parameter to the Inflation Parameter indicates, in theory, that Member Contributions should increase at the same rate as the cost of living (Inflation Parameter). Due to the “time value of money,” this creates the most equitable distribution of Member Contributions through time.
This parameter is used to develop a funding plan only; it does not mean that the reserve contributions must be raised each year. There are far more significant factors that will contribute to a Total Reserve Contribution increase or decrease from year to year than this parameter.
See the description of “Calculation Methods” in this preface for more detail on this parameter.
Anticipated Reserve Balance (or Reserve Funds)
The amount of money, as of a certain point in time, held by the association to be used for the repair or replacement of Reserve Components.
This figure is “anticipated” because it is calculated based on the most current financial information available as of the analysis date, which is almost always prior to the Fiscal Year beginning date for which the reserve analysis is prepared.
Assigned Funds (and “Fixed” Assigned Funds)
The amount of money, as of the Fiscal Year beginning date for which the reserve analysis is prepared, that a Reserve Component has been assigned based on the Full Fundiing (Component Calculation) Method. Assigned Funds do not apply to the Baseline Calculation Method or the Threshold Calculation Method.
Baseline Calculation Method
Reserve funding calculation method developed based on total annual expenditures. A more detailed description of the actual calculation process is included in the “Calculation Methods” section of the preface. This is a risky method as it leaves no room for variation of parameters. Nothing can change from what was predicted. The association can find itself short of funds in the short term particularly if the study is not updated on an annual basis.
The rate used as a built-in buffer in the calculation of the funding plan developed by the Full Funding (Component) Calculation Method. This rate will assign a percentage of the Reserve Funds, as of the Fiscal Year beginning, as contingency funds and will also determine the level of funding toward the contingency each month.
Current Replacement Cost
The amount of money, as of the Fiscal Year beginning date for which the reserve analysis is prepared, that a Reserve Component is expected to cost to replace.
Indicates the budget year for the association for which the reserve analysis was prepared. The fiscal year beginning (FYB) is the first day of the budget year; the fiscal year end (FYE) is the last day of the budget year.
Full Funding (or Component Calculation) Method
Reserve funding calculation method developed based on each individual component. A more detailed description of the actual calculation process is included in the “Calculation Methods” section of the preface.
Future Replacement Cost
The amount of money, as of the Fiscal Year during which replacement of a Reserve Component is scheduled, that a Reserve Component is expected to cost to replace. This cost is calculated using the Current Replacement Cost compounded annually by the Inflation Parameter.
The financial parameters used to calculate the reserve analysis (see Inflation Parameter, Annual Contribution Increase Parameter, Investment Rate Parameter and Taxes on Investments Parameter).
The rate used in the calculation of future costs for Reserve Components. This rate is used on an annual compounding basis. This rate represents the rate the association expects to the cost of goods and services relating to their Reserve Components to increase each year.
The amount of money contributed to the Reserve Fund by the interest earned on the Reserve Fund and Member Contributions.
Investment Rate Parameter
The gross rate used in the calculation of Interest Contribution (interest earned) from the Reserve Balance and Member Contributions. This rate (net of the Taxes on Investments Parameter) is used on a monthly compounding basis. This parameter represents the weighted average interest rate the association expects to earn on their Reserve Fund investments.
The amount of money contributed to the Reserve Fund by the association’s membership.
Monthly Contribution (and “Fixed” Monthly Contribution)
The amount of money, for the Fiscal Year which the reserve analysis is prepared, that a Reserve Component will be funded based on the Full Funding (Component Calculation) Method.
The Monthly Contribution is considered “Fixed” when the normal calculation process is bypassed and a specific amount of money is funded to a Reserve Component. For example, if the normal calculation process funds $1,000 to the roofs each month, but the association would like to show $500 funded to roofs each month, a “fixed” contribution of $500 can be assigned.
The Full Funding (Component Calculation) Method funds each component in the most efficient manner possible; assigning a “fixed” contribution in this manner can have a detrimental impact on the association’s overall budget structure in the long run.
Number of Units (or other assessment basis)
Indicates the number of units for which the reserve analysis was prepared. In “phased” developments (see Phasing), this number represents the number of units, and corresponding common area components, that existed as of a certain point in time.
For some associations, assessments and reserve contributions are based on a unit of measure other than the number of units. Examples include time-interval weeks for timeshare resorts or lot acreage for industrial developments.
Used for components that will be budgeted for only once.
A measure (expressed as a percentage) of the association’s reserve fund “health” as of a certain point in time. This number is the ratio of the Anticipated Reserve Fund Balance to the Theoretically Ideal (Full Funding) Reserve Balance:
Percent Funded = Anticipated Actual Reserve Fund Balance ¸
Theoretically Ideal (Full Funding) Projected Reserve Balance
An association that is 100% funded does not have all of the Reserve Funds necessary to replace all of its Reserve Components immediately; it has the proportionately appropriate Reserve Funds for the Reserve Components it maintains, based on each component’s Current Replacement Cost, age and Useful Life.
Percentage of Replacement
The percentage of the Reserve Component that is expected to be replaced.
For most Reserve Components, this percentage should be 100%. In some cases, this percentage may be more or less than 100%. For example, fencing which is shared with a neighboring community may be set at 50%.
Indicates the number of phases for which the reserve analysis was prepared and the total number of phases expected at build-out (i.e. Phase 4 of 7). In phased developments, the first number represents the number of phases, and corresponding common area components, that existed as of a certain point in time. The second number represents the number of phases that are expected to exist at build-out.
The date (month and year) that the Reserve Component was originally put into service or last replaced.
The length of time, in years, until a Reserve Component is scheduled to be replaced.
Remaining Life Adjustment
The length of time, in years, that a Reserve Component is expected to last in excess (or deficiency) of its Useful Life for the current cycle of replacement.
The Fiscal Year that a Reserve Component is scheduled to be replaced.
Line items included in the reserve analysis.
Taxes on Investments Parameter
The rate used to offset the Investment Rate Parameter in the calculation of the Interest Contribution. This parameter represents the marginal tax rate the association expects to pay on interest earned by the Reserve Funds and Member Contributions.
Theoretically Ideal (or Full Funding) Reserve Balance
The amount of money that should theoretically have accumulated in the reserve fund as of a certain point in time. Ideal reserves are calculated for each Reserve Component based on the Current Replacement Cost, Age and Useful Life:
Ideal Reserves = (Age ¸ Useful Life) X Current Replacement Cost
The Theoretically Ideal Reserve Balance is the sum of the Ideal Reserves for each Reserve Component.
An association that has accumulated the Theoretically Ideal Reserve Balance does not have all of the funds necessary to replace all of its Reserve Components immediately; it has the proportionately appropriate Reserve Funds for the Reserve Components it maintains, based on each component’s Current Replacement Cost, Age and Useful Life.
Threshold Calculation Method
Reserve funding calculation method developed based on total annual expenditures. A more detailed description of the actual calculation process is included in the “Calculation Methods” section of the preface.
The sum of the Membership Contribution and Interest Contribution.
The length of time, in years, that a Reserve Component is expected to last each time it is replaced. See also Remaining Life Adjustment.
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