Managing Reserves

Reserve Studies Are Required

All associations, regardless of size, must prepare a reserve study (Civ. Code § 5550) unless the total replacement costs are less than 50% of the gross budget of the association, excluding the association’s reserve account for that period. (Civ. Code § 5550(a)) The purpose of a reserve fund is to repair, replace, restore, or maintain major common-area components. (Civ. Code § 5510(b); § 5565(b)(1)) The reserve study process can be simplified as follows:

• A reserve company retained by the board identifies all major common-area components, their repair or replacement costs, and their remaining useful lives.
   
• The reserve company calculates how much money is needed and when.
   
• The board decides how to fund the reserves — whether through increased assessment contributions, special assessments, or a combination of both.
   
• The funding plan is disclosed annually to the membership during the year-end budgeting process.

Small Associations. Small residential associations, as small as two units, must perform reserve studies if they have common areas — unless the total replacement costs are less than 50% of the annual gross budget. (Civ. Code § 5550(a))

Visual Inspection Every Three Years

At least once every 3 years, the board of directors shall cause a reasonably competent and diligent visual inspection of the accessible areas of the major components that the association is obligated to repair, replace, restore, or maintain. (Civ. Code § 5550(a)) “Diligent” is not defined in the statute, but it is more than a cursory inspection. Black’s Law Dictionary defines diligent as “attentive and persistent in doing a thing.” In addition to “diligent,” we must consider what precedes it, i.e., “reasonably competent,” and what follows, “accessible areas.”

• Reasonably Competent. “Reasonably competent” does not require a particular professional license, but two national credentials are available to reserve study professionals. One is the Professional Reserve Analyst (PRA) administered by the Association of Professional Reserve Analysts (APRA). The second is the Reserve Specialist (RS) administered by the Community Associations Institute. Both organizations require demonstrated training and experience in properly preparing reserve studies before issuing designations.
   
• Accessible. Inspection of “accessible” areas does not mean tearing off roofs and opening walls. In my opinion, it means getting onto roofs, entering elevator rooms, opening electrical panels, and opening equipment service panels (such as on boilers) to obtain equipment information. NOTE: Elevated structures are treated differently.
   
• Disclosure. Finally, industry standards require reserve professionals to disclose whether they used a complete inspection or a representative sampling, whether they used field measurements or plans/schematic takeoffs, and whether they employed destructive testing.

Annual Updates. Reserve allocations are not set in stone. Allocations are only projections and are subject to revision annually as roofs, boilers, etc., wear out at their own rates. As a result, boards must review the reserve study annually, have it reviewed, and adjust reserve account requirements as needed. (Civ. Code § 5550(a))

Elevated Structure Inspections

Although elevated structure inspections follow a 9-year cycle, the association’s reserve study must include them, and they must be visually inspected every 3 years.

Inventory of Major Components 

A reserve study is not truly a "study" of the roofs, boilers, streets, etc. Instead, it lists major common area components and estimates their remaining useful life. As provided for in Civil Code § 5550(b), an association’s reserve study must contain the following reserve component details:

• Components. The study must identify major common area components that the association must repair that have a remaining useful life of less than 30 years. Examples are roofs, painting, pool heaters, and asphalt repairs/replacement. 
   
• Useful Life. The study must identify the probable remaining useful life of the components. These are estimates because it is impossible to know each component's true remaining life. Lifespans will vary depending on (i) the original quality of the component itself and (ii) whether the association has a program of regular preventative maintenance.
   
• Repair Costs. An estimate of the future replacement costs of components must be included. The estimate should factor in inflation.
   
• Reserve Contributions. An estimate of the total annual contribution necessary to defray the cost to repair, replace, restore, or maintain the components identified in paragraph (1) during and at the end of their useful life, after subtracting total reserve funds as of the date of the study.
   
• Funding Plan. The study must include a reserve funding plan to cover future component replacement costs. The plan might involve monthly contributions to the reserve fund or a combination of contributions and special assessments.

Allowances. The study should list major components with unknown lifespans, such as sidewalk repairs, plumbing repairs, slope failures, perimeter block wall repairs, etc., and add a reasonable dollar amount as a contingency. For example, an association with many slopes is likely to experience slope failure. The board should set aside a reasonable amount for a single failure, not a dozen. If and when a failure occurs, funds are available. Once repairs are made, the “allowance” for that item can be replenished. 

Fannie Mae Funding Requirements

See Fannie Mae's new reserve funding requirements.

Additional Information

For additional information on reserve studies, see “An Explanation of CAI’s Reserve Study Standards.” It covers (i) reserve component inventories, (ii) capital improvements, (iii) construction defects, (iv) an explanation of how to calculate percent funded, (v) baseline funding, threshold, and full funding. 

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