Managing Reserves
Duty to Fund Reserves
By statute, boards must impose regular and special assessments sufficient to meet their obligations under the governing documents, including funding reserves. (Civ. Code § 5600(a)) Setting aside sufficient funds to repair and replace major components is arguably one of those duties. In Raven's Cove v. Knuppe, the court held that the developer-controlled board's failure to fund the reserves constituted a breach of its fiduciary duty.
Special Assessments for Reserves. Boards must exercise prudent fiscal management in maintaining the integrity of the reserve account and shall, if necessary, levy a special assessment to recover the full amount of the expended funds within the time limits required by this section. (Civ. Code § 5515(e)) This special assessment is subject to the limitation imposed by Civil Code § 5605(b) (unless the expenditures were for emergencies as defined by Civil Code § 5610). At its discretion, the board may extend the due date for the special assessment payment. Any extension shall not prevent the board from pursuing any legal remedy to enforce the collection of an unpaid special assessment. (Civ. Code § 5515(e))
A member of the Foothills Townhomes Association sued his association, claiming that a special assessment to fund the reserve account violated Civil Code § 1366.1 [now Civ. Code § 5600(b)]. He argued that it "exceeded the amount necessary to defray the costs for which it is levied" because reserves were not required to be funded. The court disagreed and ruled that replenishing the association's reserve account was a valid basis for a special assessment. The plaintiff also argued the special assessment was unnecessary because the reserves could be funded incrementally over time. The court again disagreed: "Whether the fund could have been replenished over time is irrelevant to whether the assessment exceeded costs for which it was levied. As a matter of law, an assessment does not violate Civil Code section 1366.1 [now § 5600] merely because the costs could have been recouped incrementally. Nothing in the language of the statute suggests that it is so." (Foothills Townhomes v. Christiansen)
Real Estate Fees. The issue remains unsettled, but the fee-limitation language in Civil Code § 5600(b) makes it unlikely that associations can impose fees on the transfer of real estate to fund their reserves.
What Are Prudent Funding Levels?
How to Calculate Funding. Even though the legislature has no mandate to fund reserves, the prudent course is to fund them in accordance with the association's reserve funding plan. To determine how healthy an association's reserves are, divide the amount of money actually in reserves by the amount that should be in the account. For example, if in year five, you have $25,000 instead of the $50,000 called for by your reserve study, you are only 50% funded. Members can expect special assessments if reserves are in the 0-30% funding range. Associations with 70%+ funding are considered financially strong, and special assessments should be rare. If the reserve account is over-funded, steps can be taken to bring it back into balance.
Fully Funded. The definition of 100% funding is confusing to many people. If your association's reserve study states that you need to replace your roof in ten years for $100,000, "fully funded" does not mean that you have $100,000 today. It means you have $10,000 in the bank this year, $20,000 next year, $30,000 the following year, and so on until you have $100,000 in the 10th year when the roof is scheduled for replacement. It should be noted that the actual annual contribution for roofs would not be exactly $10,000, as reserve studies account for inflation, interest earned, and other factors that vary from year to year. As a result, the actual contribution will fluctuate around $10,000.
Impact of Underfunded Reserves
Special Assessments. If reserves are underfunded and associations face large-scale repairs, boards have no choice but to levy a special assessment to raise the funds needed to make the repairs. To lessen the burden on members, associations often seek bank loans that allow them to make immediate repairs while spreading the cost over several years, making the repairs more affordable.
Property Values. The founder of Association Reserves, Inc., Robert Nordlund, conducted a study to see if property values were affected by the strength of an association's financial reserves. He compared the sales price (measured in cost per square foot) of units in 100 comparable condominium associations to their reserve fund strength (measured in % funded). He found that market values were 12.6% higher in associations with strong reserves (over 70% funded) than those with weak reserves (under 30% funded). Sophisticated realtors now take note of an association's reserve funding levels. Low levels portend special assessments.
Fannie Mae Blacklist
Fannie Mae is one of the largest backers of home loans in the United States, with approximately 75% of condo mortgages governed by its standards. For a condominium to qualify for Fannie Mae condo eligibility, it must meet strict requirements. Underfunded reserves and deferred maintenance can also cause a condominium association to be blacklisted by Fannie Mae--meaning lenders would stop funding loans to potential buyers of units in your association. That, in turn, would drive down property values because buyers could be forced to turn to high-interest alternative loans. In addition, existing owners could find it difficult to refinance their units. Associations blacklisted by Fannie Mae may experience a 5% to 30% decrease in market value.
For mortgage applications submitted after August 3, 2026, Fannie Mae eliminated the limited review process for condominium associations. Instead, they will undergo a full review process. On that date, Fannie Mae increased its reserve contribution requirements from 10% to 15% of the annual budget. After August 3, 2026, lenders must review not only the minimum annual contribution but also the association's overall reserve health before approving loans. See Fannie Mae's March 18, 2026 Lender Letter. Find out if your condominium association is on the Fannie Mae blacklist.
Impact on Insurance
Insurance carriers have recently come to understand that HOAs with insufficient reserves are less likely to make repairs to major components, such as water pipes, roofing, or waterproofing of decks and walkways. Deferred maintenance increases the risk of water leaks, which often result in insurance claims. An association's reserve study will inform the association of the condition of its major components and its financial capacity to undertake the necessary repairs and replacements. Underfunded reserves can be used to justify policy cancellations or rate increases.
Reserve Funding Plan
Prepare a Plan. Prepare and distribute a funding plan outlining how the board will fund the annual contribution to meet the association's obligation to repair and replace all major components. The reserve funding plan must be adopted in an open meeting. (Civ. Code § 5560) Beginning January 1, 2009, boards must distribute their reserve funding plan to all members, along with the association's annual operating budget, at least 30 and no more than 90 days before the start of the association's fiscal year. (Civ. Code § 5300) The summary of the association's reserves is not admissible to show improper financial management of an association, provided that other relevant and competent evidence of the financial condition of the association is not made inadmissible by this provision. (Civ. Code § 5300(d))
Assessments. If the board determines that an assessment increase is required to fund the reserves, the assessment must be adopted in an open meeting, separately from the adoption of the funding plan. (Civ. Code § 5550(b)(5))
Required Reserve Disclosures
Required Disclosures. Boards are required to make the following reserve disclosures:
- Deficiencies. Disclose any deficiencies in the reserves expressed on a per-unit basis. (Civ. Code § 5565(d))
- Deferrals. Disclose whether the board plans to defer repairs or replacement of any major component, including a justification for the deferral. (Civ. Code § 5300(b)(4))
- Loans. Disclose whether the association has any outstanding loans with an original term of more than one year, including the payee, interest rate, amount outstanding, annual payment, and when the loan is scheduled to be retired. (Civ. Code § 5300(b)(8))
- Reserve Funding Plan. Distribute the reserve funding plan along with the association's annual operating budget.
- Form of Disclosures. Prepare and distribute specific reserve funding disclosures that comply with Civil Code § 5570. NOTE: There seems to be some concern over paragraph (3) in the Funding Disclosure Summary, which requires a definitive "yes" or "no" answer regarding future events over which the association has no control. While it is helpful for members to find a clear yes-or-no answer, boards anxious about potential liability may add qualifying language stating that the answer is only a projection. The association's attorney and/or reserve preparer can provide appropriate modifying language. Paragraph (7) also raises questions. It calls for a number of estimates for each of the five years. If those estimates appear in the more complete 30-year Funding Plan, that document can be attached, more than satisfying the Paragraph (7) 5-year requirement.
Disclosure Window. The disclosure must be made not less than 30 days nor more than 90 days before the beginning of the association's fiscal year. This is an improvement over the previous requirement, which had a 15-day window for disclosure. For other disclosures, see the disclosure checklist.
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