Managing Reserves

Duty to Fund Reserves

An association has an affirmative duty to levy regular and special assessments sufficient to perform its obligations under its governing documents. (Civ. Code § 5600(a)) This includes funding its reserves. 

…since the Association’s original directors…admittedly failed to exercise their supervisory and managerial responsibilities to assess each unit for an adequate reserve fund and acted with a conflict of interest, they abdicated their obligation as initial directors of the Association to establish such a fund for the purposes of maintenance and repair. Thus, the individual initial directors are liable to the Association for breach of basic fiduciary duties of acting in good faith and exercising basic duties of good management. (Raven’s Cove Townhomes, Inc. v. Knuppe Dev. Co. (1981) 114 Cal.App.3d 783, 800-801.)

Special Assessments to Fund 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, ruling 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 association could fund the reserves 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 real estate transfers to fund their reserves. 

What Are Prudent Funding Levels?

How to Calculate Funding. Although the legislature has no mandate to fund reserves, the prudent course is to fund them according to 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 overfunded, you can take steps to bring it back into balance.

Fully Funded. Many people find the definition of 100% funding confusing. 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. 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 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 must levy a special assessment to raise the needed funds. To lessen the burden on members, associations often seek bank loans that let them make immediate repairs while spreading the cost over several years, making repairs more affordable.

Property Values. Association Reserves, Inc. founder Robert Nordlund conducted a study to see whether an association’s financial reserves affected property values. 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 consider 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, and its standards govern about 75% of condo mortgages. 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 learned that HOAs with insufficient reserves are less likely to repair major components such as water pipes, roofing, or deck and walkway waterproofing. 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 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 this provision does not make other relevant and competent evidence of the association's financial condition inadmissible. (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))

Non-CID Associations

In California, a non-CID (Non-Common Interest Development) is not legally required to follow the Davis-Stirling Act's reserve study or reserve funding mandates. However, the community's own CC&Rs, bylaws, or articles of incorporation may obligate the association to fund reserves for private roads, gates, fences, or drains. If a non-CID association maintains shared physical property, the board still has a general duty to manage finances prudently. Skipping reserves means the association must rely on special assessments when repairs become necessary. Finally, even if state law does not require a reserve fund, external lenders like Fannie Mae or FHA, or insurance carriers may require proof of reserves if owners want to qualify for standard mortgages.

ASSISTANCE: Associations needing legal assistance can contact us. To stay current with community association issues, subscribe to the Davis-Stirling Newsletter.