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 the 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 life.
- 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 the two.
- 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 three 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 factor in what precedes diligent, 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 a demonstrated background of training and experience in properly preparing reserve studies before they issue 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 that reserve professionals disclose whether a complete inspection or representative sampling was used, whether field measurements or plans/schematic take-offs were utilized, and whether destructive testing was employed.
Annual Updates. The allocation of reserve items is 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, or have it reviewed, annually and implement appropriate adjustments to the reserve account requirements. (Civ. Code § 5550(a))
Elevated Structure Inspections
Although elevated structure inspections have a 9-year inspection cycle, they must be included in the association's reserve study and 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 is a list of major common area components with an estimate of 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 since it is impossible to know the true remaining life of each component. 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. Inflation should be factored into the estimate.
- 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 the items for major components with an unknown life, 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.
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 on how to calculate percent funded, (v) baseline funding, threshold, and full funding.
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