Adams Stirling PLC


Study Required. All associations, regardless of size, are required to 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).)

Purpose. 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:

  1. A reserve company retained by the board identifies all major common area components, the cost to repair/replace them, and their remaining life span.
  2. The reserve company calculates how much money is needed and when.
  3. The board decides how to fund the reserves--whether through increased assessment contributions, special assessments, or a combination of the two.
  4. The funding plan is annually disclosed to the membership in the year-end budgeting process.

Every Three Years. At least once every three years, the board of directors shall cause to be conducted 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).) A reserve study is not truly a "study" of the roofs, boilers, streets, etc. Instead, it is a list of the major common area components with an estimate of their remaining useful life. Reserve studies should be done by someone who specializes in reserve studies.

Reserve Analyst. The Davis-Stirling Act does not specify who should perform reserve studies for common interest developments. That means it could be performed by a CPA, a manager or the board. However, an independent, credentialed reserve analyst is the best option for three reasons:

  1. Expertise. Boards rarely have the expertise to evaluate the condition of a component, its remaining life and the cost to replace it.
  2. Liability. Boards should not take on potential liability. There is much less exposure to associations and boards to have an independent, credentialed specialist prepare the study. Depending on the extent of the common areas, preparing reserve studies internally arguably violates the Business Judgment Rule.
  3. Politics. Having a specialist prepare the study also saves the board a lot of criticism. Homeowners who dislike the board will often challenge in-house studies performed by the board or a manager. Using a specialist eliminates such criticism.

The arguments for an independent professional are stronger when the association needs a “full” or “update with-site-visit” reserve study. Less sensitive “update no-site-visit” reserve study projects tend to be much simpler and less of a problem if done internally. Boards should ask prospective reserve study companies (i) are they credentialed? and (ii) how long have they been performing studies. Do they follow National Reserve Study Standards? The Community Associations Institute (CAI) issues a "Reserve Specialist" credential to qualified individuals. There is a similar credential called the "Professional Reserve Analyst" administered by the Association of Professional Reserve Analysts.

Diligent Visual Inspection. The Davis-Stirling Act requires that associations "as part of a study of the reserve account requirements" to "every three years" cause to be conducted a 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 is clearly more than a cursory inspection. Black's Law Dictionary defines diligent to mean "attentive and persistent in doing a thing." In addition to "diligent," we must factor in what proceeds diligent, i.e., “reasonably competent" and what follows, "accessible areas."

Reasonably Competent. "Reasonably competent" does not require a particular professional license but there are two national credentials 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 will issue designations.

Accessible. Inspection of "accessible" areas does not mean tearing off roofs and opening walls. In my opinion, it means getting onto roofs, going into 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.

Components Inventory. As provided for in Civil Code § 5510(b), an association's reserve study must contain the following reserve component details:

  1. Components. The study must identify major common area components the association is obligated to repair that have a remaining useful life of less than 30 years. Examples are roofs, painting, pool heaters, asphalt repairs/replacement, etc. 
  2. 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.
  3. Repair Costs. An estimate of the future replacement costs of components must be included. Inflation should be factored into the estimate.
  4. 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.
  5. Funding Plan. The study must contain a reserve funding plan to pay for the future replacement of components. The plan might be through monthly contributions into the reserve fund or through a combination of contributions and special assessments.

Elevated Structures. Even though elevated structures have a separate 9-year inspection cycle, they need to be included in the association's reserve study.

Annual Updates. The allocation of reserve items is not written 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 cause it to be reviewed, annually and implement appropriate adjustments to the reserve account requirements. (Civ. Code § 5550(a).)

Small Associations. Small residential associations, even 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).)

Reserve Disclosures. Boards are required to make the following reserve disclosures:

  1. Deficiencies. Disclose any deficiencies in the reserves expressed on a per unit basis. (Civ. Code § 5565(d).)

  2. 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).)

  3. 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).)

  4. Funding Plan. Prepare and distribute a funding plan that indicates how the board plans to fund the annual contribution to meet the association's obligation for the repair and replacement of 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, not less than 30 nor 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).)

  5. Assessments. If the board determines an assessment increase is required to fund the reserves, the assessment must be adopted in an open meeting and separately from the adoption of the funding plan. (Civ. Code § 5550(b)(5).)

  6. Form of Disclosures. Prepare and distribute specific reserve funding disclosures that comply with (Civ. 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 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 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 done not less than 30 days nor more than 90 days prior to the beginning of the association's fiscal year. This is an improvement over the old requirement that had a 15-day window for making the disclosure. For other disclosures, see disclosure checklist.

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