A reserve study is a long-term capital budget planning tool which identifies the current status of the reserve fund and a stable and equitable funding plan to offset ongoing deterioration, resulting in sufficient funds when those anticipated major common area expenditures actually occur. The reserve study consists of two parts: the physical analysis and the financial analysis. This document is often prepared by an outside independent consultant for the benefit of administrators (Board of Directors or Strata Council Members) of a property with multiple owners, such as a condominium association or homeowners' association (HOA), strata, containing an assessment of the state of the commonly owned property components as determined by the particular association's covenants, conditions, and restrictions (CC&Rs) and bylaws. Reserve studies however are not limited only to condominiums and can be created for any "common interest community" (CIC) properties such as resort (shared vacation ownership) properties, community/neighborhood associations, coops, etc.[1]
Reserve studies are in essence planning tools designed to help the board anticipate, and prepare for, the property's major repair and replacement projects. For example, such projects would include: replacement of the roof on the building(s), replacement of the boiler, retrofit of the fire alarm devices, and resurfacing of the roadways.
In some jurisdictions across Canada, a reserve study is also sometimes referred to as a "reserve fund study", "contingency reserve fund study", or "replacement reserve study" and, in British Columbia, the legislation refers to this type of study as a "Depreciation Report".
Purpose
The purpose of a reserve study is to give those overseeing the maintenance of the property a better idea of what major expenses to expect and an educated estimate of when these expenses will occur. With this knowledge, the homeowners' association board or manager can create a budget so association members will make their fair share of reserve contributions†, designed to offset the slow but steady ongoing reserve component deterioration of the association assets, and avoid being surprised by components that deteriorated often in plain sight and over a number of years. In addition, the reserve study provides important annual disclosures to association members (and prospective buyers) about the condition of common area components, and the level of preparedness (strength) of the reserve fund (typically measured in terms of Percent funded).[2] A HOA reserve study is a roadmap that allows decisions to be made which will be efficient and effective for the long term. The International Capital Budgeting Institute has established standards for calculating percent funded. There are three methods of making this calculation, and differences between reserve practitioners can, unfortunately, result in significant differences in the percent funded amount.[3] (This reference returns the error "404 Page not found", but the methods used in cash-flow analyses don't give correct values anyway).
(†: Unfortunately, because inflation is incorrectly accounted for, anyone checking the fairness of assessments between years for a cash-low method study will find that recommended assessments cheat future owners to benefit current owners.
A reserve study for CICs should:
1. Provide budgeting information that gives some theoretical assurance that when common element replacement projects are due, sufficient funds will have been assessed to pay for them without special assessments (preferably without significant over-funding).
2. Fairly distribute inflated costs for replacement projects among owners, in proportion to their percent ownership of common elements (as defined in their association documents) for the duration of that ownership, as measured either in any year's constant dollars or in hours to earn at any pay rate assuming owner pay inflates at the same rate as component replacement costs.
3. Give a theoretically accurate percent funded based on the component cost inflation rate(s) used in the study.
If these three requirements are not met, the analysis is of little use to a condominium association; and current "cash-flow" methods cannot meet these requirements, because they cannot properly accounted for inflation.)
Results
There are three results from a reserve study:
A listing of the major components of the association to be funded through reserves, their expected useful life, remaining useful life, and current replacement cost (yielding the "scope and schedule" of the reserve projects).
An evaluation of the current strength of the reserve fund (commonly expressed as "percent funded"). (Unfortunately, because it incorrectly accounts for inflation, the commonly used method of calculating this based on a study year cost cash flow analysis, does not give accurate estimates of percent funded for a single component until the project year approaches, and cannot provide accurate estimates of percent funded for multiple component projects in different future years. This can be verified using any component and set of components using any assumed inflation rates for each component or for all components, and comparing the results — e.g., using Appendix H of the Virginia Department of Professional and Occupational Regulation's Guidelines for the Development of Reserves Studies for Capital Components, dated 9/5/2019 — to correctly inflated values; however, the mathematics in those guidelines are identical to those for an annuity,[4] implying that replacement reserves is an annuity of which principle and investment returns are paid with assessments.)
A recommended multi-year reserve funding plan.
(Conflict of interest WARNING: ICBI is closely associated with reservestudy.org, and Virginia and Nevada laws require that reserve studies include sections and calculations specified by the organization that claims to have written the book on reserve studies, trains reserve specialists, and is closely associated with reservestudy.org. It does not require that the recommendations meet the special requirements of CICs, which reserve specialists are not yet trained to do. Furthermore, when the inappropriate Appendix H calculations included in Virginia law were challenged, they were not changed because they were included on the advice of reserve specialists; and the FHA and Fannie Mae have been informed that incorrect reserve assessments can cause financial problems for owners, but they didn't seem concerned.)
Relevance
Reserve studies are required by the board or manager for due diligence, disclosure, and budget and planning purposes. An increasing number of U.S. states and Canadian provinces today require some form of reserve planning or disclosures. In addition to requiring a minimum 10% of the total budget be dedicated to reserve contributions, Fannie Mae and the Federal Housing Administration may ask for a current reserve studies (to demonstrate that the association has dedicated sufficient funds to caring for the ongoing needs of the property) to be approved for FHA insured loans and Fannie Mae lending products and services.
State reserve studies
In addition to being helpful planning tools, reserve studies for Community Associations are legally mandated in 30 states (such as California, Florida, Hawaii, Nevada, Virginia, Washington, etc.), either for budget preparation or homeowner (and prospective homeowner) disclosure purposes.[5] In California, the relevant law is California Civil Code 5300.[6] In California, the law requires an annual reserve study Update, with that update prepared on the basis of a "diligent visual site inspection" at least every third year.[7] With the passing of SB 278 in 2010, the state of Utah also requires condominium and community associations to conduct and review reserve studies on a periodic basis.[8] reserve contributions are often one of an association's largest budget line items (often 15-40% of the total budget), and the reserve fund is typically the association's largest financial asset. This means annual review of reserve contributions and annual disclosure of the status of the reserve fund are prudent.
The State of Nevada has adopted specific statutes related to reserve studies, which are set forth in NRS 116. These statutes also require that reserve preparers in Nevada be registered and background checked by the State Department of Real Estate (advised by reservestudy.org?).[9]
In October 2022, Maryland adopted House Bill 107, which requires community associations to conduct reserve studies, then update those studies every five years.[10][11] The legislation also requires associations to annually fund the reserve amount, for repairs and maintenance,[12] recommended in the reserve study, for the study to be publicly available for inspection by any unit owner, and to attain the annual recommended level of reserve funding within three years of the initial study's completion, with no exemptions based on association size "or number of condominium units."[13][11]
Since Reserve Studies help associations make fiscally responsible decisions, navigating to a successful future, a consistent high quality of Reserve Studies is desired. While foundational Reserve Study industry standards have existed since 1998 (see [14] and [15]), a small group has proposed a new set of standards. While intended as progress, as-of this writing, these 2015 standards have yet to be embraced or adopted by the industry as a whole. For more see The International Capital Budgeting Institute (ICBI).[16]
US FHA
On June 30, 2011, the Department of Housing and Urban Development published Mortgagee Letter 2011-22, which made reserve studies mandatory for all new condominium conversions applying for FHA insured loans approval, including gut and non-gut rehabilitation conversions. This new guideline went into effect September 1, 2011. Condominiums must demonstrate that at least 10% of the yearly assessment income be dedicated towards reserve contributions. The FHA enforces the 10% budget line item requirement nationally by prohibiting lending in developments that are non-compliant with this requirement.[17] Additionally, Mortgagee Letter 2011-22 stipulates all other condominiums requesting FHA project approval may be required to submit a current (completed within the last 24 months) reserve study at their discretion or whenever financial documents do not appear to meet sufficient funding requirements of the condominium association.[18]
Fannie Mae
On December 1, 2010, Fannie Mae published Announcement SEL 2010-16. The new guidelines outlined in the announcement went into effect March 1, 2011. The guidelines made reserve studies mandatory for all newly converted, non-gut rehabilitation condominium developments to be eligible Fannie Mae project approval.[19] All other types of condominiums have the option to submit a compliant reserve study or must add a budget line item for reserves equal to 10% of the yearly assessment income.
Canada
In Canada the legislation governing condominium and strata corporations is provincial. There are no national standards conducting reserve professionals with respect to conduct, reporting, methodology, calculation formula other than those of specific professional organizations. The absence of a national organization of reserve planner professionals has resulted in reserve study reports containing vital financial information being prepared using simplistic spread sheet applications and forecasts which are not compliant with financial reporting requirements of Financial Reporting & Assurance Standards Canada.[20]
The ICBI reserve study standards are very specific with respect to the information to be contained in the report and the calculation methods used in providing financial forecasts. The standards are also specific as to the software used to create the financial forecasts. A reserve professional providing reserve study/depreciation reports which comply with these standards must use the formulas provided by ICBI.
Associated Reserve Planners of Canada Inc. (ARPC)[22] is a national group of reserve study providers of various vocations and professional designations. ARPC members have adopted the ICBI standards and incorporated them into the reserve management planning process. All members use Reserve Fund Analysis software RFA Pro[23] as it has been independently audited by a national accounting firm and meets all the requirements of the ICBI Generally Accepted Reserve Study Standards. Report templates and all financial reports as required by the standards are included in the RFA Pro analysis system.
Funding methods and Goals
There are several reserve study funding methods and goals. These methods may be used to develop a funding strategy that corresponds with the risk tolerance of the community. In National Reserve Study Standards terminology,[24] there are two basic ways to calculate contributions: "Cash Flow" or "Component" (also known as "Straight Line"). See a comparison between the two here. In the same National reserve study Standard terminology, there are four funding objectives: Full funding, Threshold funding, Baseline funding, and Statutory funding. Due to its greater computational flexibility and its ability to allow the user to focus on and achieve any of the four funding Objectives, the "Cash Flow" Method has seen significant growth in popularity.[25] The four Funding Goals (excerpted from National Reserve Study Standards, or in a document expounding on those standards, are as follows:
"Full Funding" is pursuing the goal where the Reserve Fund Balance will equal (or closely approximate) the value of Reserve component deterioration (the "Fully Funded Balance").
"Baseline funding" describes the goal to have sufficient reserves on hand to never completely run out of money. This is sometimes described as a "cash-positive" plan. With less cash in reserves on-deposit, associations with a baseline funding objective have higher instances of special assessments and/or deferred maintenance.[26]
"Threshold funding" describes a goal chosen by the board other than the 100% (Full funding) level or just staying cash-positive (Baseline funding). This may be a specific Percent Funded target or a cash balance target. Threshold funding is often a value chosen in between Full funding and Baseline funding.
All funding goals are designed to meet exactly the same expenses outlined in the reserve component list. Thus the expenditures are identical, only the size of the reserve fund through the years is different. This means the size of reserve contributions between different reserve funding objectives is often relatively small (typically only 10–15%).
Qualifications & Levels of Service
Reserve studies can be created by volunteer board members, their professional managers, obtained through a variety of professionals specializing in the preparation of reserve studies, or large architectural or engineering firms who complete reserve studies as a small aspect of their larger business. Recently, certification criteria have been created to allow for a more ordered system of identifying those individuals who have been specifically trained in the creation of reserve studies. One such certification, that of Reserve Specialist (RS), is available through the Community Associations Institute (CAI). To obtain this certification, candidates must have prepared at least 30 reserve studies within the past 3 calendar years, hold a bachelor's degree in construction management, architecture, or engineering (or something equivalent based on experience and education), and complied with various other rules and codes of conducts.[24]
Another credential is the Professional Reserve Analyst (PRA), created and promoted by the reserve study industry's own trade organization, the Association of Professional Reserve Analysts (APRA).[27] The PRA was the first accrediting body for Reserve Professionals. The PRA credential is similar in that it takes years, demonstrated experience, and compliance with standardized terminology to obtain although the experience levels are a bit higher than that required for the RS and their efforts include studies both inside and outside of the homeowner association industry. APRA also requires its PRAs to maintain proficiency with continuing education.[28]
In Canada there are several designations and training programs. The Real Estate Institute of Canada (REIC) offers the Certified Reserve Planner (CRP) program, which is the only nationally accepted specialty designation listed in provincial (some provinces) legislation as qualified. Members of the Appraisal Institute of Canada (AIC) must use the methodology and standards of the REIC program if they wish to complete the report. This includes preparing a Benchmark Analysis and rating the reserve fund as a percent funded.
The Canadian National Association of Real Estate Appraisers(CNAREA)offers the Designated Reserve Planner (DRP) program to designated appraiser members since 2012. The DRP designation requires demonstrated experience and compliance with standardized terminology and methodology to obtain. All DRP designated planners are required to use the RFA Pro Reserve Fund Analysis software or provide a quality assurance report of their chosen calculation methods. Applied Science Technologists & Technicians of British Columbia (ASTTBC) offers the Registered Reserve Fund Analysts (RRFA) training program to Home inspectors, as home inspectors are restricted from completing Depreciation Reports / Reserve Studies in their bylaws. As of 2013, Sauder School of Business Real Estate Division is offering the first of 2 courses towards a certification called the Reserve Fund Planning Program (RFPP), but yet no trade group has recognized this designation.
There are three types of reserve studies based on standards set by the Association of Professional Reserve Analysts and Community Associations Institute, differing in how exhaustively the Physical Analysis is conducted. These three types of reserve studies allow the association to select the "Level of Service" appropriate to their current budget preparation and disclosure needs. Listed beginning with the most exhaustive, they are:
"Full" reserve study (creation of the reserve study, involving creation of the component list, measuring/quantifying all reserve components, and development of the Useful Life, Remaining Useful Life, and Current Replacement Cost based on a diligent, visual on-site inspection). Note that for most associations, a "Full" reserve study only needs to be done once. After a "Full" reserve study has been done, in subsequent years the association can choose between the two reserve study update options shown below:
"Update With-Site-Visit" reserve study (an update of an existing reserve study involving a diligent visual on-site inspection, but presuming that all components have been properly identified and quantified). This type of update is often performed every two to five years.
"Update No-Site-Visit" reserve study (an update of an existing reserve study without a site inspection, done by client interviews and interviews with knowledgeable vendors and service providers). This type of update is typically performed in the years in-between With-Site-Visit updates.
In addition to the above types of Reserve Studies, note that there are different levels of professional engagement. These typically fall into the categories of independently prepared reserve studies, an integrated Reserve management plan, or a Consulting engagement.
Typically Excluded Common Area Components
Some common area components may have been left out of your reserve study or been included in the component list as an “excluded item” and not been funded for. These components will typically fall into one or more of the categories listed below.
Below Threshold Costs - Component repair and/or replacement costs that are deemed too small to be considered capital expenses and are typically included in the operational or maintenance budget of the association have not been funded for in this study. Minimal threshold costs are determined by the Association or by you Reserve Analysts based on the typical minimal threshold costs for similar sized associations.
Operational Expenses - These occur at least annually and can be effectively budgeted for each year. They are characterized as being reasonably predictable both in terms of frequency and cost. Operational expenses include all minor expenses which would not otherwise adversely affect an operational budget from one year to the next.
Very Long or Unpredictable Useful Life Expectancy - Components which, when properly maintained, have a very long useful life and which cannot be accurately predicted, have been excluded from this reserve report. These components may require maintenance and upkeep which is typically funded from the operational budget of the association.
Unit Improvements - Improvements made to the property that fall within the Governing Documents’ unit description summary (owners responsibility), are not typically considered to be community owned or the responsibility of the association.
Other Non-Association Owned - Improvements installed on the property but which are owned by other parties such as governmental agencies, utility companies, the US Postal Service, etc., are not included in this reserve study. The replacement and maintenance of these improvements are not typically the responsibility of the association.
Additionally, budgeting is normally excluded for repairs or replacements of assets which are deemed to have an estimated useful life equal to or exceeding the estimated useful life of the facility, community as a whole, or exceeding the legal life of the community as defined in an association's governing documents. Examples include the complete replacement of the foundation, elevators, wiring and oftentimes plumbing. Also excluded are insignificant expenses which may be covered either by an operating or reserve contingency, or otherwise in a general maintenance fund. Costs which are caused by acts of God, accidents or other occurrences which are more properly insured for, rather than reserved for, are also excluded.[29]
Related Research Articles
Cost accounting is defined by the Institute of Management Accountants as "a systematic set of procedures for recording and reporting measurements of the cost of manufacturing goods and performing services in the aggregate and in detail. It includes methods for recognizing,allocating, aggregating and reporting such costs and comparing them with standard costs". Often considered a subset of managerial accounting, its end goal is to advise the management on how to optimize business practices and processes based on cost efficiency and capability. Cost accounting provides the detailed cost information that management needs to control current operations and plan for the future.
International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB). They constitute a standardised way of describing the company's financial performance and position so that company financial statements are understandable and comparable across international boundaries. They are particularly relevant for companies with shares or securities publicly listed.
Financial statements are formal records of the financial activities and position of a business, person, or other entity.
This aims to be a complete list of the articles on real estate.
A homeowner association, or a homeowner community, is a private association-like entity in the United States, Canada, the Philippines and certain other countries often formed either ipso jure in a building with multiple owner-occupancies, or by a real estate developer for the purpose of marketing, managing, and selling homes and lots in a residential subdivision. The developer will typically transfer control of the association to the homeowners after selling a predetermined number of lots.
An income statement or profit and loss account is one of the financial statements of a company and shows the company's revenues and expenses during a particular period.
In finance, valuation is the process of determining the value of a (potential) investment, asset, or security. Generally, there are three approaches taken, namely discounted cashflow valuation, relative valuation, and contingent claim valuation.
A budget is a calculation plan, usually but not always financial, for a defined period, often one year or a month. A budget may include anticipated sales volumes and revenues, resource quantities including time, costs and expenses, environmental impacts such as greenhouse gas emissions, other impacts, assets, liabilities and cash flows. Companies, governments, families, and other organizations use budgets to express strategic plans of activities in measurable terms.
Financial accounting is a branch of accounting concerned with the summary, analysis and reporting of financial transactions related to a business. This involves the preparation of financial statements available for public use. Stockholders, suppliers, banks, employees, government agencies, business owners, and other stakeholders are examples of people interested in receiving such information for decision making purposes.
Real estate appraisal, property valuation or land valuation is the process of developing an opinion of value for real property. Real estate transactions often require appraisals because they occur infrequently and every property is unique, unlike corporate stocks, which are traded daily and are identical. The location also plays a key role in valuation. However, since property cannot change location, it is often the upgrades or improvements to the home that can change its value. Appraisal reports form the basis for mortgage loans, settling estates and divorces, taxation, and so on. Sometimes an appraisal report is used to establish a sale price for a property.
A feasibility study is an assessment of the practicality of a project or system. A feasibility study aims to objectively and rationally uncover the strengths and weaknesses of an existing business or proposed venture, opportunities and threats present in the natural environment, the resources required to carry through, and ultimately the prospects for success. In its simplest terms, the two criteria to judge feasibility are cost required and value to be attained.
ARP4761, Guidelines and Methods for Conducting the Safety Assessment Process on Civil Airborne Systems and Equipment is an Aerospace Recommended Practice from SAE International. In conjunction with ARP4754, ARP4761 is used to demonstrate compliance with 14 CFR 25.1309 in the U.S. Federal Aviation Administration (FAA) airworthiness regulations for transport category aircraft, and also harmonized international airworthiness regulations such as European Aviation Safety Agency (EASA) CS–25.1309.
Materiality is a concept or convention within auditing and accounting relating to the importance/significance of an amount, transaction, or discrepancy. The objective of an audit of financial statements is to enable the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in conformity with an identified financial reporting framework, such as the Generally Accepted Accounting Principles (GAAP) which is the accounting standard adopted by the U.S. Securities and Exchange Commission (SEC).
In the United States, an environmental site assessment is a report prepared for a real estate holding that identifies potential or existing environmental contamination liabilities. The analysis, often called an ESA, typically addresses both the underlying land as well as physical improvements to the property. A proportion of contaminated sites are "brownfield sites." In severe cases, brownfield sites may be added to the National Priorities List where they will be subject to the U.S. Environmental Protection Agency's Superfund program.
IT Application Portfolio Management (APM) is a practice that has emerged in mid to large-size information technology (IT) organizations since the mid-1990s. Application Portfolio Management attempts to use the lessons of financial portfolio management to justify and measure the financial benefits of each application in comparison to the costs of the application's maintenance and operations.
Reserves for common-interest developments are funds (reserves) collected for the long-term maintenance or replacements of the common areas in a common-interest development (CID). The funds accumulate until they are needed for such.
Whole-life cost is the total cost of ownership over the life of an asset. The concept is also known as life-cycle cost (LCC) or lifetime cost, and is commonly referred to as "cradle to grave" or "womb to tomb" costs. Costs considered include the financial cost which is relatively simple to calculate and also the environmental and social costs which are more difficult to quantify and assign numerical values. Typical areas of expenditure which are included in calculating the whole-life cost include planning, design, construction and acquisition, operations, maintenance, renewal and rehabilitation, depreciation and cost of finance and replacement or disposal.
Infrastructure asset management is the integrated, multidisciplinary set of strategies in sustaining public infrastructure assets such as water treatment facilities, sewer lines, roads, utility grids, bridges, and railways. Generally, the process focuses on the later stages of a facility's life cycle, specifically maintenance, rehabilitation, and replacement. Asset management specifically uses software tools to organize and implement these strategies with the fundamental goal to preserve and extend the service life of long-term infrastructure assets which are vital underlying components in maintaining the quality of life in society and efficiency in the economy. In the 21st century, climate change adaptation has become an important part of infrastructure asset management competence.
One in eight Canadian households lived in a residential condominium dwellings, mostly located in a few census metropolitan areas according to Statistics Canada Condominiums exist throughout Canada, although condominiums are most frequently found in the larger cities. "Condominium" is a legal term used in most provinces of Canada. in British Columbia, it is referred to as "strata title" and in Quebec, the term "divided co-property" is used, although the colloquial name remains "condominium".
Maryland House Bill 107, also known as HB107, is a Maryland state law passed in 2022 that mandates that condominiums, housing associations, cooperatives, and homeowner associations complete a reserve study by October 1, 2023. The law, passed in response to the Surfside condominium collapse, is most notable for expanding the existing law on reserve studies, which only applied to Montgomery County and Prince George's County to the entire state, requiring community associations three fiscal years to "attain the annual reserve funding level" recommended by the study and giving the board of directors of each association the power to "increase assessments" to fund such a study, overriding any bylaws or other governing documents capping assessment increases. It became law without signature of Governor Larry Hogan.
This page is based on this Wikipedia article Text is available under the CC BY-SA 4.0 license; additional terms may apply. Images, videos and audio are available under their respective licenses.
