Hiring a Reserve Provider
Do I Need To Hire An Engineer?
The short answer is No. While an engineer may be better able to assess certain unique structural or mechanical problems that may be present at a community, these are generally rare and far between.
A Reserve Study is primarily a financial assessment and if your analyst has an adequate background in construction and finance, your report will be completed accurately.
If your reserve inspector notices something that requires further investigation, they should make note and will provide referrals to qualified engineering experts.
Who Can Complete A Reserve Study?
Reserve studies are usually prepared by people trained and certified in the field. One such certification, 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 bachelors degree in construction management, architecture, or engineering (or something equivalent based on experience and education), and comply with industry standards and codes of conducts.
Another credential is the Professional Reserve Analyst (PRA), created and promoted by the Association of Professional Reserve Analysts (APRA).
What Should I Look For In A Reserve Study Company?
You want to obtain a provider that will work with you and be there to answer follow up questions. Aside from the cost of the study, obtained from submitting bid requests, you may wish to consider the following questions:
The following questions are offered as a guide in the decision making process to select a Reserve Study firm.
1) What is the firm’s background and experience? While it is not necessary for the firm to be engineers or architects, experience is a major factor. What are their credentials? How many Reserve Studies has the firm conducted in the last year? Five years? Ask for employee qualifications in the proposal.
2) What organizations does the firm belong to that helps you in conducting Reserve Studies?
These may include the Association of Professional Reserve Analysts or Community Associations Institute.
3) Does the firm comply with APRA and CAI basic requirements for a Reserve Study? Are both the physical and financial components of the Reserve Study included, as required by both APRA and CAI? The Reserve Study must include: inventory of common elements, useful life, remaining useful life, future replacement costs, and a funding plan to set up sufficient reserves.
4) What percent of the firm’s work is for community associations? Does the firm specialize in reserve studies or is it an engineering or contracting firm working for community associations as a sideline business? If not, they may not be able to take cost saving success stories from other communities and apply them to your association.
5) What is the size of staff involved in the assignment? What is the background of the individual inspecting the association? Will others in the firm be involved? Does the firm have a strong quality control system in place? Will the principals of the firm be involved in the analysis, review, etc.?
6) Does the firm use full-time employees only, subcontract engineering or accounting services, or is it part of a loose affiliation with other firms spread throughout the United States? This question can speak volumes about the expertise of the firm and its individuals.
7) Which method do you use for funding reserves? Of the two methods, cash flow and component, APRA and CAI both endorse the cash flow method, which should determine minimum but stable levels of funding over the term of the analysis.
8) What is your basis for replacement costs of the common elements? Databases purchased from national companies, contractors, manufacturers, internal database information, etc.
9) Do the reports comply with the AICPA Audit Guide and relevant state statutes?
10) Are many Reserve Study references provided that are either of similar properties or in close proximity to home or both? Call references. They often can shed much light on their likes and dislikes with the firm.
What and Why?
What Will The Board Need To Provide?
Reserve Study preparation requires governing documents, budgets, balance sheets, component inventories, site maps (plats), detailed responsibility maps (fences, roads, open land, etc), blueprints, access keys / codes, project location driving directions, vendor proposals, preferred vendor contacts (painters, roofers, pavers, landscapers, etc), engineering studies and any prior reserve studies.
What Happens During The Site Visit?
The property inspection is conducted following a review of the documents that established and identify all common area assets. Estimated life expectancies and life cycles of common area components are based on conditions that are readily accessible and visible at the time of the inspection. The property inspection will not include any type of intrusive or destructive investigation. Where additional information is required, it may be obtained by contacting the contractor or vendor that installed or maintained the component in question.
What Does A Reserve Study Cost?
The cost of a reserve study is dependent on the complexity, size and location of an association and is basically a function of the time taken to prepare the report. Reserve study options and associated pricing is generally provided on request from a service provider.
Once a Reserve Study is completed for a community or business, future studies can be completed as an “update” at a substantially lower cost.
Is There A Legal Requirement To Get A Reserve Study?
In recent years many states, including California, Oregon, Hawaii, Utah, Virginia and Washington, have introduced laws which mandate the requirement for condominium and homeowner associations to have reserve studies prepared on a regular cycle (1 to 6 years). Other states such as Montana and North Dakota have no specific legislation in place. However, even when there is no legal requirement it is still prudent to have a reserve study prepared on a regular basis.
For information on specific state requirements we recommend that you check with your local regulating agencies.
How Often Should We Get A Reserve Study?
The board should conduct a reserve study that includes an ‘on-site’ inspection of accessible reserve items at least every three years (consult applicable state statutes for any additional compliance requirements). These necessary updates provide statutory compliance and allow for adjustments due to actual year-end reserve balance and the unpredictable nature of the lives of many of the reserve components under consideration, as well as changes in costs.
Who Should Have A Reserve Study?
Any business or association responsible for the long term maintenance and replacement of significant assets can benefit from a Reserve Study. This insures that there is no future loss of value due to the deterioration of the assets. Reserve Studies are generally performed for homeowner associations, town homes, condos and property owners associations, but also for business parks, general businesses and municipalities.
What Is A Reserve Study?
The reserve study is a budget planning tool which identifies the current status of the reserve fund and a stable and equitable funding plan to offset the expected future major common area expenditures. The reserve study consists of two parts: the Physical Analysis and the Financial Analysis.
The Physical Aspect
Should Painting Costs Be Included In The Reserve Fund?
For most condominium projects, painting is one of the largest expenditures that the Association will incur. Consequently, it is logical that it should be included in the Association’s reserves because it is not an annual maintenance expense. For most Associations it will occur every 7 to 15 years.
So why does this question arise? In 1993, the IRS office responsible for 15 Homeowners’ Associations in San Diego, California, created a national furor over the need to include the cost of painting in reserves. This became a very big issue in the industry, but only because of the misunderstanding that occurred related to this issue.
The IRS has its own set of rules, and that they really don’t care what the Homeowners’ Association industry thinks. The Homeowners’ Association industry generally refers to expenditures as being either “operating” or “reserve” in nature. The IRS refers to expenditures as being either noncapital or capital in nature. These two definitions are not the same, and the major area of difference is painting expense. It is common practice within the Homeowners’ Association industry to exclude reserve contributions from taxation because they are capital assessments. However, the IRS states that in order for an assessment to be classified as capital in nature, the related expenditure must qualify as being capital in nature. Unfortunately, there are numerous rulings and tax court cases which clearly state that painting is a non-annual maintenance expense and it is therefore not a capital expenditure. Consequently, the reserve contributions that were being excluded from taxable income of the Association’s tax return now become taxable income. That makes it very difficult for an Association to accumulate the necessary painting funds without incurring a huge tax liability. The easy answer to this question is to have the Association file income tax Form 1120-H and avoid this issue of capital versus noncapital expenditures that exists only on Form 1120.
It is the general position of the Reserve Industry that the tax tail should not wag the economic dog. Determination of reserves should be made based upon economic considerations, state statutes and governing document requirements. Taxes should not enter into that consideration. Consult with the Association’s tax accountant to find out ways to avoid the tax risks on this issue.
What About “Lifetime” Products Like Tile Roofs?
Many people think that a tile roof will last forever and therefore doesn’t need to be included in a reserve study. The truth is that the tiles themselves can last 50 years or even longer but it’s the other components of the roof that have a shorter useful life that will need to be replaced. Many clients indicate that their roof tiles have a lifetime warranty, but they don’t realize the warranty only covers the Tiles and not the other components. The tiles themselves are all you see when you look at a tile roof but there are other components of the roofing system such as underlayment, battens, and flashings. If only tile was used on a roof it would not be water tight at all. The tiles are used as a watershed and to protect the other components of the roof. They are also are decorative as many different styles and materials are available.
Underlayment is a felt that is the final layer of protection for the plywood or roof sheathing. Underlayment can last anywhere from 15-35 years depending on the quality and thickness of the product. The local climate is also a major factor, the useful life is typically less in a dry climate such as Las Vegas. The cost of replacing the underlayment under a tile roof is very expensive because all the tiles must be removed which requires a great deal of labor. In addition it is inevitable that there will be a percentage of the tiles that break during this process.
Once a tile roof reaches an age of 20-30 years it’s important to consult with a roofing company to get an evaluation of all the components of the roof to get an estimate remaining lives. Roofs are always a large percentage of an associations reserve liability and are typically around 20-40% of the annual depreciation.
How Are Components Identified?
A “Reserve Component” is an item that is the responsibility of the association to maintain, has a limited useful life, predictable useful life expectancy, typically occurs on a timeline that exceeds 1 year and costs above an agreed upon minimum threshold cost.
An “Operating Component” expense is typically expenses that occur on an annual or monthly basis or are below the minimum threshold cost for the Reserve Component list.
The Financial Aspect
What is Percent Funded?
Percent funded is the ratio of what an association has set aside for reserves vs. the total depreciation of all their components (fully funded balance). Percent funded is one of the most important numbers to look at when reviewing an associations reserve study. The higher the percent funded the better off your association is. As the percent funded increases the risk of a special assessments and deferred maintenance decreases. Many people ask what is the average percent funded for associations. The answer is that every association is different and we see associations in all situations from 0% funded to well over 100% funded. Some also have the misconception that associations must always be 100% funded. While it is ideal for associations to be 100% funded, with a current accurate reserve study associations can plan for future expenses using a cash flow funding plan and still be fiscally responsible at a level below 100% funded. In general it is thought that the following describes an association when it comes to percent funded:
0-30% Funded = Poorly Funded
30-70% Funded = Fairly Funded
Greater than 70% Funded = Well Funded
Where Do Replacement Costs Come From?
The most accurate cost source is actual bids from contractors or to look at contracts from the last time the repair/replacement was performed. In most cases bids or contracts are not available so unit costs for similar work done in the same local area are used. In addition, it is helpful to talk to local vendors who have knowledge of the work and can help with a cost estimate. A third source is to use construction cost estimators such as RS Means. Many times the entire quantity of a component will not need to be replaced or repaired all at once. An example of this is not all light fixtures on a property will need to be replaced at the same time. In this instance an allowance can be developed for the component.
What is a Special Assessment?
Special Assessment is a term used to describe a temporary, unplanned tax levied upon the members of an Association on the basis of a membership vote. A special assessment can be a single lump sum demand by the Association, or collected in multiple payments.
Sometimes the need for a special assessment comes about due to misfortune (to meet a large insurance deductible or a non-insured loss), but most of the time Special Assessments are levied to compensate for poor financial planning (i.e., failing to set aside sufficient funds in advance for predictable reserve expenses). Funding reserves through special assessments should be avoided because they unfairly penalize one unlucky set of Association members at a particular point in time.