Set Your HOA Up for Success with a Strategic Plan for Reserve Funds
This article was first published in the Q2 2023 edition of the CAICF Central Florida Times. While each state has different legislation and reserve fund requirements, Florida is one example of a state that has recently enacted changes that affect its homeowners associations. Read on for insight into how to:
- Determine reserve fund targets
- Communicate new requirements to homeowners
- Instill confidence in your association’s financial wellbeing and preparedness
Homeowners associations (HOAs) should offer peace of mind to residents: the assurance that the property receives regular maintenance and upkeep without the stress of unexpected costs. Basically, physical assets not affiliated with an individual unit or home undergo repair and replacement in a timely manner.
However, this does not happen without HOAs properly monitoring and updating reserve fund strategies, and this often requires difficult conversations with homeowners about the reserve requirement and special assessment costs to help them understand the financial obligations. As amended legislation requires condominium associations in Florida to sufficiently budget for reserves for capital expenditures and deferred maintenance in addition to operating expenses, it’s a crucial moment to communicate early and often with members, and develop a strategic financial plan that will guide your association forward.
Simultaneously, HOAs are dealing with the fallout of inflation and a recession, while trying to responsibly explore investment options that remain safe while providing an opportunity for high-yield returns.
How should your HOA determine reserve fund targets?
In an optimal scenario, HOAs typically allocate 15-40% toward the reserve budget, which will consist of liquid assets used to meet future financial obligations — both expected and unexpected. Creating partnerships with outside experts can help you to maintain and grow these funds.
Without reserves to cover the expenses of a major repair or replacement, a special assessment could subject all HOA individual members to contribute a proportionate share of the project cost — putting everyone on the hook. Understanding these risks helps validate the need to have a plan in place to properly allocate the fees.
Most states have legislation related to reserve funding or reserve fund disclosures, and Florida is among those states that legally require reserve studies. The amount to be reserved for a repair — from roofing to pavement to other replacements with a cost of $10,000 or more — will be determined by the association's most recent structural integrity reserve study completed before December 31, 2024. In addition, the HOA board is always responsible for protecting property values by meeting the financial needs of the properties.
The Community Associations Institute (CAI) closely worked with a number of reserve study professionals to define reserve adequacy and make it part of their National Reserve Study Standards. The definition contains two parts:
- Having enough cash to complete projects on time.
- Not relying on outside funding sources like loans or special assessments.
A current, up-to-date reserve study determines adequacy and contains a funding plan designed to avoid having to go to members for additional costs outside the regular fees. This study also provides boards with reliable numbers to work with in attempting to fund reserves at the same pace as the property’s deterioration and in time for repair or replacement costs.
Ideally, a 100% funded reserve would theoretically cover all anticipated costs from the study. Historically, however, many HOAs are underfunded, leading to the need to suddenly increase association dues or seek inefficient outside funding solutions when unexpected costs arise. At a minimum, HOAs should try to overcome such issues and provide a 70% funded reserve.
With a rising rate environment, HOAs are seeking the best return on their reserve funds, while also staying mindful of the risk of some of the investment options.
This becomes more important due to the current effects of inflation, which have drastically and rapidly changed reserve funding forecasts due to rising operating expenses related to labor, raw materials and other supplies.
Cash flow matters, and a strategy designed to ensure an HOA can survive a crisis and even thrive must now be considered a requirement and not a luxury.
A strong financial services partner should be helping create a plan to invest for growth and explore options to maximize every dollar. Building a strong relationship with a financial services professional can help you navigate not only the planning, but also the execution that leads to better and more productive communication with members.
With these goals in mind, HOAs shouldn’t fall for rate-driven vendor relationships. Instead, a partner truly invested in responsive, day-to-day service and proactivity can help you manage the changing financial needs for operating and reserve funds, along with considerations of the larger economic environment.
In fact, smaller reserve funds can still be adequate when matched with an aggressive plan because the amount of cash required remains relative and depends on the common areas the association is responsible to maintain. For example, an HOA with many common area amenities, such as a clubhouse, gym, pool, water park or athletic facilities, needs to have a higher balance, but more simple layouts require much less cash on hand.
Ratios can be an insightful and meaningful measure, rather than just a bottom-line figure.
The wellbeing of your HOA may depend on whether or not you have a plan in place before an urgent need hits. Professionals dedicated to understanding the full scope of a specific HOA’s needs — from operational costs like maintenance of shared spaces, security, janitorial services, legal and office expenses, and insurance premiums; to reserve considerations like structure repair and parking lot improvements — can help you to be prepared no matter the economic climate.
Ample preparedness allows your board to instill confidence that the organization is doing everything it can to avoid emergency funding scenarios. Honesty and transparency help to avoid uncomfortable conversations and show a true investment in your HOA’s finances and future.