A homeowners’ association (HOA) is responsible for managing all aspects of the community. This includes the maintenance, repair, and replacement of shared facilities and equipment. HOA board members need to allocate reserve funds for these projects. In order to do this, the board chooses from HOA reserve studies methods, such as pooled and component, to determine which is the best method to estimate its reserve fund. Reserve studies are crucial because they help the board analyze various factors such as expected costs and time for future large projects and the overall well-being of the community.
What Are the HOA Reserve Studies Methods?
Any community association must have reserve funds for roof repairs, pavement maintenance, equipment replacement costs, or anything that involves maintenance over $10,000.
The HOA decides on an amount for the community association reserve funding, and this is included in the annual budget. The board members have to make sure that all upcoming costs are covered in the process.
To ensure that the HOA has sufficient reserve funds for planned projects and unexpected expenses in the future, the board facilitates a reserve study. HOAs will usually hire companies every 3-5 years to conduct the reserve studies, and it is up to the board and their management company to implement the results
There are two HOA reserve studies methods: pooled and component. Both methods have their own advantages and disadvantages. Thus, it’s up to the HOA board to choose which one is better suited for their community.
HOA Reserve Studies: Pooled Method
The first of our HOA reserve studies methods is the pooled method, also known as the cash flow method. In this method, two or more reserve assets are analyzed and then combined into one general account. The HOA then uses this reserve account to fund all of the community’s planned projects.
When forecasting project costs, the pooled method considers many factors, such as annual cash inflows, current reserve account balance, interest earned by money in the reserve account, the taxes on the interest earned, and inflation costs.
This reserve study method ensures that the reserve account has enough money in it to fund future expenses. The HOA must also ensure that the reserve account balance doesn’t dip into the negatives.
One advantage of the pooled method is that inflation is accounted for. This ensures that all projects can be funded throughout the year, despite rising market prices. For example, the current estimated cost of a repainting project is $50,000. However, the project isn’t slated to start until two years later. With an estimated inflation rate of 2%, the estimated reserve amount is then increased to $52,020.
This reserve study method also enables the HOA to have some flexibility over the pooled funds. The money can be used for any concerned asset without needing the approval of the majority of the board members. This can be useful if a certain project needs additional funds to be completed.
However, flexibility over the pooled funds can also be disadvantageous for the HOA. Having a flexible reserve account can lead to overspending. Without spending limits, the HOA board might end up allocating more funds for one project. For example, the deck project will cost $25,000. However, the HOA may suddenly decide to add unnecessary features, and this will lead to higher costs.
Overspending could lead to a depletion of the HOA’s reserve account, which, in turn, would lead to higher reserve assessments the following year. In the case of urgent repairs, the HOA might even need to collect special assessments from homeowners.
HOA Reserve Studies: Component Method
The second of our HOA reserve studies methods is the component method, also known as the straight-line method. In this method, every asset is treated as a separate component. Each asset receives funding, which is then placed in a dedicated reserve account.
Contributions to each account are determined by subtracting the current value from the projected cost for the current year. The resulting figure is divided by the remaining useful life of the specific asset.
The main advantage of the component method is that all reserve assets will have dedicated funding. The money allocated for a specific project cannot be used for other projects without a majority vote from the HOA board. For example, the reserve fund for a new roof cannot be used to pay for new pool equipment. Any leftover amount is kept in the dedicated reserve account for next year’s estimate.
However, this can also be disadvantageous. If the actual costs of a project are higher than the estimated amount, the HOA may not be able to finish that particular project. The HOA will need to come up with additional funding without affecting the other reserve accounts.
This scenario is also more likely to happen because the component method does not take inflation rates into account. In the case of long-term projects, their reserve accounts may become underfunded when inflation hits the market.
This reserve study method also does not take into account the interest earned by the reserved accounts. A significant interest could lessen the overall cost of a project. However, with the component method, homeowners will still end up paying for the original estimated cost of the project.
Which Reserve Study Funding Method Is Best for Your HOA?
As you can see, HOA reserve studies methods come with their own advantages and disadvantages. The pooled method offers flexibility, while the component method ensures that all planned projects are funded. There are also other aspects you need to consider such as the HOA’s current funds, interest gains, short-term projects, and long-term projects.
Ultimately, the choice of reserve study funding method will depend on your HOA’s situation and financial needs. If you are currently using the component method, you may need to secure the majority vote to switch to the pooled method.
If you are having a hard time with your community association reserve funding, you may want to consult an HOA management company. They can help you with choosing HOA reserve studies methods as well as interpret the results of your chosen reserve study. Having a better understanding of reserve funding will allow your HOA to make more informed decisions for the betterment of the community.