HOA board members are supposed to do everything they can to keep the association financially healthy. To exercise this responsibility, they need to deal with reserve funds successfully.
In addition to being aware of what this money is used for, HOA managers and board members need to know when reserve studies are required and where the reserve accounts are kept.
Are the reserves of your homeowners’ association fully funded?
First, we need to clarify what exactly “fully funded” means. Some associations regard it as adequate funds in their budget that let them replace some reserve expenditures as needed.
However, others consider the reserve fund a means for replacing everything right now.
Continue reading to find out what a fully funded reserve looks like and what qualifies as expenses that this account should cover.
Reserve Funds vs. Operating Funds – What Is the Difference?
Reserve and operating funds are often confused for one another. Many people don’t understand the difference and think that one or the other can cover all costs.
Below we will explain the difference between them:
Reserve funds are typically set aside for unexpected or emergency expenses. The resources are generally used to cover any unforeseen cost that may arise in the future.
In some cases, HOAs or board members require funds that are not immediately available. In order to meet these needs, many homeowners associations turn to reserve funds.
A reserve fund is an account that companies and associations use to store money for future obligations. It is often classified as either a working or non-working fund.
A working reserve fund is used for current expenses and cash-flow needs, while a non-working reserve fund is set aside for future obligations and costs.
The amount of money in an association’s reserve fund will vary depending on its financial situation at the time of accounting. For example, an HOA may establish more reserves if it expects higher than average expenditures in the coming months or years.
Operating funds are the money a company or association uses to cover its day-to-day expenses. These accounts are usually calculated by taking the total revenue and subtracting its operating expenses.
This calculation is known as EBITDA, or earnings before interest, taxes, depreciation, and amortization.
What Are the Reserve Funds of HOAs Used for?
The reserve funds should allow the HOA to cover expenses that don’t arise on a regular basis. While there is a wide range of unexpected or unusual expenses, we will focus on the most common ways of using the reserve funds.
HOA reserve funds are commonly used to:
- Assemble or construct new playgrounds;
- Complete various landscaping projects;
- Replace the pool pump or complete other expensive pool repairs;
- Paint the common HOA areas or structures like clubhouses;
- Repair or replace the roofing of a common structure/area;
- Make significant, costly repairs to fencing, etc.
Homeowners association management involves using the reserve account, among other things, to keep the community in tip-top shape.
How Much Money Should HOAs Have in Their Reserve Funds?
In a perfect world, every community should have an HOA reserve account that is 100 percent funded. This means communities must have sufficient funds to meet all planned or anticipated expenses.
Since fully-funded reserves are not so common in reality, 75 percent is often considered decent or satisfactory. Anything below this increases the chances of leveraging special assessments.
In addition, homeowners associations may need to increase the HOA dues to cover their costs.
How Fully-Funded Community Associations Work
Generally speaking, no community association simultaneously replaces or repairs all the common components.
If an association only maintains the heating, for example, just because it has the total amount of the HVAC replacement expense on the bank account doesn’t mean it is a fully-funded community.
Actually, most HOAs don’t have the entire cost of the reserve elements available just before something should be repaired or replaced. That’s how the majority of community associations work.
Imagine that all of the funds are available at the same time. Sounds great! Well, not really. Most reserve study companies and accountants consider it unnecessary.
Instead of having the entire cost of each common component in a savings account, most community associations have a few reserve components.
Each of which is at a different point in time. Therefore, there’s no point in the community lifecycle where the reserves are equal to all the components’ complete replacement expense.
What Is the Fully Funded Balance?
According to the National Reserve Study Standards, the term “100% funded” refers to the fully funded balance equal to the projected or actual reserve balance.
That being said, the fully funded balance relates to the lifecycle fraction used up for a specific element. Here is an example to help understand this situation:
Let’s assume you have an $8,000 HVAC system that has been used for three-quarters of its life expectancy of 16 years. In year 12, the fully-funded balance would be $6,000 (75% of the HVAC replacement cost).
This means that although you do not have all $8,000 available in the twelfth year, your reserve would still be fully funded if you had $6,000 saved.
The majority of communities have a lot of different components to take care of, from general repairs and common area expenses to insurance claims and capital projects.
That’s why community associations are generally not 100% funded, i.e., they don’t have a fully funded balance that would allow them to cover each reserve component at a time.
A fully 100% funded balance is technically not possible. What’s more, in many cases, it is considered to be overkill.
So, rather than striving to be fully funded, you should aim for a sufficient balance.
The Bottom Line
Understanding the benefits of a reserve fund can improve the health of the HOAs budget. In many instances, unforeseen things happen, and communities struggle to find the resources to pay for these expenditures. Contact us today for more details about reserve studies, and let us help you get your HOA in top shape!