It is important for any homeowners association to have HOA reserve funds and to understand the purpose of this separate account. In doing so, an HOA can avoid financial ruin and minimize the need for special assessments.
What Are HOA Reserve Funds?
Reserve funds, also known as reserve accounts or HOA cash reserves, are money a homeowners association sets aside to cover the future cost of major repairs and replacements related to common areas. It differs from an HOA’s operating fund, which is primarily used to pay for recurring expenses such as accounting fees, insurance premiums, legal fees, day-to-day maintenance, and the like.
A good analogy for operating funds and reserve funds is that the former is like a checking account and the latter is like a savings account. You use your checking account to pay for everyday expenses, such as groceries, utility bills, and rent. In contrast, you rarely tap into your savings account because it is money you have set aside for unexpected or major costs.
What is a reserve expense? A reserve expense is something you use reserve funds to pay for. This typically refers to the cost of repairing or replacing existing components. Replacing the roof of the community clubhouse and repaving roads are examples of reserve expenses.
What Can HOA Reserve Funds Be Used For?
By design, reserve funds are supposed to cover unexpected expenses. These expenses are usually substantial in kind.
The association dedicates a portion of the monthly homeowner dues to the reserves every year. This way, when a major expense comes up, the association does not need to take from the operating fund, levy special assessments against homeowners, or take out an HOA loan. Instead, it simply needs to tap into the HOA reserves account.
It is worth mentioning that not all reserve expenses are unanticipated. Some of these expenses are just deferred or do not come up often.
For instance, it would be downright silly to have the pool retiled every year. You might need 10 to 20 years between each retiling, so that kind of major expense would need to use the association reserves. The board will simply need to set aside money every year so that when the time does come to have the pool retiled, you can pay for the cost without worrying about sourcing the funds.
How Do You Account for Reserve Funds?
How much should HOA reserves be? This is a common question that often comes to mind when discussing reserve funds. Unfortunately, when it comes to HOA reserve fund accounting, there is no single correct answer. The exact dollar amount you should have in your reserve fund depends on a number of factors, such as the size of your HOA and what type of common elements you have.
In general, to qualify as a fully-funded reserve, you should have an amount that can cover all of the expenses you can reasonably predict. Typically, your association’s governing documents will have provisions concerning the adequacy of your reserves. Other times, the board sets the HOA reserve funding percent requirement. A good HOA reserves rule of thumb, though, is to have your reserves at least 70 percent funded at any given time.
How much money can an HOA have in reserve? While there is no limit per se, all associations eventually need to use reserve funding to cover major expenditures. Therefore, it is nearly impossible to accumulate so much money in the reserves without tapping into them.
HOA Reserve Fund Laws
Depending on where your association is located, there may be certain laws concerning reserve funds that apply to you. It is vital to check your state laws to ensure you remain compliant. Failure to abide by these laws can result in legal trouble for your HOA.
Although it is the board’s responsibility to determine how much money to have in the reserves, the law may also have a say in the issue. A few states have specific requirements when it comes to reserve funding. For instance, Ohio law mandates that associations must allocate at least 10 percent of the budget to the reserves, though members can waive this through a majority vote. Other states simply have statutory guidelines, leaving the details to the association board.
How much should condo reserves be? Condo laws concerning reserve requirements tend to be more specific, such as in the case of Florida. According to Florida law, associations must budget for building painting, roof replacement, pavement resurfacing, and any other expenditure that exceeds $10,000. The board must calculate the cost of each item based on estimates for its remaining useful life and cost.
HOA Reserve Study Requirements
A homeowner association reserve study evaluates the HOA’s major components to roughly calculate the cost of repairing or replacing them when they eventually reach the end of their estimated useful life. Reserve studies help HOAs determine the right reserve level, but hiring a company to conduct such a study does cost money.
How often should an HOA do a reserve study? Some states have specific laws requiring reserve studies and even dictating how frequently an association should have it done. Virginia law, for instance, mandates that HOAs must conduct reserve studies at least once every five years.
You can find reserve study requirements by state here.
Reserve Report Requirements
An HOA board must always remain transparent with its membership, especially when it comes to money. Members need to know where their contributions are going. While it is part of the board’s duty to disclose financial reports, there are states that go so far as to mandate it.
Homeowners associations in California, for one, need to create and distribute a detailed reserve report to all of its owners. According to California law, the board must use the most recent reserve study to produce this report. This report should consist of the estimated remaining life of every major component as well as its estimated useful life and estimated replacement cost. It should also include an estimated reserve amount required to maintain, repair, or replace the components.
Is It Possible to Invest Your HOA Reserves?
In a word, yes. You can invest your reserves, and many HOA boards do this as a way to earn more income for the association. But, you must exercise caution.
Remember that your duty as a board member is to maintain the community — and that includes its assets. Every decision you make should be within the association’s best interests.
Therefore, you must choose your HOA’s investments wisely. Go for an investment that offers growth but will not put the principal amount in jeopardy. It is generally ideal to stay away from riskier investments. Though these offer more growth, there is also a higher chance of loss. In choosing this route, you might incite anger from the community and even invite potential lawsuits.
When using your reserve fund to invest, it is always best to follow the provisions outlined in your governing documents. Not all associations have an investment philosophy written in their CC&Rs, though. In that case, turn to an accountant, an attorney, or an HOA management company for advice.
An HOA Board’s Duty
Just as you would save money for life’s major undertakings, your association should save money for large expenditures down the road. Healthy associations have well-financed HOA reserve funds. It is up to your board to make sure you meet the optimal level of funding for your reserves.
Reserve accounts have a distinct purpose, so you must not use them to cover operating expenses. Easily keep your reserve fund separate from your operating fund with the help of Condo Manager. Call us today at (800) 626-1267 or contact us online to schedule a free demo of our software.
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