14 Warning Signs that Signal Homeowners Association Reserve Problems

State laws and/or association governing documents typically mandate that associations prepare a reserve study for funding the future replacement of major components such as roofs, streets, and exterior paint. The reserve study provides a current estimate of the costs of repairing and replacing the common area components over the long term. The preparation of a reserve study requires:

• An examination of the association’s repair and replacement obligations;
• A determination of costs and timing of replacement; and
• A determination of the availability of necessary (reserve) cash resources.

Unfortunately, because the management personnel of many homeowners associations strive to control spending and avoid increases in member assessments, they frequently neglect their responsibilities relative to the maintenance of appropriate levels of reserve funds that will ultimately be required for the replacement of the association’s major components. The failure to maintain adequate reserves for future needs is irresponsible and will most certainly lead to future financial issues within the association.

The following indicators should be viewed as “warning signs” that are indicative of a homeowners association having inadequate reserve study data and insufficient reserves:

1. The association does not maintain a list of major components;
2. The association does not have a policy to distinguish reserve expenditures from operating expenses;
3. The association does not have a clear reserve funding goal;
4. The association has not conducted a physical analysis of its components;
5. The association has not conducted a reserve funding analysis;
6. The association has not prepared information on remaining life and current replacement cost for all major components;
7. The association has not mentioned in assumptions, or included “life of the project” components in its reserve budgeting;
8. The association’s pro forma operating budget does not contain reserve study information or assumptions;
9. The association does not have a documented maintenance schedule and related assumptions for each major component;
10. The association’s list of major components in the reserve study does not include all significant common area components listed in the CC&Rs; or
11. The association does not maintain separate bank account(s) for reserve funds.
12. The association has a reserve deficit that is staying constant or increasing over time;
13. Special assessments are required to fund major repairs; or
14. Current income from assessments does not equal or exceed dollar value of annual component wear.

Associations that have the above indicators are not being responsibly managed and remedial action should be taken immediately. Because the association’s directors have a fiduciary duty to responsibly manage association funds and property, the establishment and maintenance of a replacement reserve budget is very important. The preparation of a reserve study and funding the reserves requires affirmative action by the association’s directors coupled with explicit association decisions on how to provide for long-term funding, and on the extent to which the association will set aside funds on a regular basis for non-annual maintenance requirements.