Reserve Plan — What and Why By John Russo, Ph.D.; CAI Reserve Specialist, RSTM, RESERVE CONSULTANTS, INC.
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or “older” association owners, reserve plans are easy to explain — they are what “Christmas Club” was when they were young. Christmas Club was handled by the local bank. You put a dollar or two per week into the account, and when you needed money to buy Christmas presents (voilà) you had $50 or $100 — it made Christmas a lot more fun and easy to deal with. So then — a reserve plan (account) is just the “bank,” where you deposit money every month as part of your total fees; when you need to do roofing, siding, asphalt, concrete replacement, etc., voilà you have the $50,000 or $100,000 you need. You don't need an assessment, and you don't end up with a run-down property that reduces property values, kills sales or causes financing problems. The specific components of the property that are included in a (Capital) Reserve Plan are dictated by the association bylaws, set up by the developer when the property was first built. They are the components that the developer declared as being the responsibility of the association (to collect money from owners and replace when necessary). There are no “standard” components included; the developer could have included or not included anything. Also, I called the plan a Capital Reserve Plan because only capital components (versus expense items such as grass cutting, insurance, painting, landscaping, drive seal coat) can be included. Since associations are basically corporations, any expense money accumulation year to year is called — yes, you guessed it, income, to be taxed by the government. Not so for capital components. The plan components (let’s say roofing, siding, and asphalt only) are assessed by an expert like me to determine how long it will be before they need replacement and what the current cost is to replace those components. Then, those current costs have inflation applied (so much percentage per year) to estimate what the costs will be when components will need replacement years in the future. Then the experts figure out, generally using computer help, how much has to be put into the Capital Reserve Plan account each month so that the monies will be there when needed. Part of each owner’s fee each month is dedicated (strictly) to reserves and should not be used for any expense item payment. Most of the time these monies won’t be used for many years — as many as 20 to 25 in some cases, such as for roofing and siding. It isn’t necessarily true that in the early stages of an association’s life, sufficient reserve monies have been collected. It is pretty easy to not have concern for collecting replacement monies when the whole complex is new or only a few years old. Failure to collect only $30 to $40/unit/month over a 10 to 15 year period, however, is very hard to make up all of a sudden in the last five years when roof and
asphalt replacement is reasonably imminent. Collections in these last few years can be two to five times what they would have been with a constant collection for the whole 20 years. That $30 to $40/ unit/month could suddenly be $100 or $125/unit/month — or an assessment of $4,000 or $5,000. Assessments are, of course, the worst situation that can occur, but without a good long term Capital Reserve Plan, assessments could be the only answer to avoid having to postpone proper replacements and allow deterioration of the property. Minnesota Statutes (laws) require Capital Reserve Plans for most (but not all) association properties. In addition, the association CPA, in any annual audit, will note whether or not a Capital Reserve Plan exists and whether or not it is “adequate”. Adequate means 100% funded. That says that when monies are needed for replacements at any time during the 30-year term of the plan, the plan shows funds available — in year 1 all the way through year 30. The consequence of a plan not 100% funded is assessment. Another reason to have good Capital Reserve Funds is so that work will be done (by the association) when it is needed. Components that are underfunded or left up to individual owners to replace almost always end up with not enough money to keep the property up or some owners not wanting to do the work, leading to a decline in property appearance. Of course, some components such as asphalt or roofs or boilers for condominium buildings, really cannot be up to individual owners. These components must be cooperatively done — and monies must be collected over time to do so, or groups of owners suffer directly. Capital Reserve Plans should be “normalized,” i.e., the collection should increase at a standard rate (we use 4%-5% increase per year) so there are no big swings. Collection at a standard amount, say $50/unit/month, for all 30 years of the plan is also not a reasonable approach. It does not account for inflation, and means that the current owners are paying a much larger share, because $50 today is worth much more than it will be in 10, 20, or 30 years. Good Capital Reserve plans minimize the amount to be collected ($/unit/month) at year 1 and throughout the plan, but with a reasonable increase each year. They are also easy to read and understand and don’t include too much detail that boards and owners really can’t understand or use. They are the best opinions of expert reserve professionals, but they look far into the future and therefore the “crystal balls” are understandably somewhat fuzzy. They should be updated (by Statute) every three years.
July | August 2016
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