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Reserve study

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Reserve study

A reserve study is a budget planning tool which identifies the current status of the reserve fund and a stable and equitable funding plan to offset ongoing deterioration, resulting in sufficient funds when those anticipated major common area expenditures actually occur. The reserve study consists of two parts: the physical analysis and the financial analysis. This document is often prepared by an outside independent consultant for the benefit of administrators (Board of Directors or Strata Council Members) of a property with multiple owners, such as a condominium association or homeowners' association (HOA), strata, containing an assessment of the state of the commonly owned property components as determined by the particular association's CC&Rs and bylaws. Reserve studies however are not limited only to condominiums and can be created for other properties such as resort (shared vacation ownership) properties, apartment buildings, worship facilities, private schools, private (golf/social) clubs, and office parks.[1]

Reserve studies are in essence planning tools designed to help the board anticipate, and prepare for, the property's major repair and replacement projects. For example, such projects would include: replacement of the roof on the building(s), replacement of the boiler, retrofit of the fire alarm devices, and resurfacing of the roadways.

In some jurisdictions across Canada, a reserve study is also sometimes referred to as a "reserve fund study", "contingency reserve fund study", or "replacement reserve study" and, in British Columbia, the legislation refers to this type of study as a "Depreciation Report".

Contents

  • Purpose 1
  • Results 2
  • Relevance 3
    • State reserve studies 3.1
    • US FHA 3.2
    • Fannie Mae 3.3
    • In Canada 3.4
  • Funding methods and objectives 4
  • Qualifications & Levels of Service 5
  • References 6

Purpose

The purpose of a reserve study is to give those overseeing the maintenance of the property a better idea of what major expenses to expect and an educated estimate of when these expenses will occur. With this knowledge, the homeowners' association board or manager can create a budget so association members will make their fair share of reserve contributions, designed to offset the slow but steady ongoing reserve component deterioration of the association assets, and avoid being surprised by components that deteriorated often in plain sight and over a number of years. In addition, the reserve study provides important annual disclosures to association members (and prospective buyers) about the condition of common area components, and the level of preparedness (strength) of the reserve fund (typically measured in terms of Percent funded).[2] A reserve study is a roadmap that allows decisions to be made which will be efficient and effective for the long term.

Results

There are three results from a reserve study:

  1. A listing of the major assets of the association to be funded through reserves, their expected useful life, remaining useful life, and current replacement cost (yielding the "scope and schedule" of the reserve projects).
  2. An evaluation of the current strength of the reserve fund (commonly expressed as "percent funded").
  3. A recommended multi-year reserve funding plan.

Relevance

Reserve studies are required by the board or manager for due diligence, disclosure, and budget and planning purposes. An increasing number of U.S. states and Canadian provinces today require some form of reserve planning or disclosures. In addition to requiring a minimum 10% of the total budget be dedicated to reserve contributions, Fannie Mae and the Federal Housing Administration may ask for a current reserve studies (to demonstrate that the association has dedicated sufficient funds to caring for the ongoing needs of the property) to be approved for FHA insured loans and Fannie Mae lending products and services.

State reserve studies

In addition to being helpful planning tools, reserve studies for Community Associations are legally mandated in 30 states (such as California, Florida, Hawaii, Nevada, Virginia, Washington, etc.), either for budget preparation or homeowner (and prospective homeowner) disclosure purposes.[3] In California, the relevant law is California Civil Code 5300.[4] In California, the law requires an annual reserve study Update, with that update prepared on the basis of a "diligent visual site inspection" at least every third year.[5] With the passing of SB 278 in 2010, the state of Utah also requires condominium and community associations to conduct and review reserve studies on a periodic basis.[6] reserve contributions are often one of an association's largest budget line items (often 15-40% of the total budget), and the reserve fund is typically the association's largest financial asset. This means annual review of reserve contributions and annual disclosure of the status of the reserve fund are prudent.

US FHA

On June 30, 2011, the Department of Housing and Urban Development published Mortgagee Letter 2011-22, which made reserve studies mandatory for all new condominium conversions applying for FHA insured loans approval, including gut and non-gut rehabilitation conversions. This new guideline went into effect September 1, 2011. Condominiums must demonstrate that at least 10% of the yearly assessment income be dedicated towards reserve contributions. The FHA enforces the 10% budget line item requirement nationally by prohibiting lending in developments that are non-compliant with this requirement.[7] Additionally, Mortgagee Letter 2011-22 stipulates all other condominiums requesting FHA project approval may be required to submit a current (completed within the last 24 months) reserve study at their discretion or whenever financial documents do not appear to meet sufficient funding requirements of the condominium association.[8]

Fannie Mae

On December 1, 2010, Fannie Mae published Announcement SEL 2010-16. The new guidelines outlined in the announcement went into effect March 1, 2011. The guidelines made reserve studies mandatory for all newly converted, non-gut rehabilitation condominium developments to be eligible Fannie Mae project approval.[9] All other types of condominiums have the option to submit a compliant reserve study or must add a budget line item for reserves equal to 10% of the yearly assessment income.

In Canada

In Canada the governing legislation is provincial and there are no national regulatory standards other than those enforced by national firms or associations. The intent of the various Acts are open to interpretation and as such differing opinions exist with respect to "adequate" funding. These differing opinions not only vary among planners they also vary among owners and managers. To date there are no statutory or mandatory funding requirements and as such unit owners are free to determine the level of funding which they consider to be adequate. The function of the reserve fund planner is to provide advice to the Board of Directors/Council Members who then need to sell the owners on the proposed plan. The owners will ultimately decide what level of contribution meets their objectives whether that be conservative or aggressive. The favorability of either approach will ultimately be determined by the market place and reflected in property values. Some owners will opt to purchase in properties which may have higher fees however retain higher level of reserves while other may elect to enjoy lower fees and accept a higher risk of a special assessment. These owners would rather control their own funds/investments rather than leave them in the hands of a few owners. Other factors include how the property is viewed by mortgage insurers such as C.M.H.C.[10] and Genworth Canada[11] It is important for decision makers to educate themselves on the methodologies utilized by the various planner designations and practices.

Funding methods and objectives

There are several reserve study funding methods and goals. These methods may be used to develop a funding strategy that corresponds with the risk tolerance of the community. In National reserve study Standards terminology,[12] there are two basic funding Methods: "Cash Flow" or "Straight Line". In the same National reserve study Standard terminology, there are four funding objectives: Full funding, threshold funding, baseline funding, and statutory funding. Due to its greater computational flexibility and its ability to allow the user to focus on and achieve any of the four funding Objectives, the "Cash Flow" Method has seen significant growth in popularity.[13]

  • "Straight Line Funding" utilizes a methodology in which funds are allocated on a per component basis. Straight Line funding corresponds to depreciating components in even increments throughout the life of the component.[14] The book value is offset with reserve funds to maintain a full value for the property.[15] It is "Full Funding".
  • "Baseline funding" describes the objective to have sufficient reserves on hand to never completely run out of money. This is sometimes described as a "cash-positive" plan. With less cash in reserves on-deposit, associations with a baseline funding objective have higher instances of special assessments and/or deferred maintenance.[16]
  • "Threshold funding" describes an objective chosen by the board other than the 100% (full funding) level or just staying cash-positive (baseline funding). This may be a specific percent funded target or a cash balance target. Threshold funding is often a value chosen in between full funding and baseline funding.
  • "Statutory funding" describes the pursuit of an objective as described or required by local laws or codes.

All funding objectives are designed to meet exactly the same expenses outlined in the reserve component list. Thus the expenditures are identical, only the size of the reserve fund through the years is different. This means the size of reserve contributions between different reserve funding objectives is relatively small (typically only 10–15%).

Qualifications & Levels of Service

Reserve studies can be created by volunteer board members, their professional managers, obtained through a variety of professionals specializing in the preparation of reserve studies, or large architectural or engineering firms who complete reserve studies as a small aspect of their larger business. Recently, certification criteria have been created to allow for a more ordered system of identifying those individuals who have been specifically trained in the creation of reserve studies. One such certification, that of reserve Specialist (RS), is available through the Community Associations Institute (CAI). To obtain this certification, candidates must have prepared at least 30 reserve studies within the past 3 calendar years, hold a bachelors degree in construction management, architecture, or engineering (or something equivalent based on experience and education), and complied with various other rules and codes of conducts.[17]

Another credential is the Professional Reserve Analyst (PRA), created and promoted by the reserve study industry's own trade organization, the Association of Professional reserve Analysts (APRA).[18] The PRA was the first accrediting body for Reserve Professionals. The PRA credential is similar in that it takes years, demonstrated experience, and compliance with standardized terminology to obtain although the experience levels are a bit higher than that required for the RS and their efforts include studies both inside and outside of the CID industry. APRA also requires its PRA's to maintain proficiency with continuing education.

In Canada there are several designations and training programs. The Real Estate Institute of Canada (REIC) offers the Certified Reserve Planner (CRP) program, which is the only nationally accepted specialty designation listed in provincial legislation as qualified. Members of the Appraisal Institute of Canada (AIC) must use the methodology and standards of the REIC program if they wish to complete the report. The Canadian National Association of Real Estate Appraisers (CNAREA, based in Qualicum Beach (Vancouver Island), started to offer the Designated Reserve Planner (DRP) program to designated appraiser members since 2012. The PRFA and the DRP designations require demonstrated experience and compliance with standardized terminology and methodology to obtain. All PRFA and DRP designated planners are required to use the RFA Pro Reserve Fund Analysis software or provide a quality assurance report of their chosen calculation methods. Applied Science Technologists & Technicians of British Columbia (ASTTBC) offers the Registered Reserve Fund Analysts (RRFA) training program to Home inspectors, as home inspectors are restricted from completing Depreciation Reports / Reserve Studies in their bylaws. As of 2013, Sauder School of Business Real Estate Division is offering the first of 2 courses towards a certification called the Reserve Fund Planning Program (RFPP), but yet no trade group has recognized this designation. All CRP, DRP and PRFA reserve fund planners are required to carry $2,000,000 in E & O Insurance coverage.

There are three types of reserve studies based on standards set by the Association of Professional Reserve Analysts and Community Associations Institute, differing in how exhaustively the Physical Analysis is conducted. These three types of reserve studies allow the association to select the "Level of Service" appropriate to their current budget preparation and disclosure needs. Listed beginning with the most exhaustive, they are:

  1. "Full" reserve study (creation of the reserve study, involving creation of the component list, measuring/quantifying all reserve components, and development of the Useful Life, Remaining Useful Life, and Current Replacement Cost based on a diligent, visual on-site inspection). Note that for most associations, a "Full" reserve study only needs to be done once. After a "Full" reserve study has been done, in subsequent years the association can choose between the two reserve study update options shown below:
  2. "Update With-Site-Visit" reserve study (an update of an existing reserve study involving a diligent visual on-site inspection, but presuming that all components have been properly identified and quantified). This type of update is often performed every two to five years.
  3. "Update No-Site-Visit" reserve study (an update of an existing reserve study without a site inspection, done by client interviews and interviews with knowledgeable vendors and service providers). This type of update is typically performed in the years in-between With-Site-Visit updates.

References

  1. ^ http://www.reservestudy.com/frequently-asked-questions
  2. ^ http://www.reservestudy.com/why-percent-funded-should-matter-to-you
  3. ^ http://www.reservestudy.com/legislation
  4. ^ http://law.onecle.com/california/civil/5300.html
  5. ^ http://law.onecle.com/california/civil/5550.html
  6. ^ http://reservestudygroup.com/law
  7. ^ "Condo reserve studies". 
  8. ^ "Condo reserve studies: 2011 Regulatory Changes.". 
  9. ^ https://www.efanniemae.com/sf/guides/ssg/annltrs/pdf/.../sel1016.pdf (PDF file)
  10. ^ http://www.cmhc-schl.gc.ca/en/co/buho/
  11. ^ http://www.cmhc-schl.gc.ca/en/co/buho/
  12. ^ http://www.caionline.org/about/designations_rs.cfm
  13. ^ http://www.reservestudy.com/why-straight-line-or-cash-flow-is-the-wrong-question
  14. ^ Depreciation#Straight-line depreciation
  15. ^ http://reserveanalyst.com/Funding_Stratigies.html
  16. ^ http://www.arpc.ca/Resource_Library.html
  17. ^ http://www.caionline.org/about/designations_rs.cfm
  18. ^ http://www.apra-usa.com
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