Reserve Studies: The Importance of Objectivity

Why is it important that the reserve study be prepared by an impartial, third-party provider?

This is a question that many reserve study providers would just as soon not have to answer. It is also one that the industry itself has chosen to address in only a passing manner by requiring that the reserve study provider include a disclosure in the reserve study stating that the provider does not have any relationship with the reserve study client that would result in a conflict of interest with the client.

And there you have it! The reserve study provider declares that there is no conflict of interest between the provider and their client and it’s case closed!

Why you ask, is any of this important? A fair question no doubt and one we will try to answer in this post.

The importance of an independent and objective reserve study provider is critical if the analysis is going to result in an honest assessment of the reserve funding obligations of the homeowners association for which the reserve study is being  prepared. In the case of vendors who generate revenue by providing other services to the HOA, the question arises as to whether the vendor is able to provide a truly objective assessment of what the reserve funding needs of the HOA are, if in fact it means the Board of Directors will have to raise the dues in order to fund the reserves at the level recommended by the reserve study provider.

When you consider that most HOAs under-fund their reserves in an effort to keep the assessments as low as possible, the issue becomes even more significant. If the vendor who prepares the reserve study has an  ongoing relationship with the HOA that results in a recurring revenue stream from services other than those of a reserve study provider then there is always the possibility that the vendor will not want to rock the boat by recommending that the reserve contributions be increased in those instances where an increase is warranted.

In the study of ethics the possibility of a conflict is referred to as a potential or apparent conflict of interest. An apparent conflict of interest exists when the circumstances of a business relationship are such that there is the potential for a conflict to exist that might result in harm to the client; which in this case means the homeowners association.

In the case of a vendor who provides services to an HOA client, other than those of a reserve study provider, there is always going to be a potential for a conflict of interest to occur. The fact that the vendor may state in the reserve study disclosure that there is no conflict, really doesn’t matter because the potential for a conflict of interest exists regardless of whether an actual conflict occurs.

An apparent conflict is similar in some respects to a potential conflict. An apparent conflict exists when the circumstances of the relationship are such that it might appear to an independent observer that the relationship between two parties is one that might present a conflict of interest.

When considering the ethical implications of a business relationship both apparent and potential conflicts are considered to be equally as improper as an actual conflict of interest. An actual conflict of interest exists when the relationship between the parties does in fact result in behavior that is detrimental to the client. In the case of a reserve study provider whose relationship with a client is ethically challenged the question is, why does it matter? The answer is that it matters for a number of reasons related to the ethical conduct of the professional.

If the reserve study provider is in a position to generate additional revenues for their firm, based on the reserve fund expenditures that are recommended in the study, then there exists a clear and incontrovertible conflict of interest. In this instance the reserve study provider is potentially setting the stage for “unjust enrichment” as a result of the recommendations they are making for how their client should spend its reserve funds.

Unfortunately this situation is all too common when the reserve study provider is a technical consultant such as an architectural or engineering firm or a construction/project management company that includes in the schedule of reserve fund expenditures various services that are provided by the very vendor who is preparing the reserve study.

In the most extreme example of this situation that the HOA Detective has ever seen, one local engineering firm (that also offers reserve study services to its clients) had designed a reserve funding schedule for one of its clients that resulted in a recurring revenue stream of more than $15,000 a year for the first eight years of the thirty year period covered by the study and more than $500,000 of recurring revenue over the thirty year period covered by the reserve study….Nice work if you can get it, but clearly a conflict of interest.

This revenue stream was the direct result of a reserve funding “analysis” which included the recommendation that the HOA should engage the company that prepared the reserve study to provide ongoing project management and inspection services over a period of years while a relatively simple repair project was completed.

From an ethical perspective a consultant is bound by certain commitments to the clients that they serve. These obligations are typically embodied in a code of conduct or professional code that the consultant is obligated to abide by when working with clients. Among the ethical standards of most professional disciplines is the obligation to place the best interest of the client above those of the professional.

This means that the professional is supposed to have the ethical integrity to decline the opportunity to enhance their personal fortunes at the expense of their clients, in those situations where the clients best interests may not be best served by the enrichment of the professional. The inability to muster up the ethical fortitude to act in the best interest of the client violates the duty of client loyalty.

The need for an objective and impartial funding analysis will become even more important if the Community Associations Institute’s Community Next: 2020 and Beyond agenda ever becomes a reality, as it would result in all HOAs being required to conduct a reserve study and to fund the reserves at the level recommended by the provider. Community Next: 2020 and Beyond

If this mandate ever becomes law (which clearly appears to be the goal of the CAI) it means the reserve contributions that HOA members pay will become a defacto tax. Since they are incorporated into your HOA dues you run the risk of losing your home if you do not pay this “tax.” If the reserve study provider is allowed to enhance their future revenue stream with some of the money you are required to pay into the reserve account it is all but certain to raise questions about the integrity of the reserve planning process and the code of conduct for reserve study providers, which is clearly lacking at the present time.