2020 and Beyond: Mandatory Reserve Funding…Really?

If you have been following the HOA Detective blog for any length of time then you know that yours truly talks a lot about the importance of reserve planning and funding for homeowners associations. To quickly recap, the position of the HOA Detective is that reserve planning and funding of a reserve account is the single most important responsibility of the board of directors of a homeowner association. The reserve study itself is a road map for maintaining a financially and physically sound HOA over the long term; while the reserve fund is the vehicle that delivers the HOA to its destination.

We have opined on more than one occasion about the importance of having a reserve study prepared by someone who is truly an impartial and objective third-party. Someone with no vested interest in the HOA that is their client. Someone who does not stand to benefit  from the outcome of the reserve funding analysis. Someone who does not derive income from its reserve study clients for services other than those related to preparing the reserve study.

The importance of this “impartial and objective” test was brought to the forefront this past week when the CRC REPORT® team examined a high-rise condominium association on behalf of  a prospective buyer.  The examination resulted in not one but two separate reserve studies being provided by the HOA that was the subject of the examination.

The two studies had been prepared by different providers in 2015 and 2016. Both studies were an analysis that projected the Association’s reserve spending requirements for a thirty year period into the future. The thirty year period covered by the earlier study began on January 1, 2016 while the second study included a projection of expenditures that began on January 1, 2017.

The thirty year projection is commonplace within the industry and while it may seem like an exercise in futility to try and project the repair and replacement expenditures for a complex high-rise building thirty years into the future, there are valid reasons for doing so and in most states that require HOAs to conduct a reserve study the thirty year period of analysis is required by statute.

At any rate, the similarities between these two studies were that the period covered by the analysis was within one year of being the same thirty year period and the facility that was the subject of the analysis was virtually the exact same building at the time both reserve study providers conducted their onsite evaluation.

The purpose of the onsite evaluation is to assess the physical condition of the facility and establish the inventory of assets and improvements that would need to be renovated or replaced using reserve funds that would be generated by requiring the owners to contribute to the reserve account each year for the next thirty years.

The one other similarity worth noting is that both studies were prepared by engineering consultants who profess to be highly qualified experts when it comes to evaluating facilities and determining what the appropriate course of action should be for maintaining facilities such as the one that was being evaluated in this instance.

As far as similarities between the two studies, that’s about where it ends, which is the point of this post. Whereas the esteemed expert who prepared the 2015 reserve study concluded that the total reserve spending required to maintain the facility over the thirty year period covered by the analysis would be on the order of $4.5 million, “expert” number 2 concluded only one year later that the expenditures needed to properly maintain the facility for a similar period of time would be more like $12 million!

At this point it should be noted that the  total number of condominium units in the  building is 112 which means the average per unit reserve expenditures over the next thirty years are going to be $40,000 or $107,000, depending on which analysis you choose to believe.

The significance of this situation is two-fold. First of all it raises the question of whether either analysis is credible given the wide disparity in total spending that the two studies conclude will be needed to maintain the facility over roughly the same period of time.

The second issue, which will be critical if mandatory reserve funding by HOAs ever does become a reality, is how are we going to decide who is qualified to conduct reserve studies for homeowners associations and what kind of analytical standards are going to be applied to the process of evaluating a facility and determining what the appropriate level of reserve funding should be?

Since the Community Associations Institute has gone on the record as stating that perhaps the time has come to consider mandatory reserve studies and funding for homeowners associations Community Next: Mandatory Reserve Funding and Beyond… it raises the obvious question of whether reserve study practitioners are going to be held to a standard of professional competence and integrity that places the interests of their clients above those of the firm conducting the reserve study.

The issue is brought fully into focus by comparing the two reserve studies discussed in this article. Whereas the first reserve study concluded that $4.5 million was needed to pay for major repair and replacement expenditures related to the common elements within the condominium, the second and more recent study concluded that the sum was no less than three times that amount!

After peeling away the layers of the onion in an effort to understand why two otherwise similar reports would reach such drastically different conclusions, we see that reserve study number 2 includes a recurring schedule of inspections, assessments, evaluations and “monitoring” events that are included in the list of expenditures that are to be paid for with the funds in the reserve account. Services which just so happen to be provided by the company that prepared the reserve study.

In short, this list of “recommended services” results in nothing less than one or more annual visits to the property to inspect, assess, evaluate or monitor one building system or another, all of which are conveniently designed to generate a recurring revenue stream for the firm that prepared the reserve study. Over the course of thirty years these services amount to many hundreds of thousands of dollars not including the additional millions in spending that the study suggests will be needed to maintain all of these components each time they are inspected, assessed, evaluated or monitored.

Aside from the fact that these are not capital expenditures and therefore it could be argued that they should not be paid for with reserve funds, there is a bigger issue that is raised by suggesting that funding the reserves according to the recommendations of the reserve study provider should be mandatory.

That issue is, will the industry take the ethical high road by setting a standard of professional conduct that requires reserve study providers to limit involvement with their clients so that the provider does not benefit financially from the recommendations made in the reserve study? Anything less is a mockery of professional ethics and the credibility of those who are suggesting that reserve studies and reserve funding should be made mandatory for all homeowners associations.