Publications
Reserves...How Much is Too Much?
Ask yourself, when was the last time you attended an association meeting of any type? When you did go, was it because there was a money issue that was the topic of discussion? For boards of directors that concern themselves with small turnouts, the one sure way to pump up the attendance numbers is to schedule a meeting to discuss squeezing more money out of the already hard-pressed owners. Throngs of people will be sure to attend!
Unfortunately, most operating budgets are locked into the proposed numbers because of fixed expenses. Water, insurance, electricity, gas, scavenger services, etc. often have little room for cutting! Remember Isaac Newton’s first law of physics, "for every action, there is a reaction..." Cut down bulb wattage, increase liability for slip and falls; change insurance companies, have legitimate claims denied, and so on.
The one area where a Board has the greatest flexibility, however, is in the area of reserves. Most declarations written since the mid-80's and the Illinois Condominium Property Act [Section 9(2)] provide an association shall, under certain circumstances, allocate a portion of the assessments to capital reserves. The question arises as to how much is enough and who makes that determination?
The easiest approach is to retain the services of a specialist to do an analysis of the property and prepare a reserve study. The only drawback is that the study will take a hard look at all physical amenities and provide recommendations that may be too ambitious for the limited disposable income available from most owners. In these situations, the Board must remember that the reserve study is only a "tool," and an attempt should be initiated to comply. However, if it is impractical to raise assessments to the recommended level, the Board should use its best efforts to get as close as possible.
Other factors to be considered in establishing reserves are the financial impact on the owners, recent and planned special assessments, market value of the property and the ability of the Association to obtain financing.
For years, academics have debated the appropriate formulas to use for allocating reserves. There are numerous books and articles on the subject, e.g., "Reserve Study Guidelines for Community Associations, Planned Developments and Condominiums," Richard Wyndhamsmith, Windhamhouse, Inc., 1989.
There are some pundits who recommend 10% of yearly assessments or the equivalent of one month’s revenues or some other type of arbitrary formula. Since no one can accurately predict the future, only a scientific study can provide a standard. This is the "useful life study" that can be performed by an engineer or specialist in a particular area such as roofs, asphalt, aluminum siding, etc. By a physical examination, lab tests, etc., it can be reasonably predicted as to how long these amenities last. Divide cost of replacement plus inflation by the number of years, and you have an accurate measure as to how much to reserve for that item. Reserve study specialists will often include a useful life study as part of their analysis.
Regardless of who does the study, the results should be reviewed by the association’s independent accounting firm in order to set goals and objectives, both short and long term.
Whatever the standard, it is critical for an association to have money set aside for emergencies, to cover the cost of cyclical maintenance programs (i.e., painting, seal coating, etc.), and of course, long term capital projects. The idea behind this forced savings is obviously to avoid or limit the need for a special assessment or bank loans in the future.
Lastly, some potential mortgage lenders review an association’s statement of financial condition before they approve loans.
By utilizing sound business practices, in conjunction with prudent planning, an association will have "adequate" reserves and the need to borrow money or special assess becomes unnecessary.