In the reserve study the Reserve Analyst’ recommendations for the allocation rates of the different funding models apply only to the year the reserve study is being developed for. All projections in the study are future educated guesses with assumptions about a significant number of variables (e.g., inflation rate, financials, component useful life, component remaining useful life, maintenance protocols of components).
Projections can be accurate or extremely inaccurate based on these assumptions; because of this we do not suggest giving much consideration to projections in the decision making for overall reserve budgeting. This may sound counterintuitive, but this is due to recommendations for the allocation rates, in the initial year of the study, being based on predominantly current known factors (e.g., current costs, current inflation, current maintenance practices) versus projections which are based on future assumptions to a variety of variables (e.g., future costs, future inflation rates, and future maintenance practices).
The Reserve Analyst Recommendations – Based on Known Current and Historical Factors
When a reserve study is completed the first and most important step is to develop the component list. This is done by completing a site inspection and taking an inventory of the Association maintained components (component: those items that are the responsibility of the Association). After we know what components are the responsibility of the Association, we then need some more information about the history of them (e.g., when installed, is maintenance done, historical replacement cycles etc.).
After this process is completed the Reserve Analyst will develop funding models and give recommendations for allocation rates for these models (each will have a different goal in mind) and provide a Current Percent Funded figure which is a barometer of the health/adequacy of the reserve account as of a specific date. The formula we use for the Current Percent Funded calculation is:
Current Cost X Current Age / Useful Life
The Current Cost is well supported as we are constantly reviewing invoices/bids/estimates and have a whole host of different sources to cross reference costs on (e.g., cost manuals, website data, cost services).
Current Age is well supported as we typically are provided with or discover the last installation date of components in the reserve study. This typically is done through asking questions of the Client, county/city records searches, permit searches, dated aerial photo searches, manufactures label dates, serial number cross references. etc.
Useful life of component is an average based on Vendor recommendations, our experiences and research for the specific component for the region. This aspect of the formula can be less accurate as there can be variety of factors that can and do impact the service life of a component. Examples of these can include poor installation by the Vendor, high/low use, adequate/inadequate maintenance practices, etc. It has been our experience that relying first on the Client’s Vendor recommendations and then on averages for the useful life for most components is completely adequate for budgeting purposes; we do not have to be exact as some components will last longer and others will last longer than the predicted useful life of the component. Because the recommendations are predominately based on known factors the current recommendations are much more accurate that the projections in the study. This is also why it is important to update the reserve study annually (most states with reserve study laws require annual updates).
Next year’s update to the reserve study will have items adjusted to known factors and variables at that time and the corresponding recommendations for the funding models will adjusted to reflect these historically known factors at that point in time. An example f this would be the inflation rate in the reserve study. When an update is completed, we revise the cost of the component to what we are seeing in the market (e.g., in recent years lumber prices jumped up over 300% within a two-year period which in turn resulted significant increases to projects cost like wood siding and wood fencing). The increased project costs will correspondingly require updated recommendations for the allocation rates and result in an updated Current Percent Funded calculation.
The reserve study is neither set in stone or a static document and relying on an old one is not something we suggest as that would mean all the projections (i.e., assumptions) in the prior study have occurred exactly as projected.
cost data for component projects is the foundation on which the remainder of the reserve study is based as all funding models are directly impacted by the current estimate and projected costs for repair / replacement of the different site and building component projects in the reserve study. Inaccurate data during the component analysis portion of the reserve study will likely lead to inaccurate recommendations for the different funding models that are developed.
Future Projections – Based on Future Estimates (Averages and Assumptions)
Future projections are included in a reserve study to help visualize the projected outcome of the allocation rates and decisions that may be made with respect to reserve budgeting. The assumptions and variables for projections in the reserve study are numerous and the further out in time a reader looks the more likely they are to be inaccurate.
Many of the variables have a compounding affect based on the previous years in the projections (e.g., inflation is calculated annually and has a compounding impact , so several years of higher inflation that what was originally projected can result in a significant higher project cost sooner than originally projected – cost double every 23-24 years at a 3% inflation rate but double at only 11-12 years at a 6% inflation rate). Even a few years with a much higher than historical average inflation rate can and does have a dramatic impact on the projects costs and required allocation rates of the funding models. This is one of the main reasons that reserve studies should be updated frequently.
It has been our experience that focusing on what we know now and trying to make the necessary revisions to the funding of the reserve account now is the best option for Clients that really want to positively impact the reserve account adequacy over time. This is a "baby step" in the right direction approach, but we have found that many baby steps in the right direction eventually leads to a giant leap later. Just as the impact of compounding inflation has on project cost may impact the reserve account negatively, baby steps made for a more adequate reserve allocation rate can have a compounding impact that affects the reserve account in a significantly positive way.