Reserve Studies - Made To Order or Made for Disclosure?

condo disclosure

Over the years I have learned there are two types of Clients that commonly come to us for our reserve study expertise. Those that would like us to complete a “made to order” reserve study – where the component list and costs are determined by them either before the study is completed or after an initial draft is submitted and those that have a hands off approach and just ask us to do a comprehensive reserve study that includes all common area component projects and their associated costs. Now before I begin, I want to make it very clear we only do one type of reserve study here at Reserve Data Analyst and that is for full disclosure, we strive to have comprehensive and reliable component lists, cost figures and useful lives for common area projects. Making sure our Clients are aware of the true costs that need budgeting for is our top priority; bringing into the light the true long-term project costs the community can expect to encounter. 

Most of the Clients who are seeking a reserve study are already 15+ years old and have had Boards making budgeting decisions for many years at this point. It’s not uncommon for there to already be some sort of component list with project costs and even projections into the future. So, with a Board, a list of components and a timeline of project expenses why are most reserve accounts in such a dire financial position? Well to put it simply it’s because most of them have an incomplete component list (site and building repair/replacement projects), poorly researched cost figures and inaccurate useful life expectations (e.g. composition shingle roof lasting 50 years is a common mistake). Typically whoever compiled and kept up these databases of components and costs was not able to put in the time and effort needed to make sure it was accurate and/or as they get passed down to new Boards over the years they are not accurately updated to reflect the current scenario in the community. This can often go on for years or decades before the true financial position of the reserve account comes to light – often during a time of Peak Expense Years (Link: About Peak Expense Years) when infrequent but very costly projects “surprise” the Client.

Why Would a Board/Community Request A “Made to Order” Reserve Studies?

This is a great question which has many answers. Some include:

Budgeting Mistakes May Have Been Made

Often a Board has created and relayed the message that a budget is adequate for many years in a row. Nobody likes to make mistakes and often a reserve study will indicate a very low reserve account balance and a low reserve allocation rate (i.e. past Boards made inaccurate projections). Often Board members may have overstepped their experience level and given advice which is not accurate or typical of the industry. Examples include confusing installation cost with replacement cost and not considering compounding inflation of project costs over time.

To Have A More Palatable Document/Budget to Vote On
Even when the Board does have a goal of raising dues, they often do not want to shock others into thinking the they are on the brink of running out of money (even when many are). Essentially, they want something more palatable to view and discuss and this often means asking for components to be removed, useful lives to be extended or cost figures adjusted in the reserve study. When making these types of revisions to the reserve study the numbers often will look better than what the Reserve Analyst originally submitted in their Draft. The Board is usually pleased with this type of outcome as it makes everything “appear” better and they can then relay these more pleasant numbers to the community members.  

Marketability to Buyers & Lenders

Board and community membership also want the financials of the reserve account to appear healthier than they really are so Buyers and Lenders have a positive view of the financial situation with respects to the reserve account. We are regularly asked to remove or un-fund a large component expense so a community’s percent funded figure will increase to a level that falls within Statutory Requirements or Lender’s approval guidelines; now do we do this? Absolutely not, this would go exactly against our philosophy of being open, honest and forthcoming in our reserve studies. As Professionals Reserve Analysts’ our independence is perhaps our greatest strengths, we present realistic studies so all readers of the reserve study can have an accurate portrait of the true financial health of the reserve account. This may very well have negative impacts for the community, but we are bound by ethical guidelines (PRA & RS Designations) as well as some statutory requirements regarding what must be included in a reserve study.  

Unwarranted, unrealistic and inaccurate revisions will typically just make matters worse by installing a false sense of financial stability in the community and there will be a continued trend of underfunding the reserve account. It is important to remember that the project costs will occur whether the Board acknowledges them or not – their exclusion from a reserve study simply makes things looks better on paper. When the project costs come due and an invoice is waiting to get paid, the Client must pay it with real money and not past year’s wishful thinking.

Case for “Made for Disclosure” Reserve Studies

As I previously noted a Reserve Analyst is often the bearer of bad news with suggestions or recommendations to increase the reserve allocation rate to a much higher level than may be realistic at that point in time; underfunded reserve accounts are typically the results of years or decades of severely underfunding reserve accounts no there is no easy fix. The whole goal of the reserve study is to provide a realistic document outlying the predictable projects costs the Client will encounter in its future. Reasons for a realistic and comprehensive reserve study include:

Knowing is Half the Battle
With an inaccurate component list or cost that are not in line with industry averages how is a Board and Community supposed to make the appropriate budgeting decisions? Well they can’t and Don’t … A lack of understanding the true long-term costs in the community is why most of the reserve accounts we come across are in a low funded range. Unfair special assessments for expected common area projects have becoming common and are the direct result of Board and Communities not having accurate numbers to base their budgeting decisions on. Over the years we have found that communities will typically make more appropriate decisions related to reserve account budget when the Community Members, Buyers and Lenders are aware of the actual position the reserve account is in.

When a comprehensive list of projects is available multiple bids can be obtained, usually well in advance of the project needing completion. Savings of tens or evens hundreds of thousands is common when bids are obtained well in advance and a “pick of the little” is possible with respect to Vendors.

Surprises Are Minimized
Even though a community may not be able to fund what is being recommended in the reserve study they will at least have an accurate measure of financial health of the reserve account (Percent Funded) and will not at all be surprised if they find themselves in a position of having to secure emergency financing (e.g. loans, special assessments). Project expenses and/or special assessments will not be surprises but will instead be an expected outcome of continuing to underfund the reserve account. Additionally, Buyers coming into the community will be aware of the financial health of the reserve account and associated risk with purchasing a unit in the project.

Disclosure Requirements
States like Washington, Hawaii, Oregon, Nevada and California have passed laws related to Board disclosure requirements to the community membership as well as potential Buyers in the community. An accurate reserve study, component list and related items are needed to have accurate numbers to disclose to the community, potential Buyers, Lenders, Insurers, etc. By falsifying the component list through exclusion of components, inaccurate cost figures or unrealistic useful life expectancy the disclosures will not be accurate per state law – liability & litigation concerns all around on this one.

Property Values & Marketability Protected
A Board and Community which has a reliable reserve study to base budgeting decisions on will typically make better decisions in their future. They will have a desire to retain or increase the marketability in the community and protect their property values. Some decisions may be very tough and include significant increases in the reserve allocation rate or special assessments, but they can accurately make these decisions when a reserve study is comprehensive and has reliable figures to base them on.

Deception, glossing over or keeping secrets should have no place in a common interest community financials; let’s keep them out of reserve studies as well.