HOA reserve study: how to read one before you buy

What a reserve study includes

California's Civil Code section 5550 offers a clear model of what a study should contain. For many associations, the board must have a reasonably competent and diligent visual inspection of the accessible areas of the major components done at least once every three years, and must review the study annually. The study must at least identify:

1. The major components the association must repair or replace that have a remaining useful life of less than 30 years.
2. The probable remaining useful life of each.
3. The estimated cost to repair or replace each.
4. The total annual contribution needed to pay for them, after subtracting current reserve funds.
5. A funding plan showing how the association will meet those costs.

Other states have different rules, and some have none. Even so, a good study in any state covers these same points.

Reading the component list

The component list is the heart of the study. For each item, look at remaining life and cost. Pay particular attention to large items due soon: roofs, elevators, siding, windows, parking structures, boilers and plumbing. A $900,000 roof due in three years means the association needs most of that money now.

Reading the funding plan

The funding plan compares what the association should contribute each year with what it actually budgets. If the study recommends $60,000 a year and the budget funds $18,000, the gap must eventually be made up by higher dues, a special assessment or a loan.

Many studies also give a percent funded figure: the current reserve balance divided by the amount that would have been saved if contributions had kept pace with wear. A higher percentage means the association is closer to where it should be. A low one means it is behind.

The lender benchmark

Lenders look at reserves too. In a full review of a condo project, Fannie Mae requires the lender to confirm that the budget provides for replacement reserves of at least 10% of the budget, by dividing the yearly reserve contribution by budgeted assessment income. A lender may instead rely on an acceptable reserve study showing adequate reserves. Fannie Mae's condo questionnaire, Form 1076, also asks whether a reserve study was completed in the past three years and about the reserve balance, special assessments and loans.

The 10% figure is a minimum for loan eligibility, not proof of good health. A building with an old roof and aging elevators may need far more.

Warning signs

• No study, or an old one. Costs and conditions change; an outdated study may understate needs.
• Big items due soon with a low balance. Expect a special assessment or loan.
• The board has not adopted the funding plan. A plan on paper does not help if dues do not follow it.
• Recent dues held flat for years while costs rose.
• Minutes discussing deferred maintenance, loans or assessments.
• Insurance problems. Shared-building insurance costs and deductibles can strain budgets. Colorado's HOA insurance toolkit is a useful guide to how master policies and owner policies fit together.

Questions for the board or manager

1. When was the last study done, and has the board adopted its funding plan?
2. Which major projects are planned in the next five years, and how will they be paid for?
3. Are any special assessments approved or under discussion?
4. Has the association borrowed money, or does it plan to?
5. How have dues changed over the last few years?

The bottom line

A reserve study lists shared components, their remaining life and cost, and how much the association should save. Read the component list for big items due soon, compare recommended and actual contributions, note the percent funded and check whether reserves meet at least Fannie Mae's 10% budget benchmark. Gaps today usually become special assessments later.