Q & A - Underfunded Reserves
Question: Our Association has underfunded reserves. What is the best remedy to become adequately funded?
Answer: The Directors of a Common Interest Development (CID), as officers of a corporation, are governed by civil and corporation Codes. They must act and make decisions on behalf of the entire Community or membership, including future members. The Board must give special consideration to the severity of the underfunding and whether or not repairs or replacements will be deferred. Prospective sources for loans need research and the Board must establish policy or priority for adequate funding. The standard alternatives are:
DO NOTHING: Doing nothing benefits current members, but it penalizes future members. Quoting from the California Department of Real Estate's Common Interest Development Brochure:
"Failure of the Association to adopt a 'pay-as-you-go' plan for the future can create an environment of declining property values due to the increasing deferred maintenance. This in turn, can have a serious negative impact on sellers in the project. By contrast, a well-funded reserve goes a long way toward maintaining property values within a CID. Not only does it help eliminate the need for special assessments, but it spreads the costs of predictable repairs and replacements over time. Healthy reserve do away with the inequitable concentration of costs for anticipated major repairs and replacements on the owners in the project at the time the repair or replacement is required."
SPECIAL ASSESSMENT: This option penalizes current members and benefits future ones. Mr. Houston C. Kier's article "HOA Dilemma - Special Assessment or a Loan?" makes these points:
"The CC&R's require a vote of the members for special assessments, either a simple majority vote or often times it may require a two-thirds affirmative vote (or even higher). In either case the results can cause a financial hardship on the individual owners, and more importantly, the Board can be criticized for not having taken the necessary action to provide for proper funding of 'reserves'. In reality the past and future owners have either had an economic advantage or an economic disadvantage to share the costs of repairs that should have been provided for by adequate funding of reserves."
DISTRIBUTION: The Board's requirement to act on behalf of the entire Community and the burden of special assessments have led to the requirement to perform a reserve study. Most professional reserve programs use some form of cash flow analysis to assist the Board. By arranging the reserve components in ascending remaining life order and then assigning their respective ideal level of reserves until funds are depleted is a distribution method that allows the longest make-up period for underfunding. This is the most equitable and least penalizing way of becoming adequately funded.
LOANS: Loans are a possible solution for those Associations lacking funds to perform current needed repairs or replacements. The problem here is that an Association with severe underfunding may not be able to obtain a loan.
Notes: California
law requires all associations to perform reserve studies. However,
many questions are left un-answered such as what to reserve for
and how much? Board members and managers often have questions
in this developing area of community association practice.