What Is a Reserve Study?

A reserve study is an in-depth evaluation of a property's physical components and an analysis of its reserve funds. Based on a thorough on-site inspection, a reserve study details anticipated replacements or repairs to common-area elements and recommends annual reserve funding to cover capital expenditures for the next 30 years.

Reserve studies give community association managers, board members and property owners assurance that future major property expenses are identified early and that a funding plan is in place to pay for those expenses.

A well-prepared reserve study can avert special assessments and supports a harmonious community.

Why Is a Reserve Study Needed?

There are 4 important reasons to conduct a reserve study.

To maintain the property's value and appearance
A reserve study helps maintain the property's value and the property owner's investment. By identifying and budgeting for future capital improvements, the property's common elements continue to look attractive and well-kept, adding to the community's overall quality of life.

To fulfill the board of directors' fiduciary responsibility
Board members of community associations have a fiduciary responsibility to their members. Directors are legally bound to use sound business judgment in guiding the association and cannot ignore major capital expenditures or eliminate them from the budget.

To establish sound financial planning and budget direction
A comprehensive reserve study lays out a schedule of major repairs or replacements to common property elements and applies cost estimates to them. To ensure property owners have adequate reserve funding to cover anticipated costs, a reserve funding plan typically spans 30 years. In short, it's your blueprint for the future.

To comply with state law
Many states now require community associations to disclose reserves, accumulate reserves or have professional reserve studies conducted. It's anticipated more states will adopt similar legislation.

What Does a Reserve Study Include?

All reserve studies include two parts:

Physical Analysis
Focuses on the common property elements and includes a component inventory, condition assessment and life and valuation estimates.
Financial Analysis
Recommends reserve fund contributions for capital expenditures over the next 30 years and includes the current fund status and suggested funding plan.

A reserve study from Valuation Consulting Group includes additional detailed information that many community association managers and board members find helpful.

Our analysts identify problems or defects, assess the remaining useful lives of elements and document problems with color photographs. We provide insight and advice on how to maintain property elements to extend their useful lives. This Enhanced Solutions and Procedures (ESP) information is something other companies don't deliver.
We use our proprietary database of contractor bids, local estimates and historical costs to establish the most accurate local repair and replacement costs.

Easy-to-Understand Reserve Studies

A reserve study from Valuation Consulting Group summarizes the key findings at the beginning of the report.

Our reports include:

Executive Summary

Quickly summarizes the main findings of your study and can be used as a board meeting handout
Identifies the number of common property elements requiring capital repair or replacement during the next 30 years
Assesses whether the current reserve funding plan will properly fund the capital expenditures for the next 30 years
Prioritizes near-term projects and capital expenditures
Recommends an adequate and reasonable reserve funding plan for replacement of all your property elements

Narrative Section

Provides a Condition Assessment of each property component by an experienced analyst, and delivers recommendations on when repairs or replacements need to be done. Color photos document conditions and problems, such as drainage issues, isolated roof defects, warped siding, etc.
Delivers Money-Saving Advice to extend the life of common property components, based on our knowledge and extensive experience. For example, Reserve Advisors recommends specific procedures to maximize the useful life of roofs, asphalt pavement, paint applications, etc
Helps With Contractor Bids. Our reserve studies include advice on what to look for when deciding whether to repair or replace an element. These recommendations also help you evaluate contractor bids. For example, contractors' proposals may not meet the minimum standards of care we refer to in our narrative report recommendations. Our illustrations of roofs or retaining wall construction can assist in obtaining and evaluating contractor proposals, which saves valuable time in meetings.

Thousands of property owners, community association managers and board members throughout the country rely on our expert recommendations, which establish a repair/replacement schedule and reserve fund budgets.

The exhibits provided include:

Table of Reserve Expenditures
Table of Recommended Reserve Funding
30-year Graph of Reserve Expenditures and Reserve Funding
Pie Chart illustrating the relative importance of each property element by anticipated future replacement costs

Supplementary Information Section

This section provides your accountant summary information of reserve expenditures and reserve funding that's needed to prepare financial statements for your association.

Definitions Section

For those unfamiliar with reserve studies, we provide a glossary to define terms commonly used in a reserve study.

How Is a Reserve Study Conducted?

A reserve study includes a physical analysis of the common property elements and a financial analysis of the reserve funding needed to cover future capital expenditures to repair or replace property elements.

Physical Analysis

The physical analysis includes a component inventory, condition assessment and life and valuation estimates.

To prepare a customized reserve study, a Valuation Consulting Group analyst conducts an information-gathering meeting at the property, with the property manager or a board member, or both. The meeting allows the analyst to secure important background on the property. It's also an opportunity for the property manager or board member to describe any problems the property is experiencing.

After the meeting, the analyst performs the property inspection to record, measure and assess the current condition of each common element. The analyst will pay special attention to problem areas.

As part of the physical analysis, the analyst takes photos to document the condition of the common elements. Based on the physical analysis of each element, the analyst estimates a remaining useful life and recommends when repairs or replacements need to be done.

Financial Analysis

Reserve Funding Methods

There are two industry-accepted methods for calculating a reserve funding plan - the Component (or straight-line) Method and the Cash Flow (or Pooling) Method. Both methods are approved by the Association of Professional Reserve Analysts and Community Associations Institute.

The component method divides the current replacement cost of each common element by the number of years before replacement (remaining life) to arrive at the necessary annual funding amount for each common element. The component method results in annual reserve budgets which vary from year to year. As such, the annual funding amount must be recalculated each year. Component method reserve funding also results in higher than necessary reserve balances.

The cash flow method pools all of the future replacement costs of the common elements and determines a funding plan that is designed to offset the collective (or pooled) future costs from the reserve fund. This method:

utilizes reserve funds more efficiently
provides a relatively stable level of reserve funding
results in realistic and more reasonable reserve contributions

How Valuation Consulting Group's Approach Benefits You

While Valuation Consulting Group is fully versed in both methods and occasionally conducts component method plans upon request, we highly recommend, and most of our clients prefer, the cash flow method. Our financial analysis determines an adequate, not excessive, reserve funding plan. The analysis compares reserve expenditures with the association's existing reserves to establish a funding plan that is reasonable.

Key elements of Valuation Consulting Group's adequate and reasonable reserve funding plan are:

Maintaining a threshold funding goal of realistic year-end reserve balances. This funding goal, which sets a minimum threshold or dollar amount, is determined by the engineer to ensure your reserve fund will always have a positive balance, even in years with significant capital projects.
Applying interest earned on the reserve fund
Using local costs for materials and labor
Applying inflation to future cost estimates

Applying a threshold funding goal to existing reserves, local construction costs, future inflated replacement costs and interest earnings produces the most accurate reserve funding plan.

Reserve Study Definitions

A reserve study contains a number of industry-related terms and phrases. To help you better understand the reserve study process and reports, we've provided definitions for the most commonly used terms.

Cash Flow Method - A method of developing a reserve funding plan where contributions to the reserve fund are designed to offset the variable annual expenditures from the reserve fund. Different reserve funding plans are tested against the anticipated schedule of reserve expenses until the desired funding goal is achieved.

Component - The individual line items in the reserve study developed or updated in the physical analysis. These elements form the building blocks for the reserve study. Components typically are: 1) association responsibility 2) with limited useful life expectancies 3) predictable remaining useful life expectancies 4) above a minimum threshold cost 5) as required by local codes.

Component Assessment and Valuation - The task of estimating useful life, remaining useful life, and repair or replacement costs for the reserve components. This task is accomplished either with or without on-site visual observations, based on the level of service selected by the client.

Component Inventory - The task of selecting and quantifying reserve components. This task can be accomplished through on-site visual observations, review of association design and organizational documents, review of established association precedents and discussion with appropriate association representative(s) of the association or cooperative.

Component Method - A method of developing a reserve funding plan where the total contribution is based on the sum of contributions for individual components. See "cash flow method. "

Condition Assessment - The task of evaluating the current condition of the component based on observed or reported characteristics.

Current Replacement Cost - See "replacement cost. "

Deficit - An actual (or projected) reserve balance less than the fully funded balance. The opposite would be a surplus.

Effective Age - The difference between useful life and remaining useful life. Not always equivalent to chronological age, since some components age irregularly. Used primarily in computations.

Field Inspection - A site visit which includes a visual inspection of all components. In cases where plans of the property are unavailable, it would also include the quantity survey.

Financial Analysis - The portion of a reserve study where current status of the reserves (measured as cash or percent funded) and a recommended reserve contribution rate (reserve funding plan) are derived and the projected reserve income and expense over time is presented. The financial analysis is one of the two parts of a reserve study.

Fully Funded - 100% funded. When the actual (or projected) reserve balance is equal to the fully funded balance.

Fully Funded Balance (FBB) - Total accrued depreciation. An indicator against which actual (or projected) reserve balance can be compared. The reserve balance that is in direct proportion to the fraction of life "used up" of the current repair or replacement cost. This number is calculated for each component and summed together for an association total. Two formulae can be utilized, depending on the provider's sensitivity to interest and inflation effects. Note: both yield identical results when interest and inflation are equivalent.
FFB = Current Cost X Effective Age / Useful Life
or
FFB = (Current Cost X Effective Age / Useful Life) + [(Current Cost X Effective Age /Useful Life) / (1 + Interest Rate) ^ Remaining Life] - [(Current Cost X Effective Age /Useful Life) / (1 + Inflation Rate) ^ Remaining Life]

Fund Status - The status of the reserve fund as compared to an established benchmark such as percent funding.

Funding Goals - Independent of methodology utilized, the following represent the basic categories of funding plan goals:

Baseline Funding - Establishing a reserve funding goal of keeping the reserve cash balance above zero.

Full Funding - Setting a reserve funding goal of attaining and maintaining reserves at or near 100% funded.

Statutory Funding - Establishing a reserve funding goal of setting aside the specific minimum amount of reserves required by local statues.

Threshold Funding - Establishing a reserve funding goal of keeping the reserve balance above a specified dollar or percent funded amount. Depending on the threshold, this may be more or less conservative than "fully funding. "

Funding Plan - An association's plan to provide income to a reserve fund to offset anticipated expenditures from that fund.

Funding Principles:

Sufficient Funds When Required
Stable Contribution Rate over the Years
Evenly Distributed Contributions over the Years
Fiscally Responsible

Life and Valuation Estimates - The task of estimating useful life, remaining useful life, and repair or replacement costs for the reserve components.

Percent Funded - The ratio, at a particular point of time (typically the beginning of the fiscal year), of the actual (or projected) reserve balance to the fully funded balance, expressed as a percentage.

Physical Analysis - The portion of the reserve study where the component inventory, condition assessment, and life and valuation estimate tasks are performed. This represents one of the two parts of the reserve study.

Remaining Useful Life (RUL) - Also referred to as "remaining life" (RL). The estimated time, in years, that a reserve component can be expected to continue to serve its intended function. Projects anticipated to occur in the initial year have "zero" remaining useful life.

Replacement Cost - The cost of replacing, repairing, or restoring a reserve component to its original functional condition. The current replacement cost would be the cost to replace, repair, or restore the component during that particular year.

Reserve Balance - Actual or projected funds as of a particular point in time that the association has identified for use to defray the future repair or replacement of those major components which the association is obligated to maintain. Also known as reserves, reserve accounts, cash reserves. Based upon information provided and not audited.

Reserve Study Provider - An individual that prepares reserve studies

Reserve Study - A budget planning tool which identifies the current status of the reserve fund and a stable and equitable funding plan to offset the anticipated future major common area expenditures. The reserve study consists of two parts: the physical analysis and the financial analysis.

Responsible Charge - A reserve specialist in responsible charge of a reserve study shall render regular and effective supervision to those individuals performing services which directly and materially affect the quality and competence rendered by the reserve specialist. A reserve specialist shall maintain such records as are reasonably necessary to establish that the reserve specialist exercised regular and effective supervision of a reserve study of which he was in responsible charge. A reserve specialist engaged in any of the following acts or practices shall be deemed not to have rendered the regular and effective supervision required herein:

The regular and continuous absence from principal office premises from which professional services are rendered; expect for performance of field work or presence in a field office maintained exclusively for a specific project;
The failure to personally inspect or review the work of subordinates where necessary and appropriate;
The rendering of a limited, cursory or perfunctory review of plans or projects in lieu of an appropriate detailed review;
The failure to personally be available on a reasonable basis or with adequate advance notice for consultation and inspection where circumstances require personal availability.

Special Assessment - An assessment levied on the members of an association in addition to regular assessments. Special assessments are often regulated by governing documents or local statutes.

Surplus - An actual (or projected) reserve balance greater than the fully funded balance. See "deficit. "

Useful Life (UL) - Total useful life or depreciable life. The estimated time, in years, that a reserve component can be expected to serve its intended function if properly constructed in its present application or installation.