Reserve Study Requirements for Florida Condominium, Townhome, and Homeowners’ Associations

Glenn Tyndall, CPA

Glenn Tyndall, CPA

glenn@tyndallcpa.com

Tel: (904)568-2839

The reserve study give those overseeing the maintenance of condominium, townhome, or homeowners’ associations a better idea of what major expenditures to expect and an estimate of when these expenditures will occur. Associations use the reserve study reports to get the amount to charge each owner for their share of the reserves savings. The reserve study is also used to accurately disclose the status of the Reserve Fund to owners in the association's annual financial statements.

Reserve Study Report

The reserve study report is issued from a reserve study. This report will include:

  1. A listing of the major assets of the association funded through reserves, their expected useful life, remaining useful life, and current replacement cost.
  2. An evaluation Reserve Fund's current financial strength (usually expressed as percent funded).
  3. A recommended multi-year Reserve Funding Plan.

Each reserve analyst may present the reserve study report in a slightly different format. However, the information contained in the reports will generally be the same.

What components are included in the reserve study?

The reserve study will include common elements, such as roofing, painting, paving, and fencing. Only components for which the condo association or HOA has maintenance responsibility are included in the reserve study. The condominium, townhome, or homeowners’ association’s governing documents provides guidance on this determination. Florida Statutes governing condominium and homeowners’ associations have specific requirements for each type of community association.

Does our association need to have a reserve study?

State law governs when and how often an association must have a reserve study performed. Chapter 718 of the Florida Statutes governs condominium associations and Chapter 720 governs homeowners’ associations. In short, Florida law generally requires condominium associations to have a reserve study performed once every three years. HOAs perform reserve studies only as their governing documents require.

Condominium Association Reserve Study Requirements: Florida Law

Florida Statute 718.112(f) [2] requires condominium associations to fund a reserve account for certain capital expenditures and deferred maintenance. The statute requires all condominium associations to maintain reserves for roof replacement, building painting, pavement resurfacing and any other expenditure which is expected to exceed $10,000.

The statute doesn't state that a reserve study be conducted to determine the level of funding required. However, the statute does require that the reserve contribution be computed using a formula which is based upon the estimated remaining useful life and the estimated replacement cost or deferred maintenance expenditure for the component. Florida Statute 718.112(f) [3] regulates the use of money collected for reserves, limiting the use of such funds to authorized reserve fund expenditures. A vote is required if reserve funds are used in operations.

Inspection by a licensed architect or engineer is required for condominium associations containing buildings over 3 stories once every 5 years. The architect or engineer must issue a report, under seal, attesting to the required maintenance, useful life, and replacement costs of the common elements.An association may wave the inspection requirement by majority vote. Any such waiver must occur before the end of the 5-year period and is only good for the 5-year period in question.

Homeowners’ Association Reserve Study Requirements: Florida Law

Florida Statues are much simpler for an HOA. First, reserve funds are not required unless the homeowners' association's governing documents call for the study. The law does not prohibit including reserves in the proposed budget for the homeowners’ association. Likewise, the proposed operating budget need not follow any specific statutory formula, but should include the anticipated expenditures for the year.

Types of Reserve Studies

Full Reserve Study is the most comprehensive type of reserve study. The reserve analyst will complete a site inspection to get measurements and counts of common elements, including assessing the condition of common elements and taking a photo inventory of most components. The results are then compiled in the reserve study.

Update of Reserve Study with Site Inspection is performed after a Full Reserve Study. This type of reserve study is less comprehensive than a Full Reserve Study in that the reserve analyst verify measurements and counts unless there have been changes to common elements. The reserve analyst will make limited evaluations of conditions and will update the photo inventory only when necessary. The results are then compiled and reserve study report is issued.

Update of Reserve Study without Site Inspection is generally accomplished through inquiry only. The reserve analyst will ask the association about expenditures made, changes in pricing of replacement costs, and variations in funding from the original plan. No site inspection’s performed.

Reserve Study vs. Engineering Study: The Differences

Even with a Full Reserve Study, a site inspection is a limited visual inspection of the association’s common elements. The reserve analyst will only inspect the items; the analyst generally will not do any interfacing or destructive testing. The purpose for the site inspection is to generate information to support the funding plan of the reserve study report.

A condominium, townhome, or homeowners’ association that requires more detailed testing should consider having an engineering study. Unlike a reserve study, an engineering study's are designed to determine the structural integrity of common elements. Engineering studies are usually performed in older associations or in newer associations when there are questions about the structural integrity.

Funding Reserves: Methods and Objectives

The association will need to fund the reserves in a way that meets the risk tolerance of the community. In National Reserve Study Standards terminology, there are “Funding Methods” and “Funding Objectives.”

Funding Methods:

1. Straight-Line (Component) Funding Method.

The reserve schedule accompanying the proposed budget has traditionally used the straight line method of calculating the reserves. The straight-line method provides for the independent funding of each common element. That is, the reserves for each type of component (roof, paving, etc.) are calculated separately and funded independently of other components.

Example of Straight-Line Method. Assume that the roof on a condominium building has a 20-year useful life, is 10 years old, and will cost $50,000 to replace. If the condominium association has $25,000 in roof reserves, the association will need to collect $2,500 per year for the next 10 years to accumulate another $25,000 to “fully fund” the roof reserve. This calculation is then made for all other required reserve items (buildings, painting, repaving, and so on). This is traditional, straight-line funding of reserves.

2. Pooled (Cash Flow) Funding Method.

The cash flow method determines reserve allocation by projecting reserve allocations and disbursements over a timeframe of 30 years and testing different allocations until a minimum allocation is found that maintains a Percent Funded or Net Reserve Balance amount above a specified funding objective, such as Full Funding or Baseline funding (see “Funding Objectives” section for detailed discussion of ways associations can fund reserves). The main difference in the pooled presentation of reserves is that instead of each reserve line item having its own fund balance, there is a “pool” of money in the reserve fund. Funds in the pooled reserve are available for costs affiliated with any item in the reserve pool. For example, the painting and roof reserve monies are “pooled” into one fund. Unlike the straight-line method, there’s only one reserve fund. Therefore, unit owners don’t need to vote when monies from one reserve account would be used for another reserve purpose.

Under pooled reserves, it’s still necessary for the reserve schedule which accompanies the annual budget to set forth required reserve items (roofs, painting, paving, and other items with the replacement cost/deferred maintenance expenditure of more than $10,000.00). Further, the pooled reserve schedule must still disclose estimated remaining useful life and replacement costs for each reserve component.

Straight-Line vs. Pooled Method: A Brief Discussion

The straight-line method is more conservative than the pooled method in that it’ll result in more money being put away into reserves. The pooled method is easier to administrate because money in the pool can be used for any reserve item, whereas the straight-line method is much more restrictive.

As mentioned, the law provides that reserves funds can only be used for their designated purpose when using the straight-line funding method. Painting reserves can only be used for painting expenditures, and money cannot be taken from the painting reserves to pay for roofing expenditures.

The association can use reserve funds for non-scheduled purposes if approved in advance by a majority vote of the unit owners. A vote waiving or changing the reserve funding and a vote using reserves for non-scheduled purposes are two separate votes. The pooled method only needs a vote when using reserve funds to fund operations.

A community’s risk tolerance dictates the use of the straight-line or cash method of calculating reserves.

Funding Objectives:

1. Full Funding.

Full Funding describes the objective to have Reserves on-hand equal to 100% of the value of each reserve elements deterioration. This is the most conservative approach to funding reserves.

2. Baseline Funding.

Baseline Funding describes the objective to have sufficient Reserves on hand to never completely run out of money. This is sometimes described as a "cash-positive" plan. With less cash in Reserves on-deposit, associations with a Baseline Funding objective have higher instances of special assessments and/or deferred maintenance.

3. Threshold Funding.

Threshold funding describes an objective chosen by the Board other than the 100% (Full Funding) level or just staying cash-positive (Baseline Funding). A specific Percent Funded target or a cash balance target is generally used by the association. Threshold Funding is often a value chosen in-between Full Funding and Baseline Funding.

4. Statutory Funding.

Statutory Funding describes the pursuit of an objective as described or required by local laws or codes.

Inflation Factor for Reserve Studies

Yes, inflation should be included in the reserve study for its effects on costs and interest earnings. The reserve study estimates costs over a 30-year period, so inflation will have significant effects on the results of the reserve study. Reserve analysts generally use a 3% or 4% inflation rate.

Padding the Reserve Budget with a Contingency Factor

Some reserve analysts will include a contingency factor into a reserve study. This contingency factor is simply padding for the reserve budget. Associations that pad their reserves budgets typically use contingency factor of 1% to 2% of the cost of items or just use a fixed amount per year.

Presenting the Reserve Report in the Annual Financial Statements

Florida law requires associations to the association to engage a Certified Public Accountant to audit, review, or compile the association’s annual financial statements. In the financial statements, the association will provide owners with a section “Supplementary Information of Future Major Repairs and Replacements,” which is based on the results of the reserve study.