Ever wonder what a reserve fund is for and why your community needs one? Equipment, major components (like roofs in a condo community), and everything from private street repairs to pool maintenance must be undertaken from time to time, regardless of whether your community has planned for the expenses.
A reserve fund, which is similar to a savings account, is a financial fund that sets aside the difference between the income and expense of an hoa.
The Reserve funds should be used on expenses that will last longer than 3 years or cost greater than $10,000.
Most HOAs prefer to plan ahead and set the funds aside now to avoid increasing dues or issuing special assessments when the money is needed later. Nobody likes surprise special assessments! Reserve funds are not an extra expense to your community—they just spread out expenses more evenly.
If a reserve study is obtained for an association, the planed expenditures will be listed out and explained how much should be going into reserves vs. how much should be going out and when.
There are other important reasons your HOA will put association monies into a reserve fund every month, read on for more details.
Why HOAs Need a Reserve Fund
- Reserve funds meet legal, fiduciary, and professional requirements. A replacement fund may be required by:
- Any secondary mortgage market in which the association participates (e.g., Fannie Mae, Freddie Mac, FHA, VA).
- State statutes, regulations, or court decisions.
- The community’s governing documents.
- Reserve funds provide for major repairs and replacements that your HOA knows will be necessary at some point in time. Although a pool may need repairs every 5-10 years, every home owner who is able to use the pool should share its replacement costs.
- Reserve funds minimize the need for special assessments or borrowing. For most home owners in an HOA community, this is the most important reason. Surprise assessments and increases in dues are not a pleasant measure to take.
- Reserve funds enhance resale values. Lenders and real estate agents are aware of the ramifications for new buyers if the reserves are inadequate. Many states require associations to disclose the amounts in their reserve funds to prospective purchasers.
- The American Institute of Certified Public Accountants (AICPA) requires the community association to disclose its reserve funds in its financial statements.
How Do You Set Up a Reserve Fund for Your Community?
In our discussions with boards, Heritage Property Management, Inc. constantly emphasizes the need to build the appropriate level of reserve funds. One question that comes up frequently is how best to invest the reserve funds. The three main goals of investment for associations should be to:
- minimize risk
- make sure funds are liquid
- earn a decent rate of return
Associations can minimize risk by taking the appropriate steps.
The community's board of directors is responsible for choosing its investments. A good property management company can help your HOA navigate the investment options available. Heritage, for example, provides a list of institutions we deal with frequently and their current rates, but the ultimate decision lies with the board.
Once the board makes a decision on investing money, this decision should be communicated in writing to your property management company. At Heritage, when our clients notify us that they want to invest money in a reserve fund, we attempt to do as much of the leg work in getting the account set up as possible. Once an account is set up, the statements should always be addressed to the property management company so that all transactions can be properly recorded in your community's financials.