The spotlight on POA financials has been shining bright over the last several years. Since the 2021 collapse of the Champlain Towers South Condominium in Florida, state legislators, the media and loan providers, including Fannie Mae and Freddie Mac, are more closely scrutinizing the financial state of POAs. Fannie Mae and Freddie Mac in particular are requesting more information on the amount of deferred maintenance accrued by POAs. An important tool for POAs to combat this scrutiny is the reserve study.
What is a Reserve Study?
To better understand what a reserve study is and its purpose for a POA, let’s start by reviewing what it is not. The reserve study is not an evaluation on the integrity of the components within the POA or a thorough examination of the wiring, water/sewer lines or other pipes found within the walls or underground in the components held by the POA. The reserve study is also not all about the future or to be used as a capital improvement plan.
Rather, a reserve study is a comprehensive analysis of the life expectancy of the major components owned by the POA. In a single-family association, this could be made up of the recreation center, clubhouse, pool, signage, lighting components, or private roads. In a condominium, it is the structure of the building(s), the mechanical systems within the building(s), roads and other common elements, such as the pool, gym, and parking lot or parking garage. The purpose of the reserve study is to estimate the costs of future repairs and replacement of these components. In addition, the reserve study serves as a budget planning tool to assist the POA in managing the cash reserves for non-annual, expected, predictable expenses.
POA Reserve Funding Levels
As part of its budget planning function, the reserve study analyzes the POA’s cash reserves, which the POA has placed into one of three categories: baseline, threshold, or fully-funded.
Baseline
The POA keeps reserves above $0, but this makes long-term maintenance of assets unlikely. By maintaining reserves at this level, a POA makes itself susceptible to special assessments as assets need to be replaced and/or being forced to take out loans that can result in long term payments at high interest rates. Many times, this results in a deferred maintenance POA as the assets cannot be repaired and/or maintained when needed.
Threshold
The POA reserve account is maintained but is not adequately funded for all maintenance projects. Some long-term maintenance can be met with threshold level funding, but not all. Again, this may result in special assessments or loans for the POA over time. The goal for the POA is for the reserve account to not drop below a designated value.
Fully-Funded
The reserves for the POA can meet all future expected maintenance obligations, and the assets can be replaced in a timely manner. By maintaining this level of funding, it is unlikely a POA would need to levy a special assessment for maintenance projects. While this level of funding may seem impossible or impractical for many POAs, it is a goal all POAs should strive to achieve. At a minimum, POAs should maintain their reserves as close to fully-funded as possible but more than threshold levels.
Why Should a POA Consider a Reserve Study?
A POA should consider a reserve study because it is fundamental to understand the future needs of the POA. The reserve study will assist the POA in establishing a funding plan to address the future financial needs of the POA, while defining how much money the POA has in its reserve account and determining if current funding levels will meet the future needs.
Currently, there is no law in Texas requiring a POA to conduct routine reserve studies. Therefore, it is the responsibility of the board to ensure routine reserve studies are conducted. As board members, the board has a standard of care to maintain long-term, sound financial accounts.
By not taking action, especially if advocated for by an industry specialist, such as a CPA or attorney, many boards may risk violating their standard of care.
POAs and their boards need to be proactive in monitoring their reserve accounts, particularly with lenders evolving their requirements regarding deferred maintenance. The lack of a strong reserve and deferred maintenance challenges could have devastating effects on property values in the POA. This could result in questions on whether the board is meeting their standard of care to the POA resulting in the potential for litigation. If a POA has questions on the reserve process and what a reserve study would look like for their specific association, the POA should turn to its management team, CPA and/or attorney to assist them in navigating and using this essential tool that benefits the long-term health of the POA and ultimately its members.
