Why Reserves “%-Funded” Should Matter to You

It is not surprising that a roof fails. From the moment the last shingle on a new Association is nailed into place, that shingle (along with all the other Association assets) starts a slow, steady process of deterioration that will culminate in the roof reaching the end of its Useful Life. The anticipated Useful Life (measured in years) of various roofing types is well-documented and none are rated to last “forever”.

It is also not a surprise when a roof fails. The roof may give you visual clues to its demise that could be detected in a physical inspection or obvious physical clues, including roof leaks during a rainstorm. Roofs regularly fail when the Remaining Useful Life (measured in years) approaches “0” years.

Of course, the entire process starts afresh with each new cycle of common area repairs & replacements.

Given the inevitable and predictable nature of deterioration, what is surprising is how often Association-governed communities under-reserve for their Reserve expenses. When the roof fails, the asphalt crumbles, the building needs paint, or the elevator needs modernization, the Association that has allowed their assets to deteriorate without funding Reserves through offsetting contributions will be financially ill-prepared.

It doesn’t have to be that way.
Athletic competitions offer a good analogy. An Olympic runner that falls behind on his pace will know exactly how much he has to hustle the last lap in order to “catch-up” before the finish line. For an Association that is behind pace on Reserves, the “finish line” is being able to make necessary repairs & replacement s in a timely fashion. And just like the trained runner, there are two pressing questions:

#1. How “off pace” are we?
#2: How can we catch up?

The answer to the first question, “How off pace are we?” lies in a calculated ratio called Reserves “%-Funded”. Reserves %-Funded was established in National Reserve Study Standards as a way to measure the relative strength of a Reserve Fund by comparing the size of the Reserve fund to the value of Reserve component deterioration, at a particular point in time (usually the first day of every fiscal year).

In one number, %-Funded provides a key insight into how well the Reserve Fund has kept pace with common area deterioration:

• 100% funded means perfectly “on pace”

• 70% - 130% funded means substantially “on pace”

• 30%-70% funded means somewhat “off pace”

• 0%-30% funded means substantially “off pace”

The answer to the second question, “How can we catch up”, depends on two factors:

A. What is our current Reserve %-Funded?
B. How close is the next big repair/replacement project?

If an Association’s Reserve Fund is substantially “on pace” with common area deterioration and the next big repair/replacement project is a few years off, they should be able to accomplish the reserve project in a timely manner. On the other hand, if an Association’s Reserve Fund is substantially “off pace” and the next big repair/replacement project is looming, they will likely be unable to catch-up without the help of a “Special Assessment”.

The graph below illustrates the relationship between “%-Funded” and the “Risk of a Special Assessment”. It is clear to see that as the strength of the Reserve Fund (%-Funded) decreases, the risk of Special Assessment increases significantly.

Reserve %-Funded should matter to you for three reasons:

• It makes it easy to track whether the Reserve Fund is keeping pace with deterioration
• It predicts how well prepared the Association will be to meet its repair & replacement obligations without resorting to a Special Assessment
• It eliminates surprises

There is no escaping the fact that the funding of reserves associated with common area deterioration will occur. The only question is whether Reserves will be proportionately funded through regular monthly contributions collected over many years, from all the past owners who enjoyed the use of those assets, or “catch-up” funded through a Special Assessment levied upon the unlucky current homeowners. Reserve %-Funded can give you a clue to the answer!