The Reserves Truth
Performing reserve studies and establishing adequate reserves is absolutely vital for community associations. We must do more to make that fact known.
By Peter B. Miller, RS
©2021 Community Associations Institute
ALMOST IMMEDIATELY after Champlain Tower South collapsed, local officials, media outlets, and building experts were trying to make sense of the events leading up to the tragedy. People wanted to understand how and why something so unexpected and heart-wrenching could happen. Issues like lack of planning, inaction, lack of funding, and deferred repairs all were brought up as contributing factors.
At the time, it was far too early to form conclusions or to assign blame. Even now, it's still too soon. I was taught by my father at a young age that, "It is better to extend a hand than to point a finger." This early lesson was valuable, and it is one that we all should keep in mind.
As an outsider, I will never know nor will I be able to fathom the struggles and turmoil experienced by the Champlain Tower South board over the past several years, nor will I know what turmoil they endured in their prolonged deliberations regarding the extensive repairs that they faced.
Another lesson I learned growing up also applies to this horrific tragedy: "There's nothing to be learned from the second kick of the mule." We all need to recognize the need for adequate reserve funds.
Performing reserve studies and establishing adequate reserves is absolutely vital to the long-term viability of our community associations. They should not be an optional budget adjunct that can be ignored or waived without real consequences—ranging from loss of property value and skyrocketing assessments to delinquencies, foreclosures, and, in the worst cases, infrastructure failure.
"Underfunding of reserves is a common issue that associations face," says Matt Kuisle, RS, of Reserve Advisors' Tampa, Fla., office.
Kuisle estimates that roughly 40% of his Florida clients either fully or partially waive funding of the reserves—as allowed under Florida law.
More than 20 years ago, CAI adopted the National Reserve Study Standards. Since then, CAI has provided thousands of hours of educational seminars and professional development courses on reserves and reserve studies. Still, we hear people say, "I didn't know that reserves were important to my community."
The onus for planning and adequately funding the reserves falls at the feet of community association owners, board members, and managers. Elected officials who haven't passed meaningful and effective legislation that gives community association boards the authority they need to insist on reserve studies and on adequate reserve funding also should take some of the onus.
Unfortunately, not enough states have laws requiring reserve studies and reserve funding. And for those states that do, too many contain an exclusionary clause if the funding presents a financial hardship. These legal provisions don't actually protect owner finances. By not requiring adequate reserve funding, we are dooming future owners to bare inequitable financial burdens when previous owners should have been paying their fair share too.
The issue of underfunded reserves isn't limited to high-rise condominium associations. Mid-rise condominiums, townhouse communities, and both large and small homeowners associations all face the same challenge. The longer communities wait to address the issue of reserve funding, the larger the shortfall grows and the narrower their options become.
Maryland Delegate Marvin E. Holmes Jr. recognized the need to mandate reserve studies and reserve funding as a way to protect owners from unnecessary financial burden.
"Elected officials are consistently receiving complaints from members in associations that are assessed with very high special assessments because of not having enough funds in their reserve accounts because reserve studies had not been done for a significant period of time," says Holmes, the primary sponsor of recent reserves legislation in Maryland. "This bill will help protect against those scenarios."
The onus for planning and adequately funding the reserves falls at the feet of community association owners, board members, and managers.
TAKING RESPONSIBILITY
We each need to examine, understand, and acknowledge how our role in community association governance affects adequate funding of reserves. Each of us, whether we are an owner, a board member, a community manager, or a consulting professional, has the ability to positively influence the outcome of discussions regarding adequately funding reserves.
Owners need to become educated about funding for future repairs. How many times have we heard the statement, "Why should I pay for a roof that will be replaced sometime in the future when I may no longer be living here? How does that benefit me?"
Owners need to understand that they are only being asked to pay for the portion of the roof's life that was used that current year. We also need to acknowledge that by not properly funding the reserves, we are forcing future owners to pick up the tab for unpaid shares.
By purchasing a home within a community association, owners are agreeing to abide by the covenants, which includes paying assessments as determined by the budget. I f for no other reason than to protect their own investment, owners need to ensure that the budget includes funding for reserves.
As Robert A. Felix, CMCA, LSM, PCAM, RS, a longtime industry professional, says, "It's like the oil filter commercial: You pay me now or pay me later."
Owners can pay as they go, when the special assessment comes up, or in the loss in property values because of the poor physical and aesthetic condition of the community.
Boards of directors need to be committed to uphold certain duties, one of which is to make prudent, business-like decisions in the financial management of the association. Many boards meet resistance from owners regarding assessment levels. There is an institutional pressure to keep assessments down, but that should not be the board's goal. Instead, the board should focus on the best course of action for the community as a whole, not the most popular decision.
"Perhaps the greatest duty of the board of directors is to protect, preserve, and enhance the value of the homes with the community," says Robert Lyles, of Lyles & Lyles Attorneys in South Carolina.
Among all of the other challenges a board faces, perhaps the biggest challenge is convincing owners to approve a budget that increases funding for reserves. Boards need to make clear to their members that adequately funded budgets are essential to protect each homeowner's financial interest. In many cases, this is not an easy task. This is made all the more difficult in states where there are no laws or where there are ineffective laws that still do not provide boards with the authority to insist on adequately funded reserves.
Community managers need to direct boards toward best practices in the industry and educate them on the possible consequences of their actions or inactions. One of the best ways to do this is by encouraging board members to take advantage of CAI educational events. Hundreds of classes are taught every week at the local and national level on a variety of topics by qualified and experienced industry professionals. With virtual learning fast becoming the standard, it is vastly easier to attend many of these webinars, seminars, and events.
Getting boards to adequately fund reserves is easier when there are state laws that require common interest communities to conduct reserve studies and to fund the reserves. Unfortunately, not all states have such laws in place. "Most association boards in Virginia just assume that reserve studies are going to be done," says Michelle Baldry, RS, of Reserve Advisors. In Maryland, Baldry says she is getting some complaining and pushback on the recently passed law.
WHAT CAN WE DO NOW?
As an industry, we need to continue to emphasize the education of boards and homeowners. We also need to develop educational opportunities for legislators and other public officials that show the vital importance of reserves to the financial and physical viability of community associations in their districts. We need a concerted effort to get more (and more reasonable) state laws requiring reserve studies and reserve funding.
CAI has been timely and focused in its response to the tragedy in Florida. CAI's reserve study and reserve funding working group is reviewing current policies and will modify them where necessary to better address the challenges that community associations are facing today.
WHAT MUST WE LEARN?
We all play a role in community association living.
As homeowners, we need to develop a more realistic attitude toward budgeting and reserves that considers both our own short-term interest as well as that of the long-term interest of the community. And we need to support the board in its decisions.
As board members, we also need to think in both short- and long-term interests. We need to commit to being effective leaders and make decisions based on the best interests of the community, not just what is popular at the time.
As community managers, we need to continue to emphasize the education of board members. And we need to effectively guide boards to learn about and adopt the best practices of the industry.
The reserve analysts who conduct those reserve studies that help boards make informed planning and budgeting decisions also have a role.
We must emphasize the National Reserve Study Standards and best practices of our profession when dealing with our clients. We must make sure that the guidance that we are providing is clear and accurate, and we must be willing to point out when and where the current practices of our clients do not comply with those standards. And we also must continue to review and adjust those standards and practices as the industry and our profession matures and changes.
Peter B. Miller is principal and co-founder of capital reserve consulting firm Miller-Dodson Associates in Annapolis, Md. Miller is a member of CAI's Board of Trustees.