In my last article, I shared my disbelief that there isn’t a law requiring property owner associations to conduct reserve fund studies. Managing an association without a reserve fund study is akin to flying a plane without instruments, piloting a boat without a rudder, or driving a car with no brakes.

In short, it’s a risky proposition. Adequate reserves are essential to ensure the continued, safe operations of the community and help maintain the stability of property values.

There are basically four funding options when an association needs large amounts of capital or extensive maintenance. The most desirable option is to have enough funds on hand to cover these expenses – a goal that can only be achieved by allocating an accurate percentage of the annual assessments to fund the reserves. Having a reserve fund study performed is the only logical way that a board of directors can prepare to meet the future capital needs of the community. Unlike an individual homeowner, solely responsible for determining the best course of action, the board is accountable to the “community” as a whole.

The second option is to acquire a loan from a lending institution to perform required repairs or replace common elements. Banks will often lend to an association using “future membership assessments” as collateral for the loan. What that means is that the current board of directors is pledging the association's future assets. Obtaining a loan creates additional costs in the form of interest and loan fees, in addition to the original amount of principal.

The third option is to defer the repair, replacement, or required maintenance. Understanding that this can create an environment of declining property values, partially due to continuously expanding lists of deferred maintenance items, this option is not recommended. Deferring maintenance can also impact an association’s financial ability to keep pace with the normal aging process of the common area components. All of this can have a seriously negative impact on the association because it can make it difficult or even impossible for potential buyers to obtain financing from lenders.

The fourth and probably least popular option is to levy a “special assessment” to the membership in the amount required to cover the expenditure. There is never a guarantee that a special assessment will be passed if membership approval is required. As a result, the association cannot accurately state that it will be able to perform required repairs or replacements when the need arises.

Having a reserve study performed and updated every three years by a professional reserve-study provider will facilitate the effective management and help to protect a community’s future over the long term. In fact, the only way to really know the overall financial health of an association is to review a reserve study, along with the financial statements.