By Gary Porter
The reserve study is the budget tool used to determine the reserve portion of your annual maintenance fees. Reserve assessments generally represent 15 to 25 percent of the total maintenance fee. No rule of thumb is available to guide you as to what that amount should be. Every resort is different, so the only way to determine that amount accurately is to perform a reserve study. Plan the process the right way and you will get a better result.
This article ignores the details of actual preparation of the reserve study, as that generally falls to the reserve preparer. Instead, the focus here is on those action items that fall to the association to provide guidance to help you create a better reserve study.
Where to Start
You don’t start bysimply “going out to bid” for a reserve study. When you “go out to bid,” you abdicate your own responsibility by allowing the reserve preparer to define the reserve study engagement, and determine what goes into the reserve study and how the engagement is performed.
You take control of your reserve study when you determine your maintenance responsibilities, establish policies to meet those responsibilities, and create a request for proposal (RFP) process that helps you find a qualified reserve preparer who will work within your established guidelines.
Start by looking at state statutes for any statutory or regulatory requirements regarding reserve studies. So far, only a few states have established specific reserve studies statutes. Unfortunately, all of these are relatively defective, some so poorly designed that they appear actively to prevent the association from making good, common-sense decisions about reserves.
Next, look to your governing documents for maintenance obligations. Most are so vague that they leave many questions unanswered about maintenance responsibility.
Finally, look at prior reserve studies to see what components have been designated as an association maintenance responsibility.
After determining your maintenance responsibilities, you can develop policies about your physical maintenance plan. One mistake that many people make is stating that the reserve study is the maintenance plan. It is not, and should not be.
The reserve study is the financial reflection of the maintenance plan. Very few associations have developed reserve policies; it’s just not on anybody’s radar screen. Because this is where associations often spend their biggest dollars, they should have policies to guide them regarding the reserve-study process. If you don’t have policies, by default you allow your reserve-study preparer to establish policies for you.
Reserve policies should address:
- Components – What components go into the reserve study and what components do not, and how often the reserve study is updated.
- Funding plan – Funding goals, calculation methods (component or cash flow), inclusion of interest and inflation assumptions, and assessment structure.
- Reporting – What reports should be generated to understand the reserve study.
- Reserve cash management – Budget creations, bank accounts, transfers to reserves, authorizations for expenditures, restrictions on inter-fund transfers.
- Investment policy – approved investment vehicles.
Sample reserve policies are available at the ICBI website, www.capitalbudgeting.org/index.php/reserve-study-information.
Request for Proposal
Create the right RFP to match your policies and goals. It should:
- Describe your association.
- Describe the desired scope of work.
- Identify the reserve-study standards to apply.
- Specify the type of service to be provided, independent study or Reserve Management Plan (see details below).
- Indicate if software is to be made available to the association.
- Specify the reports and other deliverables to be provided to the association.
- Set forth engagement terms and conditions.
- Specify the proposal submission requirements, and the required format and content of proposals (so they may be compared).
- Inform proposers of the association’s review process for proposals.
While this may seem like overkill to some, it is the only way for the association to control the process to ensure satisfaction with the results.
Sample RFP forms are available at the ICBI website.
Selection of standards
Most people don’t appreciate that the selection of reserve-study standards to follow can result in dramatically different conclusions. For example, under Community Associations Institute (CAI) and Association of Professional Reserve Analysts (APRA) reserve-study standards, any component with a very long life may be excluded from the reserve study. Reserve preparers who follow these standards often omit such components (such as windows and doors, plumbing systems, etc.). Under International Capital Budgeting Institute (ICBI) reserve-study standards, these components must be included, or their omission must be disclosed.
Also, under CAI and APRA reserve-study standards, any component without a predictable remaining life may not be included in the reserve study (such as landscaping replacement or block-wall repairs). Under ICBI reserve-study standards, these components must be included, or their omission must be disclosed.
ICBI reserve-study standards address “reserve activities” whereas CAI and APRA reserve-study standards address only “reserve components.” Activities that are not physical components (such as costly engineering reports or other professional studies) are included under ICBI standards, but excluded under CAI and APRA standards.
The ICBI reserve-study standards are far more comprehensive than CAI and APRA reserve-study standards, and are the only standards that specifically address the unique needs of timeshare associations.
See the ICBI standards at the ICBI website, www.capitalbudgeting.org/index.php/rs-professional-standards.
Types of service
The ICBI standards also provide for two types of service that a reserve preparer may provide:
- Independent study – The traditional industry service. It’s the only service level under CAI and APRA standards, and is allowed under ICBI standards. At the independent study service level, reserve-study preparers issue their report, offering their opinion.
Most preparers are extremely reluctant to make a change requested by the association as it may harm or dilute their opinion. The resulting report is often relatively useless. It may not fit into the association’s maintenance-fee structure, and often does not compare to the association’s actual maintenance plan. Such as report meets statutory requirements, but otherwise sits on the shelf, unused.
- Reserve Management Plan – Only the ICBI standards provide for the Reserve Management Plan level of service, in which the reserve preparer works with the association to create a reserve-study report that reflects the association’s actual maintenance plan, and fits within the association’s maintenance-fee structure.
The reserve preparer adds his knowledge and experience to the association’s history, knowledge, and plans, to create a report that has the best of both parties’ input into the process. The reserve preparer has a one- or two-page “preparer’s report” within the reserve-study report that reflects his or her opinion on the overall reserve study. The preparer’s report also includes any reservations the preparer may have about the reserve study. The reserve management plan, when used with software by the association, becomes a dynamic management-budgeting tool, and is considered far superior to the independent study.
Enhancing the process
Now it’s time to start your reserve study. You can help the process even more by providing your reserve preparer with as much information as possible. Paid invoices for past major repairs and replacements, and/or bids for anticipated future work, provide a higher level of precision to the timing and cost of reserve expenditures. Information on anticipated future projects helps the reserve preparer understand how and when you intend to spend reserve dollars.
The above information also is crucial in helping to determine the useful and remaining life of various components. Most reserve preparers almost ignore useful life and focus solely on remaining life, as that is the only number that figures into the cash-flow analysis of future expenditures.
What those folks fail to understand is the impact useful life has on the calculation of percent funded (for those that actually calculate this number). Certain components may exceed their life expectancy by considerable time periods, and useful lives may be cut short for various reasons. Our company always attempts to determine the reasons for these differences. Were original life expectancies too long or too short, did operating-maintenance activities cause a difference in life, or are these just outlier items that don’t follow the norm. The answers are important, and impact your reserve study.
Gary Porter, RS, FMP, CPA is chief executive officer of Facilities Advisors International LLC (FAI) and has performed reserve studies since 1982. He is the only reserve preparer to hold credentials or have experience in all three of the disciplines that comprise the reserve-study process. He manages FAI’s nine offices and also performs reserve studies nationwide. He is coauthor of Reserve Studies—The Complete Guide, the most comprehensive analysis ever compiled on the topic of reserve studies. Copies are available free to all TimeSharing Today subscribers. To request one, email email@example.com.
In addition, he is the author of more than 300 articles and has been published or quoted in a variety of publications, including The Wall Street Journal, Money Magazine, Kiplinger’s Personal Finance, CAI’s Common Ground, CAI’s The Ledger Quarterly, The Practical Accountant, and a number of major newspapers. He has been a featured speaker for 32 state CPA societies on the topic of homeowners associations.
Mr. Porter is president of the International Capital Budgeting Institute (ICBI), which has established international standards for preparation of and reporting on reserve studies. He is the primary author of ICBI’s standards, the only reserve-study standards that consider the unique needs of the timeshare industry.
Mr. Porter also is a past president of the Community Associations Institute (CAI), the 36,000-member trade organization representing the whole-ownership homeowners-association industry.