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The Value of Professionally Prepared Reserve Studies

Common interest communities may ignore the value of a professional prepared reserve study, but they do so at their own peril.

Announcer:     Welcome to Community Wise, brought to you by Wise Property Solutions.


Joe Wise:         I’ve been joined today by Ted Salgado, a reserve specialist and professional engineer from Milwaukee, Wisconsin.  He’s a co-owner of the company, Reserve Advisors.  Welcome, Ted.


Ted Salgado:   Thank you, Joe.


Joe Wise:         Tell us a little bit about what exactly a reserve study is.


Ted Salgado:   Well, a reserve study is a planning tool that the board can use to help prepare for replacements in the future.


A typical reserve study, Joe, consists of two parts:  one is the physical analysis and the other part is the financial analysis.  And it’s easy to understand the physical analysis because it deals really with the hard assets of the property.  The analysis, physical analysis, defines the reserve components and much of that is determined by the covenants or the declaration, the by-laws that the association has; the community association.


And the second part of a physical analysis is the condition assessments.  Once you’ve identified, for example, that a roof is a common element, the reserve specialist can determine its condition through a visual inspection.  The condition assessment can be something that relies on, some can say book values.  We might ask ourselves, well how long does a roof last and one might say 20 years or 15 years.  But understanding the age of the roof and you can also estimate how long it might last based on just simply of age.  And that suffices for what condition assessment – that would fulfill the needs of the condition assessment under the current standards of CAI.  So part of the physical analysis involves this condition assessment, but also estimates of life and value, the cost to replace these items.


The financial analysis is the second part of the reserve study.  Two parts to the financial analysis:  one is the fund at status.  And in simplest terms it’s simply, how much cash do you have?  OK?  There are other types of measure, percent funded, the listener can read about those, but ultimately you want to know how much cash you have to start with as part of what you have in the reserves.


The second part of the financial analysis is the funding plan.  All right, the funding plan simply matches all of the future expenditures that you can identify against your existing reserves and future contributions to reserves.  Because essentially they have to match, they have to slightly exceed – the reserves have to exceed over the future the amount of expenditures, otherwise you’re going to have a special assessment.


And so that’s the plan that a reserve study tries to really craft.  It really doesn’t matter where the association is today, many associations do not fund it properly, I mean, through no malice they’re just not aware of how much they should fund.  And so no matter where an association is today, the funding plan gets you from today through and into the future so that the association can adequately address the future needs of replacements.


Joe Wise:         For the board member that’s concerned about a reserve study, concerned that it might reveal something that they’d rather not know about, concerned about fees going up.  What do you say to that board member?


Ted Salgado:   Well I think if I were the board member or the home owner, I mean, every board member when you’re serving and, you know, my wife and I have lived in community associations for more than 20 years.  We look at it as a fiduciary responsibility.  In other words, I think that if you’re a community leader volunteer, you’re there because you care about your property, you care about, in essence, your investment in your property.  And it’s just –it becomes something that you have a natural interest in and addressing to understand when these replacements are going to occur.  If you have the facts in front of you then you can make essentially an informed business decision in how to deal with those facts.


And you don’t necessarily need to do this in a vacuum.  You have other board members to help you through decisions that can be made.  And you have also the homeowner membership.  And as a community, that’s kind of the essence here is that it is community living, it reveals the information to the membership so that as a group, as a group of people that live in a community, you can make decisions on how to address these replacements.  It isn’t necessary just simply; oh we might have special assessments.  There’s many other avenues to dealing with these replacements.  The industry has gotten much more sophisticated, Joe, where you can contact banks, for example, that specialize in loans to community associations to address these future replacements.


So in every one of our reports, for example, we recognize that, sure, you can have level, relatively level reserve funding, year after year, with slight increases for inflation.  You can also, you know, the special assessment is also a possibility although many associations don’t want that.  And then the third type of forming capital – creating capital, is going to a financial institution and borrowing the money.  And many communities do a combination of all three of these things.


Okay that, for example, a major replacement of an association’s exterior skin, I’ll call it the siding and the roofing and the windows, in many associations the board will provide the option for the association, the community, to self-fund these replacements through, let’s say, a homeowner’s equity loan or through a general loan for the community through the bank.  It all has to be, of course, you know, you have to pay this back, or through existing reserves.  And a combination of these three things gets the job done.


Joe Wise:         When an association has obtained a reserve study, they don’t just put it on the shelf.  There really is some added value to it.  How does an association or its board get the maximum value out of its reserve study?  How do they use that, leverage that to save money?


Ted Salgado:   Right.  That, you know, a custom comprehensive reserve study allows the board to use it almost every month rather than just at the budget time.  So in the budgeting season you obviously want to pull the number out of the study that says, well how much would we be contributing.  But the comprehensive reserve study is going to also reveal a plan of where or how much the association should have accumulated in the reserves as of a point in time, as of this year end, for example.  Where are we going?  What’s our goal?  How are we going to get there?


And it’s also going to identify various projects that are slated for replacement.  And the comprehensive reserve study is going to provide specific information in the narrative report about what the board should look for or the professional management team to look for that guides them on when to replace the common elements.


Another way a board can use the reserve study, or again, the professional management team, is to take a look at the future replacement cost and when you’re obtaining bids you can look, compare your actual bids to the third-party estimates, the independent estimate that the reserve specialist gave you and if the bids are high, you can ask why.  You can go back to the contractors and say, you know, we have an independent third-party opinion that says that this item should have cost $20,000, for example, and we’re getting bids of $27,000, $28,000.  Can you explain why?  Do you want to take a second look?  And in this way the independent third-party opinions that a study provides can save the association thousands of dollars during the course of a replacement.


Joe Wise:         That brings up a good point.  Reserve specialists are providing a very specific service, and that’s to prepare a reserve study.  You’re not in the business of selling resolution to your findings.  So if you come out and say this roof needs to be replaced, it’s not because you have a roof to sell, it’s because you have assessed the condition of the roof and determined that it’s reached that point where it requires some remedy.


Ted Salgado:   Yeah, that’s correct, Joe.  And there’s an important distinction because the origins of having reserve studies done in the first place, typically a board would say, how are we going to plan for the replacement of the roof?  Well, the natural inclination is to go to the roofing contractor and say, hey, can you come out and take a look at my roof?  Can you give us an estimate of the cost to replace the roof?  And of course, that’s not an independent third-party opinion.  You may or may not get, you know, all the information you’re looking for when you go that route.  It’s an opinion, but it’s not an independent opinion.


And so that’s the value of having a reserve specialist that doesn’t have any relationship with or is going to do the replacement project itself.  And so that’s an important factor.


Joe Wise:       A reserve study is not something that’s once and done.  How often does an association need to anticipate coming back, looking at its reserve study again and perhaps revising or updating or engaging a subsequent study?  What is the life cycle of a reserve study?


Ted Salgado: Like, I can tell you that most of our clients will come back to us and look to update their study anywhere from three to five years from the initial study.  You know, and why is that?  Well, the comprehensive study is going to include estimates for inflation.  Okay, not your consumer price index, but actual estimates of how labor costs for construction are going to increase or material costs.  And because those are estimates there could be differences, obviously, over time as to what the actual rates of inflation are going to be for construction and labor.


The other thing that has an effect on a reserve study, tow other things really is, one is, how are the investments doing?  Okay?  You know, it’s very difficult to get any kind of a return on your investments, but with the reserve study and the cash flow analysis, it helps the board understand how much money they’re accumulating and how long they can sort of tie up the money in investments, whether it’s a CD or some other guaranteed investment.  They can get a better return, a higher return.


The third item that really effects when you’re going to do a reserve study is really the weather.  You know, you might have weather events.  We have several clients that, you know, they get to about the 17th year on a roof replacement and a hail storm comes through and they’ve been blessed with a new roof, okay.  So when something like that happens, you’ve got a situation where, all of a sudden you’re roof has been replaced by an insurance claim and you’ve got a lot more money possibly than you anticipated.  And a great time to do the update is because the funding needs change over time based on the actual, you know, circumstances for every association.


So those are all things that affect the need to have an update.


Joe Wise:       So it’s in fact possible that a reserve study would reveal that an association was overfunding reserves.


Ted Salgado: Oh yeah, that’s entirely possible.  In fact, I was reviewing two studies this past week before we came out to the national conference here and we had adjustments that we were recommending for two of the clients.  It is kind of rare, and I think the item that’s more important as for the, really the board to understand, when and how the replacements should be conducted.  And that’s the true value of a reserve study.


Joe Wise:       If somebody wanted to find more information of a general nature about reserve studies and the reserve specialist designation, what are some good resources that somebody could delve into to learn more?


Ted Salgado: Yeah, anybody can go to CAI’s website.  And it’s called CAIonline.org and look for the credentialed section on reserve studies.  Also CAI has a foundation that provides information about reserve studies for free.  So that information’s available, educational resources from the foundation are available for the public.  More and more, clients are looking at the type of information that a reserve study provides in a very similar fashion to what other professionals can do for an association like legal advice, professional management, insurance.  All of these are experts; they’re specialists in the field of serving community associations with the best information possible.


And it just makes sense as a community leader volunteer to obtain that – to assemble your team, I’ll call it.  Okay, our team of experts, whether it’s management, banking, you know, your engineers, your reserve specialist or, you know, insurance specialist, any of those.  It’s just a good idea to have a good team behind you and relationships that you can rely on for the future care of your property.


Joe Wise:       Because when you’re talking about future expenses, it’s not a question of if you pay, it’s a question of how you pay.  You can pay by planning or you can pay by incurring the unfortunate consequences of not planning.


Ted Salgado: Well that’s true.  And as somebody that’s lived in community associations for more than 20 years, I’m going to say, 10, 15 years ago, even 10 years ago, homeowners that were shopping didn’t ask questions about reserves.  Now when people are shopping for a condo association or a condo unit, they’re asking questions like, well could I have the last two or three meeting – copies of the meeting minutes.  Okay, the annual minutes.  Can we see the financials to the association?  Can we see the declaration, the by-laws?  And, oh, by the way, how much do you have in reserves and is the property in compliance with, for FHA financing?


And so all of those things have, you know, the savvy buyers are now asking these because a lot of times it’s the second time they’ve lived in a condo association.  You know, they’ve gone from maybe a homeowner’s association to a condo apartment-style development or vice versa.  So they’re a lot more savvier, the public.  And that’s only going to increase as time goes on.


Joe Wise:       We’re seeing that, we’re also seeing that the banks are becoming more sophisticated as to how to evaluate and underwrite properties and common interest communities and that they’re beginning to look for some of that information to better understand what they’re getting themselves into on a loan.


Ted Salgado: Sure.  And on the loans, if, you know, just in the mortgage market, if a property is – does not qualify for a FHA financing and there’s a lot of things that go into that, that’s really off the subject here, but if that’s the case, it affects the marketability of the property, how quickly you might, as a homeowner, be able to sell the property and ultimately, you know, possibly has an effect on the value of the property, you know, based on just how easily it is to sell it.


Joe Wise:       Well, Ted, thank you for your time today.  We appreciate having you with us.


Ted Salgado: Well, it’s been a pleasure sharing some of these insights.


Announcer:    This episode of Community Wise was hosted by Joe Wise and is a production of Wise Property Solutions.  For more helpful information, visit us on the web at WisePropertySolutions.com.  Or you can view our blog and sign up for our e-Newsletter.



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