Inadequate Reserve Funds

October 2021

Has your community ever had or contemplated a special assessment?

Reserve funds, and reserve fund studies, are complex moving targets.  Each year things change requiring revisions to many assumptions.  Building parts degrade or get damaged each year.

Failing to update your assumptions and addressing reality guarantees an inadequate reserve fund.  Adequate, when referring to the reserve fund, is not intended to reflect today’s needs.  It refers to meeting needs many years in the future without special assessments or additional supplemental funding.

Physical deterioration is inevitable but predictable.  Building parts get damaged because of wear and external events which must be addressed on an ongoing basis.  Today’s “adequate reserves” may not be sufficient a few months or years from now.  Meeting this moving target is a complex undertaking involving engineering studies, renovation costs, cost escalation, financial expertise and constant updates to adjust for changing factors.  A reserve fund study should be updated every few years to make these adjustments.

Cash balance is one aspect of any reserve fund analysis.  Reserve fund strength can be evaluated by looking at “percent funded” – comparing current cash reserves with the deteriorated value of all reserve fund components.  Because the future is unclear no one can say with certainty when a reserve fund is at “full strength”.  Statistics show that when “percent funded” exceeds 70 percent the need for special assessments are rare, and a level below 30 percent presents a high risk of needing special assessments.

Today’s strong reserve fund does not guarantee sufficient reserves for future repair and replacement projects.  If reserve fund contributions drop there may not be enough money for a major expenditure five years from now thus making it inadequate.  Conversely, today’s weak reserve fund can be made strong by increasing reserve fund contributions.  Annual monitoring of the “percent funded” helps evaluate the current strength of a reserve fund.