March-April 2005 Issue
Construction Defect and Large Projects---Reserve Study Aspects
|The California Civil Code mandates that a reserve study must include those major components that an association is obligated to repair, replace, restore, or maintain which (as of the date of the study) have a remaining useful life of less than 30 years. The obvious components would comprise such items as roofs, gutters and downspouts, painting, pool equipment, etc. They tend to have predictable life expectancies based on actuarial tables, modified by grades of materials, geographical, environmental, and other factors, and are cyclical in nature (i.e. will require replacement at various intervals in the future). However, there may be other potential expenditures, although less obvious, which might also be necessary to include in a reserve study.
Certain components might have unpredictable lives, or lives well in excess of 30 years, and accordingly, would not normally be included in a reserve study. However, due to unforeseen circumstances they may eventually become "includable" components. The following are a few examples to illustrate this:
Any of the above mentioned examples can have a dramatic financial impact on an association's budget and must be identified and quantified to the extent possible.
So, how can an association provide for these unpredictable / unique / non-recurring (hopefully) expenditures in their reserve study? In the case of defects / problems, the first step would be to obtain expert evaluation, which may entail the development of specifications for repair, replacement or remediation. Estimates should then be obtained for corrective measures and line items can be inserted in the reserve study accordingly. It is important to at least establish the component in the study and include the most "educated" costs determined at that time, disclosing that it is based on current estimates and may be subject to change. The amounts can always be adjusted in a future reserve study update as greater insight is gained regarding the extent of the issue. With respect to an item such as slope failure, it would be prudent to establish a contingency line item for the potential of such occurrence. One method might entail deriving an amount based on total acreage, contributing towards this "fund within a fund" until it reaches a certain level, and thereafter keeping it constant. In the event of a slope failure, the "contingency" could then be drawn down to the extent necessary and replenished over a certain time frame accordingly.
It is, therefore, even more critical that reserves be well-funded in light of the potential of such unexpected unique or nonrecurring expenditures. The California Civil Code only requires an association to disclose its percent funded. It does not specify an amount or percentage that an association needs to be funded. However, to be less than well-funded may undoubtedly necessitate the imposition of special assessments or even require obtaining a loan, which will involve various restrictions and compliance issues. What then is well-funded? The general consensus among reserve providers is that anything below 100% would not be adequate. Practically speaking though, it would be prudent to increase contributions to the reserve fund as necessary with the goal of ultimately achieving 100% funding, and then maintain regular funding to stay at or near that level thereafter.
To recap, the essential things to remember when trying to manage unpredictable or one-time reserve expenditures are:
Les Weinberg, RS, MBA is a principal of Reserve Studies Incorporated.
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