COLUMN: Barbara Holland

Q. Our association is arguing over what constitutes adequate reserves. We have been told that the amount needed in our reserve account is the amount required to pay for scheduled repairs and replacement. We have also been told we did not have to fund 100 percent, but can fund as low as 70 percent of the required reserve. What is your opinion?

A. State law requires that the board shall review the results of a reserve study to determine if its reserves are sufficient. It also states that the board shall make any adjustments it deems necessary to maintain the required reserve.

What is the required reserve? Well, according to the law, it is an estimate of the cost of repair or replacement of each major component identified which has a remaining useful life of less than 30 years.

Consider some of the fundamentals and assumptions that underline a reserve study.

First, it is based upon estimates: how much does it cost today to replace a major component? These costs are based upon average contractor estimates that can be found in many different construction texts. These estimated costs do not factor into an association's ability to negotiate price and terms, nor do they factor into an association's preventative maintenance programs that can extend the life expectancy of a major component, which in essence lowers the funding of the annual reserves.

Second, it is based upon the mathematical concepts of discounting and compounding, which must take inflation into account. The cost of replacing a roof today is not the cost five years from now, or 30 years from now.

During the funding time period, the reserve study estimates the interest earned on the reserve funds. Many associations have layered reserves, earning different interest rates depending

upon the terms agreed upon with their investment institutions.

Third, at different time periods, the association may withdraw funds faster to meet scheduled maintenance projects than it is required to fund those reserves, simply because of the amount of the previous funds that have been deposited into the reserves.

The point is that a reserve study is an estimate, not a precise science. The board has been given the obligation and the authority to review the reserve study each year and to decide what adjustments, if any, need to be made.

Each year when the board reviews the proposed budget for the coming year, the board needs to have an appraisal as to the maintenance status of the major components. Too often associations will not spend the money each year for professional inspectors to review and evaluate the physical needs of the community.

As you can see by my answer, I do not believe in rules of thumb -- each community is different. How it is managed and maintained is different. Proper funding

of reserves will help reduce the need for special assessments.

The problem for many associations, especially older ones, is that the law did not require proper funding from day one. By the time new laws were passed, many associations' physical structures were more than 20 years old. Hence, if a reserve study were conducted, these associations could have been already so far behind in their funding that a series of special assessments could actually be needed to catch up.

The conservative, safe and prudent step is to try to fund the reserves according to the reserve study and the physical condition of the community. If the board believes that the reserve study is not accurate, it should obtain a second opinion.

Questions for Barbara Holland may be sent to Association Q. & A., P.O. Box 7440, Las Vegas, NV 89125. Her fax number is 385-3759.

Barbara Holland, Certified Property Manager, is president and co-owner of H&L Realty and Management Co. She is a member of the Institute of Real Estate Management and is the author of two books on the subject. Holland is a past president of the Greater Las Vegas Association of Realtors.

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