Far too many homeowners associations have underfunded HOA reserves, not recognizing the importance that reserves play in a community’s financial stability. To avoid and potentially remedy underfunded reserves, an HOA board must first analyze its situation and determine possible causes. From there, the board can seek the proper solutions and keep the association financially healthy.
Underfunded HOA Reserves Pros and Cons
An HOA reserve fund is a designated account set up by the HOA to cover major repair and replacement expenses for common areas and components within the community. These common areas may include roofs, building exteriors, sidewalks, landscaping, swimming pools, and recreational facilities.
The reserve fund’s purpose is to ensure that the HOA has enough money set aside to pay for future capital expenditures without needing to rely solely on special assessments or borrowing funds. By regularly contributing to the reserve fund, the HOA aims to spread out the costs of long-term maintenance and replacement projects over time instead of burdening homeowners with large, unexpected expenses.
There are no benefits to underfunded HOA reserves. However, there are several consequences, such as the following:
1. Noncompliance With State Laws or Governing Documents
For some HOAs, there is a statutory requirement to fund reserves. An excellent example of this is Florida, where condominiums must maintain a reserve fund for budgets adopted on or after December 31, 2024 (Florida Condominium Act Section 718.112(f)(2)). Florida legislators passed the amendment after the collapse of the Champlain Towers South building in Surfside.
Apart from state laws, an HOA’s governing documents may require reserve funding. If an HOA fails to abide by its governing documents, the board may be found violating its fiduciary duty. This could lead to potential liability for the HOA and the board members.
2. Increased Long-Term Costs
A reserve fund serves as a safeguard in times of unpredictability. An HOA reserve fund aims to offset sudden, costly maintenance and significant repair needs. Thus, inadequately funded HOA reserves can leave essential repair projects incomplete.
However, neglecting vital fixes and postponing repairs and replacements will inevitably worsen the extent of damage over time. Ultimately, an underfunded HOA reserve fund today poses the risk of greater expenses.
3. Diminished Buyer Appeal
Prospective buyers find reassurance in purchasing a home in a properly managed community. Buyers often review an HOA’s financial reports, including its reserve study, to determine its financial condition.
An underfunded reserve account signals poor financial management. Buyers will think twice about buying into the community because they see potential dues increases or special assessments in the near future.
Possible Causes of an Underfunded HOA Reserve Fund
An HOA board can do its best to ensure adequate reserve funding. However, some efforts still come up short. Before an HOA board can fix the situation, it must first determine the root of the problem. This way, the board can remedy it at the source and avoid making the same mistakes.
Why does an HOA have underfunded HOA reserves? Here are the possible causes.
- Inadequate Budgeting. HOA boards may underestimate future expenses or fail to adjust budgets for inflation or unexpected costs. Additionally, mismanagement of funds, such as poor investment choices or embezzlement, can leave the reserve fund underfunded.
- Large, Unanticipated Expenses. Major repairs, such as roof replacements or infrastructure repairs, can quickly deplete reserve funds if not adequately prepared.
- High Delinquency Rate. Delinquent homeowners who fail to pay their dues can significantly impact the reserve fund if their payments are not collected promptly.
- Unadjusted Dues Calculation. If HOA fees are set too low or haven’t been adjusted for a long time, it can result in insufficient contributions to the reserve fund to cover future expenses.
- Economic Downturns. Economic recessions or downturns can affect property values and homeowners’ ability to pay dues, decreasing reserve fund contributions.
How Much Should an HOA Have in Reserves?
When managing an association’s reserve fund, it is crucial to allocate the funds appropriately. There is no one-size-fits-all amount, though. How much an HOA needs to have in its reserves depends on several things, including the community’s size, needs, and location. As such, it is essential to conduct a reserve study, which determines how much an HOA needs in reserve funding. It also sets up a schedule for reserve contributions.
Ideally, an HOA should maintain a fully funded reserve account, which means it holds sufficient funds to cover all anticipated expenses. This can prove challenging, though, so aim for a reserve account that is 70% to 85% funded. If the percentage dips below 70%, the HOA will likely resort to special assessments or increased association dues to cover expenses.
HOA Reserves Underfunded? 5 Ways to Fix That
As harmful as underfunded reserves can be, they are not beyond redemption. An HOA can adopt a few strategies to boost reserve funding, such as performing a reserve study, raising HOA fees, levying special assessments, applying for a line of credit, and hiring a financial advisor.
1. Perform a Reserve Study
A reserve study involves assessing current reserves, evaluating their sufficiency, and monitoring trends. It aids boards in determining necessary changes to the association, such as potential increases in dues.
This report offers a comprehensive overview of an HOA’s financial standing and suggests strategies to address any shortfall in funds. Moreover, a reserve study helps maintain reserves at suitable levels and establishes projections for repair budgets.
2. Raise HOA Fees
Raising HOA fees to compensate for a shortfall in reserves is usually the wisest choice. Of course, HOA boards should expect some pushback from homeowners. After all, nobody wants the added expense. However, increasing HOA dues is sometimes the only solution.
If the situation allows, an HOA board should consider making incremental adjustments. This will help address the issue without placing too much financial burden on homeowners. It is important to recognize, though, that incremental increases are not always a practical remedy.
3. Levy Special Assessments
Apart from raising HOA dues, an association can also levy special assessments to bolster its reserves. Depending on state laws and the governing documents, though, an HOA may be limited in how much it can charge in special assessments. An HOA may need to secure a majority vote from the membership for significant charges.
4. Apply for a Line of Credit
An HOA can also apply for a line of credit or loan from a bank to obtain financing. This is the best action if the HOA needs funding urgently and homeowners can’t immediately make contributions.
Of course, this also comes with pitfalls. Loans must be paid back, often with interest, and funding will still need to come from homeowners no matter what.
5. Hire a Financial Advisor
Underfunded HOA reserves can prove detrimental to an association. If an HOA board isn’t equipped to handle the situation, hiring a professional financial advisor is best. An advisor can analyze the HOA’s financial condition, devise strategies to lower costs and increase funding, and provide insight to the board.
The Bottom Line
Underfunded HOA reserves can pose many problems and risks for an association. This can stem from several reasons, such as poor financial management and a high delinquency rate. Fortunately, ways to boost an HOA’s reserves include raising dues and levying special assessments.
Navigating the complicated world of HOA reserve funding can be challenging. This is where Clark Simson Miller comes in. Call us today at 865.315.7505 or contact us online to learn more!
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