After more than two decades of review and re-calculating numbers in reserve studies, it is conclusive that there is a range of different financial results being produced by reserve study companies.

At the end of the recent CAI National Conference, the Reserve Shop Talk session was attended by some of the largest reserve study company principals. The subject of setting industry standards on calculations and reporting was introduced. It was stated that many reserve study companies produce much differing report presentations while also producing different calculation results (using a variety of different undisclosed formulas for calculations).

While one attendee disagreed, others agreed. This may display a lack of and need for standardization of calculations and reporting. Different reserve study company reports should have the same resulting numbers if using identical data. This may be a logical approach for the reserve study industry, but there was no interest in pursuing this direction. This raises questions (and is the basis of confusion for property managers and HOA Board of Directors) when changing reserve study companies? “How did our reserve position change so much?” Whether it be positively or negatively.

For the purposes of illustrating this point, let’s review the various formulas and calculation results of one area of reserve reporting, 100% Funded. It probably it is not generally known, but there are currently four different methods for calculating 100% Funded:

•    Current Cost – Straight Line
•    Future Cost – Straight Line
•    Current Cost – Future Cost – Straight Line
•    Future Cost – Time Valued

The following shows how these methods are calculated (assumes a current cost of $10,000, estimated useful life of 4 years, 3.00% inflation and the reserve item has been in service for one year):

Current Cost–Straight Line:

The current cost-straight line method is the easiest and the most straight forward to understand of all the methods. This method does not take into consideration inflation. It is a simple calculation that if a reserve item has a current cost of $10,000 and a four year estimated useful life, then at the end of each year the 100% Funded amounts would be by year: 1) $2,500, 2) $5,000, 3) $7,500 and 4) $10,000. Calculated as: $10,000 / 4 = $2,500 per year.

Future Cost–Straight Line:

This calculation is the same as Current Cost-Straight Line except instead of using the current cost the future cost is calculated and divided by four years. The future cost is calculated with the following formula (this formula takes into account the reserve item has been in place for one year and will be replaced or maintained in three years):

( Cost * ( ( 1 + Inflation Rate ) ^ 3 ) ) / Useful Life = $10,927.27

The future cost is divided by the estimated useful life of four years ($10,927.27 / 4 = $2,731.82) calculating the 100% Funded amounts would be by year: 1) $2,731.82, 2) $5,463.64, 3) $8,195.45 and 4) $10,927.  

Current Cost-Future Cost-Straight Line:

Some States Civil Codes have been interpreted that the existing cycle of a reserve item should be calculated on a current cost-straight line calculation and the future recurring cycles on a future cost-straight line calculation. The 100% Funded amounts would be presented as above for the existing cycle (current cost-straight line) and the recurring cycles (future cost-straight line).

Future Cost-Time Value:

The future cost-time value calculates each year’s 100% Funded as a progression from year to year which more fairly represents the compounding of the inflation rate. The current cost of $10,000 compounded for one year at 3.00% equals $10,300. This future cost is divided by the estimated useful life of four years and multiplied times two years to calculate $5,150 as 100% Funded at the end of year two. The following year calculation is then repeated using the previous year future cost of $10,300 which is compounded for one year, $10,609. This is divided by the estimated useful life of four years and multiplied times three years to calculate $10,609 as 100% Funded at the end of year three. This calculation would continue for the ongoing existence into the future of the reserve item.

This method most accurately calculates the 100% Funded amount of a reserve item taking into account inflation compounded annually as opposed to any straight line calculation.

Note: the above methods utilize the current cost taking into account that the reserve item has been in service for one year

The matrix below presents the different balances of the 100% Funded calculation methods.

The variances of the straight line methods exist on their own and are materially different when compared based on the percentage differences with the future cost-time valued method.

It is obvious why the 100% Funded calculation can vary from reserve study to reserve study due to different methods. Usually it is not disclosed in the reserve study what method was used which adds additional confusion to property managers and HOA Board of Directors for first understanding their current reserve study and then when comparing results to a previous reserve study.

There is currently no documentation or guidance on these calculations from CAI (Community Association Institute), APRA (Association of Professional Reserve Analysts, AICPA (American Institute of Certified Public Accountants), FHA (Federal Housing Administration, or any individual state Civil Codes or regulations.

This examines just one area of reserve study calculations. Other calculations need to be addressed in the same manner while addressing reserve study formulas and calculations. Reserve study reports also need to be addressed in the same manner as the above in order to set standards for consistency and understanding for the benefit of all property managers and HOA Board of Directors.

Reserve Studies of some type have been done for over half a century now for many common-interest-developments. Prior to that, in some situations, maybe an abacus or pencil and paper process was attempted. The studies became simpler to do and more efficient to produce when spreadsheets came to life in the 80’s. The first version of professional cash management of reserve funds for owner associations and resorts was introduced in 1983. And surprisingly, the first cash flows projections weren’t presented until 1989.

In the 60’s, when a common-interest-development property was in the planning stages, some proactive State’s Departments of Real Estate required documentation for budgeting and disclosure purposes as to the amount potential owners would be paying for operating and maintaining the property. As we know them today, “maintenance fees” for the daily operations and reserves for the long-term maintenance and replacement of the physical common areas. Originally, the Reserve Study report was intended to be an independent (arms-length, third party) opinion at a specific point in time regarding the condition of the property, common areas and the individual assets or reserve items that made up the property. This would be similar to the concept of a CPA’s audit opinion on the financial position of a company.

Furthermore, the study accounted for the balance of existing reserve funds and calculated how much would be needed from the owners to pay for reserve items that would require maintenance or replacement in the future. The conclusions and the report were basically done with no involvement from the association’s board of directors, management, or any other advisors.

In the 90’s, Reserve Studies started to change noticeably. With dramatic changes in the economy, many boards of directors and management personnel became more involved in the end product report with participation on the assumptions used for inflation, interest earned, annual contribution increases, or the occasional “we are not raising the dues” no matter what the report says input from board members. The professional Reserve Study preparer was primarily relied upon for estimated lives, costs and the approximate timing of when maintenance or replacement would be needed next. This of course was questioned by many boards of directors as to, “how can we extend the lives of the reserve items”, or “even change the assumptions so we do not have to raise dues”. In many situations globally, this is still the case today. 

So what is changing? And is the static reserve study metamorphosing into a dynamic, “living-breathing” process and a valuable financial planning tool for the future? The fact is, the world is a different place than it was 50 years ago and today there is a dramatic difference between the original Reserve Study and the developing Reserve Management Plan.

Where a Reserve Study is basically an independent report done once every few years, a Reserve Management Plan incorporates not only the involvement of the board of directors and management, it also incorporates cutting edge technology, real-time analysis, access and expertise from various other professionals.

A Reserve Study is what a professional reserve study preparer’s opinion is, where the Reserve Management Plan is an ongoing collaboration of what the intent, or plan is, of the board of directors and management today, tomorrow and into the future.

In other words, a Reserve Study is a snapshot or the view from 20,000 feet while the Reserve Management Plan starts at ground level, allows one to get off the ground safely and fly confidently at a cruising altitude with more end user intent, detail and useful managerial information. 

The first thing the board of directors and management must determine is what is the end purpose the report? Is it purely for internal purposes, is it being required by a lender for the association to borrow money, for individual owners trying to meet refinance requirements, or owners trying to sell to potential buyers? This will determine if an independent Reserve Study is needed or a collaborated Reserve Management Plan. 

In the summary narrative of the report it should disclose that it is an independent (arms-length, third party) opinion, or a collaboration with the board of directors, management, or any other advisors. It should continue to state the scope, intent, and how the data was originated. Also, the method used for calculating the current and projected year’s owner’s contributions, and that these calculated contributions provide a plan to assure that reserve funds will be available when needed in the future. 

Where a Reserve Study might be considered one dimensional, a Reserve Management Plan can extend to including other useful managerial information:

• How reserve funds can be invested to maximize the return on investment
• Calculating individual owner contributions based on unit type or location by size, percentages, entitlements, weeks or points (timeshare/vacation ownership)
• Financial planning for underfunded owner associations that need to borrow money, special assessments, or a combination of both
• Different tracking methods that fit the desired intent and timing of reserve fund expenditures
• Documentation and compliance of the American Disability Act (ADA)

One of the biggest challenges for reserve (funds and items) analysis and reporting has been for the timeshare/vacation ownership industry. Typically, two-thirds of the total replacement/maintenance costs for a property are related to the unit interiors with common area items being the balance. Pre-planning of these types of property is extremely important for reserve consultants or the exercise can turn into “a runaway train”. Unless there is some type of understanding of what the board of directors and management are expecting, the odds are very slim that the end report will meet expectations.

Reserve consultants, management, or other advisors are the first line of education for owner associations and board of directors. The services available should be explained along with the mechanics of a Reserve Study and a Reserve Management Plan and their differences. Also, that the end services and report costs to the owner association will vary based upon what has been requested and agreed upon.

You do get what you pay for. If the board of directors is just trying to meet some requirement, then they will go with the least expensive option. But a conscientious board of directors will consider what managerial information they need to make proper decisions in the interest of all the owners.

After more than two decades of review and re-calculating numbers in reserve studies, it is conclusive that there is a range of different financial results being produced by reserve study companies.

At the end of the recent CAI National Conference, the Reserve Shop Talk session was attended by some of the largest reserve study company principals. The subject of setting industry standards on calculations and reporting was introduced. It was stated that many reserve study companies produce much differing report presentations while also producing different calculation results (using a variety of different undisclosed formulas for calculations).

While one attendee disagreed, others agreed. This may display a lack of and need for standardization of calculations and reporting. Different reserve study company reports should have the same resulting numbers if using identical data. This may be a logical approach for the reserve study industry, but there was no interest in pursuing this direction. This raises questions (and is the basis of confusion for property managers and HOA Board of Directors) when changing reserve study companies? “How did our reserve position change so much?” Whether it be positively or negatively.

For the purposes of illustrating this point, let’s review the various formulas and calculation results of one area of reserve reporting, 100% Funded. It probably it is not generally known, but there are currently four different methods for calculating 100% Funded:

•    Current Cost – Straight Line
•    Future Cost – Straight Line
•    Current Cost – Future Cost – Straight Line
•    Future Cost – Time Valued

The following shows how these methods are calculated (assumes a current cost of $10,000, estimated useful life of 4 years, 3.00% inflation and the reserve item has been in service for one year):

Current Cost–Straight Line:

The current cost-straight line method is the easiest and the most straight forward to understand of all the methods. This method does not take into consideration inflation. It is a simple calculation that if a reserve item has a current cost of $10,000 and a four year estimated useful life, then at the end of each year the 100% Funded amounts would be by year: 1) $2,500, 2) $5,000, 3) $7,500 and 4) $10,000. Calculated as: $10,000 / 4 = $2,500 per year.

Future Cost–Straight Line:

This calculation is the same as Current Cost-Straight Line except instead of using the current cost the future cost is calculated and divided by four years. The future cost is calculated with the following formula (this formula takes into account the reserve item has been in place for one year and will be replaced or maintained in three years):

( Cost * ( ( 1 + Inflation Rate ) ^ 3 ) ) / Useful Life = $10,927.27

The future cost is divided by the estimated useful life of four years ($10,927.27 / 4 = $2,731.82) calculating the 100% Funded amounts would be by year: 1) $2,731.82, 2) $5,463.64, 3) $8,195.45 and 4) $10,927.  

Current Cost-Future Cost-Straight Line:

Some States Civil Codes have been interpreted that the existing cycle of a reserve item should be calculated on a current cost-straight line calculation and the future recurring cycles on a future cost-straight line calculation. The 100% Funded amounts would be presented as above for the existing cycle (current cost-straight line) and the recurring cycles (future cost-straight line).

Future Cost-Time Value:

The future cost-time value calculates each year’s 100% Funded as a progression from year to year which more fairly represents the compounding of the inflation rate. The current cost of $10,000 compounded for one year at 3.00% equals $10,300. This future cost is divided by the estimated useful life of four years and multiplied times two years to calculate $5,150 as 100% Funded at the end of year two. The following year calculation is then repeated using the previous year future cost of $10,300 which is compounded for one year, $10,609. This is divided by the estimated useful life of four years and multiplied times three years to calculate $10,609 as 100% Funded at the end of year three. This calculation would continue for the ongoing existence into the future of the reserve item.

This method most accurately calculates the 100% Funded amount of a reserve item taking into account inflation compounded annually as opposed to any straight line calculation.

Note: the above methods utilize the current cost taking into account that the reserve item has been in service for one year

The matrix below presents the different balances of the 100% Funded calculation methods.

The variances of the straight line methods exist on their own and are materially different when compared based on the percentage differences with the future cost-time valued method.

It is obvious why the 100% Funded calculation can vary from reserve study to reserve study due to different methods. Usually it is not disclosed in the reserve study what method was used which adds additional confusion to property managers and HOA Board of Directors for first understanding their current reserve study and then when comparing results to a previous reserve study.

There is currently no documentation or guidance on these calculations from CAI (Community Association Institute), APRA (Association of Professional Reserve Analysts, AICPA (American Institute of Certified Public Accountants), FHA (Federal Housing Administration, or any individual state Civil Codes or regulations.

This examines just one area of reserve study calculations. Other calculations need to be addressed in the same manner while addressing reserve study formulas and calculations. Reserve study reports also need to be addressed in the same manner as the above in order to set standards for consistency and understanding for the benefit of all property managers and HOA Board of Directors.