Why an HOA Needs Sufficient Cash Reserves
Large expenses are to be expected in a development, and homeowners must cover the costs, one way or another.
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What happens when a development’s homeowners’ association (HOA) encounters large or unexpected expenses? For example, if the clubhouse roof starts leaking, the pool needs resealing, or a piece of equipment in the fitness room breaks down, where does the HOA get the money to repair or replace these? At such times, the HOA’s reserve fund comes into play.
Just as you probably keep some savings to pay for large, infrequent expenses, such as repairing a car or fixing a plumbing leak, an HOA commonly maintains a type of savings account called the “cash reserves” or a “reserve account” for large, infrequent, or unexpected common area costs.
Responsibilities of an HOA
To fully understand why an HOA must keep some money in reserve, you must first understand its duties and obligations. These are set forth in the development’s governing documents (usually including the articles of incorporation, bylaws, and Covenants, Conditions, Restrictions and Easements (CC&R’s), and any separate rules and regulations).
The governing documents typically obligate the HOA to maintain, operate, and repair and replace the common areas in the development. Common areas normally include the parts of the property owned jointly by everyone who has purchased a home there, and which they all have a right to use. Pools, clubhouses, and parks are common areas found in many developments. In a more upscale development, the common areas might also include entrance gates, fountains, spas, and the like.
How an HOA Pays for Common Area Expenses
The governing documents typically give the HOA the right to collect periodic dues from each homeowner, to pay for the ongoing operation, maintenance, repair, and replacement of the common areas. To determine how much money it needs to collect, an HOA adopts an annual budget.
The amount of ongoing maintenance costs depend, of course, on how many common areas the development contains, and the amenities offered. For instance, the HOA may need to budget for landscaping common parks, cleaning and maintaining a common pool, or providing janitorial service and utilities for a common clubhouse. In a higher-end development, the HOA might also be responsible for paying neighborhood security staff, maintaining outdoor lighting, and caring for common tennis courts and spas.
In a well-run development, in addition to the ongoing daily maintenance and operation costs, the HOA’s annual budget will designate a portion of the dues collected to go into a reserve fund. Such expenses might include, for example, the cost to repair leaky pipes in the common clubhouse, replace broken down fitness equipment in the common workout room, or resurface the common swimming pool.
How Much Money Should Be In the HOA Reserve Fund?
Just as you might have a formula for maintaining a certain amount in your personal savings account (three to six months’ worth of your salary, for example), the HOA must determine an appropriate amount to put in its reserve fund. An HOA commonly has an outside accountant prepare a “reserve study,” which sets out a long-term schedule of likely costs and repairs. The reserve study will, in most cases, estimate the cost and timing of the repairs and replacements to the common areas that will likely be needed over the next 20 to 30 years.
For example, if the reserve study anticipates that the clubhouse will need a new roof in ten years, the study’s schedule will spread out the estimated cost of the repairs over the ten-year period, and advise that the HOA collect enough in periodic dues to set an apportioned amount into the reserve fund in each of those ten years.
No Reserve Fund = Higher Dues or Special Assessments
An HOA without an adequate reserve fund is asking for trouble. When an HOA without money in reserve is faced with expenses outside its general operations budget, the HOA will likely have two choices: increase dues significantly right away, or levy special assessments.
Neither of these will go over well with the development’s homeowners. Owners will likely balk at, and might not be able to afford steeply increased dues or the demand for a large amount of money at one time (as in the case of a special assessment).
Also, both raised dues and special assessments are inefficient solutions. Both penalize current owners for the HOA's previous lack of planning. It’s much more fair and efficient to include repair and replacement costs automatically as a part of the periodic dues, as occurs when a reserve fund is properly maintained.
The Reserve Fund Must Be Kept Funded
Properly maintaining the reserve fund is important. Even if the HOA has an adequately funded reserve fund now, it must ensure that it stays that way.
In order to avoid angering homeowners with frequent, modest raises to periodic dues (as is commonly needed to keep up with increased maintenance costs), HOAs have been known to dip into the reserves for regular, ongoing expenses. Sometimes this is due to a board member who obtained a position on the board by promising not to raise dues. Of course, if expenses continue to rise, and the dues stay the same, the HOA’s ongoing use of the reserve fund money will eventually leave the fund empty and the HOA unable to meet its repair and replacement obligations.
Some states have responded legislatively to this problem of HOAs abusing reserve funds. In California, for example, HOAs must, by law, have a reserve fund study completed every three years, have a plan to meet the anticipated repair and replacement obligations, and each year disclose whether the reserve funds are sufficient to meet the HOA’s obligations over the next thirty years. (See California Civil Code §1365-1365.6).
Even if the state you live in does not regulate reserve funds, you should be concerned about whether the HOA in your development (or the one you’re thinking of buying into) has funded and maintains an adequate reserve account. If not, you can expect a major hike in dues or a large special assessment down the road.
If you need help determining whether the HOA in the development you live in (or are interested in living in) has a reserve fund, and if so, how much is held there, a real estate professional in your area can assist you.