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? The regular dues probably won't be enough to cover such unhappy surprises. At such times, the HOA's reserve fund comes into play.
Just as you probably set aside some savings to pay for major unexpected expenses such as repairing a car or fixing a plumbing leak, an HOA commonly maintains a type of savings account called "cash reserves" or a "reserve account" for large, infrequent, or unexpected common-area costs. Let's take a closer look at why homeowners should, rather than resisting paying dues that go into such reserves, embrace the concept and even keep an eye on whether the HOA board is setting aside adequate reserves.
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&Rs), and any separate rules and regulations).
The governing documents typically obligate the HOA to maintain, operate, and repair and replace the common areas; that is, the parts of the property owned jointly by everyone who has purchased a home there, which they all have a right to use. Pools, clubhouses, and parks are examples of common areas found in many developments. In a more upscale development, the common areas might also include entrance gates, fountains, spas, and so on.
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 expenses depend partly, of course, on how many common areas the development contains, and the amenities offered. For instance, the HOA might 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 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 swimming pool.
Just as you might have a formula for maintaining a certain amount in your personal savings account for emergencies (three to six months' worth of your salary is usually recommended), the HOA must determine an appropriate amount to put in its reserve fund. An HOA commonly has an outside accountant prepare a "reserve study," setting 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.
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 a 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.
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 by mandating that HOAs keep a reserve fund. 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 30 years. (See California Civil Code §§ 4177, 4178, 5510, 5515, 5520, and 5570).
Even if the state you live in does not regulate reserve funds, you should be concerned about whether the HOA governing your development (or the development you're thinking of buying into) has funded and maintains an adequate reserve account. If not, you can logically 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.