HOA Reserve Funds: Everything You Need to Know

A crucial responsibility for members of a homeowners association (HOA) Board of Directors is understanding their fiduciary duty. Essentially, this means that Board members are responsible for taking all necessary actions to maintain the financial stability of the association. To meet this obligation, Board members should be well-informed about the HOA’s reserve funds. This includes understanding the purpose of reserve funds, where the reserve account is maintained, and the timing for conducting a reserve study.

In this article, we’ll cover the key aspects related to HOA reserve funds.

What’s the Difference Between Reserve Funds and Operating Funds?

Homeowners associations (HOAs) manage two main types of accounts: the operating fund and the reserve fund. The operating fund, as the name implies, is used for everyday expenses and routine upkeep of the HOA’s assets. This account handles most of the HOA’s regular transactions. In contrast, the reserve fund acts as a savings account, where the HOA sets aside money for larger, more expensive repairs and replacements down the road.

Unfortunately, many HOAs have underfunded reserves, lacking sufficient savings to cover projected future expenses. While not every state mandates reserve studies, it’s a wise practice for any HOA to conduct one at least every few years. A reserve study assesses the state of key assets, estimates when they’ll need repairs or replacement, and calculates the associated costs.

How Much Should Be in Your Reserve Fund?

Ideally, an HOA’s reserve fund should be 100% funded, meaning it has enough money set aside to cover all projected expenses. If full funding isn’t possible, aiming for at least 70% is a reasonable goal. Falling below the 70% mark, however, increases the likelihood that the HOA may need to implement special assessments or raise association dues to meet financial obligations. (We’ll discuss this further in a moment.) This can be an unwelcome surprise for members, who might suddenly face additional costs without prior notice.

What Is the HOA Reserve Fund Used For?

When planning the amount needed in your HOA’s reserve fund, it’s helpful to understand the typical uses for this account.

Generally, HOA reserve funds cover non-routine expenses—costs that arise infrequently but can be significant. While unexpected expenses vary, common uses of HOA reserve funds include:

- Large landscaping projects

- Building or installing a new community playground

- Replacing the pool pump or other costly pool repairs

- Replacing the roof of the clubhouse or other shared buildings

- Painting common areas and HOA structures

- Significant fence repairs or replacements

- Other major construction projects, such as sidewalks

These examples provide a sense of when to tap into reserve funds versus the regular operating fund.

Why Are HOA Reserve Funds So Important?

Why is it essential for an HOA to maintain a well-funded reserve? In short, HOA Board members are tasked with the ongoing upkeep of the community, including all common areas. This not only involves daily operations but also preparing for unexpected or urgent expenses that may arise.

For instance, what if the clubhouse roof starts leaking or the pool pump breaks down just as swimming season begins? These issues can disrupt residents' quality of life, and the community will expect prompt repairs. HOA reserve funds ensure that the Board is financially prepared to cover these costs.

Reserve funds are also critical for handling unexpected repairs caused by natural events, such as hurricanes, tornadoes, or flooding, especially in regions prone to these risks.

In addition, reserve funds aren’t limited to emergencies. They can be used for approved upgrades or improvements to shared areas, benefiting the entire community. These types of projects are often too costly to fund through routine operating expenses, so a healthy reserve allows the Board to manage such initiatives without needing to raise funds or take on debt.

What Is An HOA Reserve Study?

An HOA reserve account should ideally have enough funds to cover all anticipated expenses; for example, if it’s known that the clubhouse roof will need replacement in a few years, this should be factored in.

However, no HOA can predict every repair or maintenance need. This makes it difficult to set an exact reserve fund amount. Instead, informed estimates are necessary.

To guide these estimates, regular HOA reserve studies are recommended. A reserve study provides the Board with a clearer understanding of how much should be in the reserve fund. Generally, it’s advisable to conduct one every three to five years.

Reserve studies typically involve a detailed inspection of the HOA’s property and features. This physical assessment helps anticipate upcoming repair needs, while a financial review assesses the HOA’s current fiscal health and reserve stability.

Since reserve studies are highly technical, they’re usually conducted by external professionals with the necessary expertise. A property management company can often connect you with qualified professionals for this purpose. At Your Real Estate Needs, we’re always available to discuss reserve funding and help answer your Board’s questions.

What Happens When HOA Reserve Funds Fall Short?

Given the importance of HOA reserve funds, it’s clear that an underfunded reserve can create serious risks.

HOAs should strive to keep their reserves as close to fully funded as possible; while a 100% funded reserve is ideal, a reserve fund at 70% is still manageable.

If a reserve fund isn’t adequately funded and emergency repairs become necessary—such as after a severe storm—the HOA may struggle to cover the costs. When this happens, HOA Boards have limited options for making up the shortfall, and most of these solutions are less than ideal.

What to Do When Your HOA Lacks Reserve Funds

When an HOA’s reserve fund is underfunded, the options to cover unexpected costs are often challenging:

1. Increase HOA dues – While this is one way to build up reserve funds, it’s not without issues. Homeowners may be unhappy with the increase and may question why the reserve fund wasn’t maintained sooner. Additionally, it can take time for a dues increase to generate the funds needed for urgent repairs, so it won’t fix the problem overnight.

2. Issue a special assessment – A special assessment is a one-time fee on top of regular dues, intended to cover specific expenses. While this can quickly raise funds, it’s often unpopular and may lead to homeowner dissatisfaction, especially if they feel the Board hasn’t managed reserves well.

3. Seek external financing – HOAs can take out loans to cover gaps in the reserve fund, but this option adds debt and increases future expenses. Loan repayments can strain the HOA’s budget, reducing financial flexibility and potentially leading to a dues increase or special assessment later.

Ultimately, fully funding HOA reserves is essential to avoid these difficult choices. Regular reserve fund evaluations can help prevent shortfalls. If you’re unsure how to start, consider consulting your property management team for guidance.

HOA Reserve Funds: Key Tips

If you're just beginning to address HOA reserve funds, here are some tips to help you manage them effectively and strategically.

- Seek expert assistance – Reserve fund management requires specialized knowledge. If no one on your Board has experience, consider consulting a professional. Your property management company is often the best resource for this expertise.

- Consider reserve funds when hiring – When selecting a management company, ask about their experience with HOA reserves. A knowledgeable company can help you build and maintain a solid reserve fund.

- Make gradual adjustments – When adjusting budgets or raising dues, smaller, gradual changes are usually more manageable for members than sudden, large increases. Members are more likely to agree to a small monthly increase than a large, unexpected expense.

- Be transparent – Open communication is essential. Reserve funds belong to the community, so members should be informed about the fund’s balance and how it’s used.

- Keep an eye on common areas – While you can’t predict every repair, regular monitoring of common areas can help identify potential issues before they become urgent.

- Prioritize preventative maintenance – Investing in routine maintenance can often reduce the need for major repairs. A preventative maintenance program aligns well with regular reserve studies to keep the community’s infrastructure in top shape.

Following these guidelines will set you on the path to effectively managing your HOA’s reserve funds.

Content provided by Kuester Management Group - Thanks to them!!