Tag Archives: pooled reserves

Reserving Funding Requirements and the Procedures for Waiving Reserves in Florida Condominium Associations

Posted on March 4, 2014 | 108 Comments

Florida law is very clear: every association must fully fund reserves unless a vote to waive reserves is obtained. This post will review the reserve funding requirements detailed in the Florida Statutes/ Florida Administrative Code and the process for waiving reserves.

Reserve Funding Basics

NOTE: There are specific requirements for developer-controlled condominiums and multicondominiums that are not discussed here.

Section 718.112(2)(f) of the Florida Statutes and Rule 61B-22.005 of the Florida Administrative Code require ALL Florida condominium associations to fund reserve accounts for deferred property maintenance and replacement projects. Specifically, a reserve account must be established for roofing replacement, property painting, asphalt paving, and any other project that has an anticipated cost of greater than $10,000.

For each identified project, the association must identify the anticipated date and cost of the project. For example, a community’s roof may have an estimated remaining useful life of 10 years and replacement cost of $50,000. Therefore, in 10 years, the association will need to have $50,000 in the roof reserve account to pay for the replacement.

The association must calculate annually the amount it needs to contribute to its reserve accounts and include this amount in the budget. Generally, associations will collect one maintenance fee payment from each unit owner monthly or quarterly and deposit it into an operating account. From there, the percentage of maintenance fees allocated to reserves per the budget is transferred into a separate reserve account. Reserve and operating funds may not be commingled for more than 30 days from the date of receipt of a maintenance fee payment. As such, if an association receives maintenance fees monthly (quarterly), they must contribute the appropriate amount to their reserve funds monthly (quarterly).

NOTE: There are two ways to look at monthly or quarterly reserve funding. Let’s look at an example. An association has a $100,000 annual budget with $20,000 (20%) allocated to reserve funding. The association requires maintenance fee payments monthly. In a given month, the association should received $8,333 in maintenance fees ($100,000/12) of which $1,667 is allocated to reserves ($8,333*20%). Let’s say in January the association actually received $7,000 in maintenance fees (several units failed to pay). The association could choose to fully fund the reserve account that month by transferring $1,667 dollars of the maintenance fees received to a reserve account. Or, the association could choose to only transfer $1,400 ($7,000*20%) to a reserve account, as they have not yet received the maintenance fees that would have contributed the remaining $267 ($1,667-$1,400) in reserve funds. The majority of associations (and management companies) choose the first option, ensuring that reserves stay fully funded. Both are acceptable per the law in my opinion. While the first option is preferable, if there is a situation where a large percentage of unit owners fail to pay maintenance fees and contributing the full budgeted monthly amount to the reserve account would hinder the association’s operations, then the second option may be best.

Florida law specifies two acceptable methods for calculating the necessary annual reserve contribution: pooling or straight line (component). We have discussed these two methods as well as the pros and cons of each here.

Recap: So, we know that condominiums must budget for sufficient reserve funds to pay for all long-term maintenance and replacement projects greater than $10,000. Further, we know that the annual reserve contribution necessary is based on the expected timing and cost of each project using one of two calculation methods (pooling or straight line). Great. But how does a board know exactly what projects greater than $10,000 will need to be done, when they will need to be done, or how much they will cost?

This is where a reserve study comes in. A reserve study is a professional engineering survey of your property. The reserve study firm will examine the property and determine what major capital maintenance and replacement projects will need to be done in the next 30 years. The study will provide expected costs of each project and expected timeframe for completion. While there is no specific requirement in Florida law that associations obtain a professional reserve study, I don’t see any way for a board to properly determine annual reserve contributions without one. I recommend a reserve study be completed every 2-3 years. Prices generally range from $3,000 – $6,000 for an initial study with a reduction in price for study updates completed by the same firm. To ensure the association always has the funds to complete routine reserve studies, I recommend including a reserve account for the study itself.

NOTE: If you need a good reserve study firm, I have had great success with Reserve Advisors.

Waiving Reserve Contributions

For those communities where, for whatever reason, fully funding reserves is infeasible, Florida law provides the option to reduce or eliminate reserve funding. Here’s how it works.

Every year, the board must present a proposed budget to the community assuming full reserve funding. The association cannot hold a vote to waive or reduce reserve funding until after a proposed budget with full reserve funding has been provided to the membership. If the board would like to put a vote on the table to reduce or waive reserves funding, then they should provide (along with the proposed budget which must be distributed 14 days prior to the budget meeting): (1) a second budget with waived or reduced reserves and (2) a limited proxy to be filled out by unit owners specifically requesting the membership to vote on the second budget. The proxy must include the following wording per Florida Statutes:

WAIVING OF RESERVES, IN WHOLE OR IN PART, OR ALLOWING ALTERNATIVE USES OF EXISTING RESERVES MAY RESULT IN UNIT OWNER LIABILITY FOR PAYMENT OF UNANTICIPATED SPECIAL ASSESSMENTS REGARDING THOSE ITEMS.

To successfully reduce or waive reserve funding, a majority of the membership (i.e., 51% of unit owners) must vote in favor of the reduction/ waiver.

If by the time of the budget meeting arrives the association has received insufficient votes, the board may delay approving the budget to attempt to collect more votes. Of course, realistically, the board may only postpone so much as the budget should be approved in time for coupon book deliveries prior to year-end. Further, the limited proxies are only valid 90 days from the date of the first scheduled budget meeting. So, if your association would like to vote to waive reserves but getting sufficient unit owner participation will be a struggle, it may be worthwhile to set the budget meeting earlier in the year than you would otherwise.

If a majority vote is not obtained, the board must approve the budget with full reserve funding. If a majority vote is obtained, the board must proceed with the waived or reduced reserve funding. It is important to note that any vote to waive or reduce reserves is only effective for one annual budget. Therefore, the vote must be obtained for every year the board would prefer not to fully fund reserves.

Why Fund Reserves?

Arguably one of the biggest problems facing condominium associations today is the failure to fully fund reserves. Many associations put little to no money aside, creating project delays and large special assessments. With the primary focus being low maintenance fees, boards can easily loose sight of the big picture reasons to fund reserves.

Let’s look at our roof example. The community’s roof has an estimated remaining useful life of 10 years and an anticipated replacement cost of $50,000. If an association does not put aside money routinely in a roof reserve account, then the unit owners would likely have to pay a $50,000 special assessment in 10 years. This is a negative outcome in several ways:

  1. Hesitancy to issue a special assessment or difficultly collecting the special assessment may lead to delays in project completion and further deterioration of the roof (i.e., more roof leaks which cost money to repair.
  2. The special assessment will be a burden on the unit owners.
  3. A special assessment is unfair in that prior unit owners did not have to contribute any money to the roof (though they benefited from it) while current unit owners have to pay for the entire thing. This creates an inequitable distribution of expenses.
  4. Limited reserve funds and a history of special assessments will drive away buyers, keeping home prices lower than they otherwise would have been.

I strongly recommend that every board fully fund reserves. If a board does not feel that full funding is feasible right away, they should still contract for a professional reserve study and establish a long-term plan for achieving full funding by gradually increasing reserve funds each year.

I hope this overview of condominium reserve funding was helpful.

Please let me know if you have any questions,

Emily

 Emily Shaw is a condominium homeowner in Tampa, Florida and a Director of VERA Property Management, a firm providing full-service community association management in the Tampa Bay Area as well as consulting, financial and legal services to all Florida community associations. 

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Condo Association Reserve Funding: Component Method or Pooling Method

Posted on July 2, 2013 | 43 Comments

Anyone who has been involved with condominium associations knows about reserve funding. Chapter 718.112(1)(f) of the Florida Statutes requires that all associations put aside funds for large future projects such as building painting, roof replacement and any other project expected to cost more than $10,000. The amount of money that the association is going to contribute in any given year to reserves is included in the annual budget and is based on the expected cost and timing of future large projects. As Board members are not generally qualified to determine the remaining useful lives and replacement costs of the various parts of the condominium property, it is imperative that the Association hire a professional engineering firm that will complete a reserve study of the property and provide guidance to the Board. Reserve studies should be updated every 2-3 years to ensure that all estimates are still accurate. There are many different reserve study firms out there but I have had good experiences with Reserve Advisors in the past.

There are currently two different methods used to account for reserve funds. Below I have provided a brief comparison of the two methods.

The first method is called the Component or Straight Line Method. Here are several important things to consider about this method:

  1. Each maintenance project has its own reserve account and annual contributions to each account are determined by taking the current year’s project cost, subtracting the current value in the reserve account, and dividing it by the remaining useful life of the item.
  2. Once money is allocated to a specific reserve account, the Board cannot utilize those funds for any purpose other than that particular project without a majority vote of the homeowners. For example, if the Board has allocated $200,000 to the building painting reserve account based on expected cost, and the project’s actual cost only ends up being $150,000, they cannot use that additional funds for any other purpose. The extra $50,000 would be the initial value of the reserve account for the next time the buildings need to be painted. Likewise, if the project’s actual cost was $250,000, the Board cannot use reserves from any other reserve account to cover the additional $50,000 without a vote of the majority of the homeowners.
  3. Interest earned on reserve funds is kept separately and can be used for any reserve project.
  4. By using the current year project cost, as opposed to the expected project cost at the time of completion, this method does not take inflation into account. For projects that are expected to be completed in 1 or 2 years, this has a limited effect; however, for projects that are not expected to be completed for 15 or 20 years, this can cause an underestimation of the project cost.
  5. Expected interest that the reserve funds will earn is not taken into account in the association’s budget. If your association has material reserve funds, annual interest earned can be a material amount of money which, when using the component method, cannot be included in the reserve contribution calculations. Therefore, in essence, homeowners have to contribute more (the amount of interest earned annually) to the reserve accounts annually under the component method than they would if interest could be taken into account.

The second method utilized is called the Pooling or Cash Flow Method. Here are several important things to consider about this method.

  1. This method is similar to the component method; however, instead of having individual reserve accounts for each project, there is one pool of funds that can be used for any reserve project.
  2. Inflation is taken into account. For example, if a project is scheduled for two years from now, the current estimated cost of the project is $100,000, and annual inflation is expected to be 1%, then this method would require that the reserve pool have $102,010 available two years from now to complete the project. This is calculated as follows: $100,000*(1.01)^2.
  3. Earned interest is included in the reserve pool and anticipated future interest is taken into account. For example, let’s say that the reserve funds are held in a money market account with a .5% annual interest rate. If the pooled reserve account currently has $300,000, annual interest could be roughly estimated at $1,500. This is $1,500 that does not need to be contributed to the reserve pool from maintenance fees.
  4. Reserve studies anticipate property projects thirty years into the future and provide a schedule of annual reserve contributions for each of those thirty years. These schedules are set up to increase by no more than the estimated rate of inflation annually.

The following is an example that shows how the component and pooling methods would work in the same situation. Let’s assume the time has come to replace the roofing on all of the property’s buildings and the reserve account for this project has $250,000. Let’s also assume that the total amount of reserve funds for all projects is $750,000. If the actual cost of the project is $300,000, under the component method, the Board has several options. (1) The Board can wait to do the project until there is $300,000 in the roofing reserve account. If the roof replacement is urgent due to leaking or other issues, this may not be a feasible option. (2) The Board can issue a special assessment on the unit owners to make up the $50,000 deficit. (3) The Board can wait until the following year and increase maintenance fees substantially to make up the $50,000 deficit. (4) The Board can have a homeowner vote to take $50,000 from a different project reserve fund. This 4th option would require at least 51% of the homeowners to vote. Under the pooling method, the Board would be able to pay the $300,000 out of the $750,000 total reserve funds to complete the project in a timely fashion. The Board would then need to determine how to earn back the extra $50,000 that was used for the roofing project over future years. This could be done through an increase in reserve contributions in future years or, if lucky, another reserve project(s) will cost less than estimated. In the end, the pooling method provides significantly more flexibility to the Board and allows for more efficient project completion. However, it is also possible that the Board could decide to approve a $400,000 roofing proposal even though only $250,000 has been allocated for this project and, in doing so, could set up the community to not have enough funds down the road to complete the next big reserve project. In this case, a special assessment may be required which puts and unfair financial burden on the current homeowners.

So which method is right for your community? That decision is up to the homeowners. In order to switch from the component method (the method the majority of associations use) to the pooling method, a majority vote of the membership is required. If you are considering a switch to the pooling method in your community, there are several things to consider:

  1. When was the most recent reserve study completed? You should obtain a current reserve study using both the pooling and component methods to compare the required annual reserve contributions (typically the component method calls for higher contributions as it is the more conservative approach). If you are trying to avoid an increase in maintenance fees, switching to pooled reserves may help in that effort; however, this should not be the primary factor when deciding whether or not to switch to pooled reserves.
  2. Is the current Board fiscally responsible? Will future Boards be responsible with reserve funds? Pooled reserves allows the Board much more flexibility in reserve spending and, in the case of an irresponsible Board, this can lead to overspending.
  3. Is there a Board member that is comfortable enough with Excel to take the thirty year reserve schedule and adjust it based on actual project costs, changes in interest and inflation rates, and/ or changes in annual reserve contributions? This is very important because before a Board can decide if they should spend more on a particular project than estimated, or if they should complete a project sooner than anticipated, the impact on the reserve pool and future reserve contributions will need to be analyzed. You may be able to have the engineering firm that completed your reserve study complete this analysis for you but there would likely be a fee involved.
  4. How many reserve projects does your property have coming up? If you have a large property with many reserve projects, pooling reserves may benefit your community. Let’s examine why. Large communities may have one or two reserve projects annually and maybe more on rare occasions. If the community uses the component or straight-line method, they can only look to the reserve account for that particular project, and the earned interest account, when determining how much they can spend on that project. If the Board does not have sufficient funds in these accounts to complete the project and they don’t want to use operating funds or issue a special assessment, they may want to use some funds from a different reserve account (one that they think is overfunded or one that has funds remaining after a recently completed project). In order to do this, they would need a majority vote of the membership. Given that the estimates used to determine how much should be reserved for each project can often be inaccurate, it is possible that the Board could need multiple votes of the membership each year to move money between accounts in order to complete reserve projects. If your community is very active and obtaining a majority vote of the membership is easy to do, then this is no problem. However, in many communities, convincing a majority of the homeowners to submit a limited proxy can be a very time consuming task.

This post only serves to provide a brief overview of reserve funding methods. If you need any assistance in determining what the best path is for your community, feel free to email me.

Emily

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