Reserve account realities: what the HOA industry won’t tell you

By Deborah Goonan, Independent American Communities

Homeowners’ association industry trade groups have been beating the drum about the importance of strong reserve accounts for many years. It seems like common sense advice for HOAs to plan for future expenses.

But planning for future financial solvency is not as simple as reserving at least 10% of the Association’s monthly, quarterly, or annual fees. There are several important factors to consider, which I’ll explain in this article.

But first, I’ll summarize the HOA-industry’s promotion of reserve studies and bank accounts.

What is the purpose of HOA reserves?

Reserve experts tell us that owners in HOA-governed communities should be paying higher assessments, setting aside part of their fees for inevitable repair and replacement of common elements.

Specifically, condo and co-op association members should be saving money toward big jobs such as a roof replacement, elevator maintenance, new floor coverings in the lobby or hallways, repair and upkeep of exterior surfaces, plumbing repairs, and so on.

Property owners in planned communities will eventually need to take on expensive construction projects such as dredging retention ponds or canals, resurfacing private roads, refreshing landscape plantings, or removal of hazardous trees.

Community amenities eventually wear out, too. Therefore, HOA reserve specialists often recommend that the Associations set aside money for things like renovating the club house, re-lining the community swimming pool, replacing exercise, playground, or sports equipment, rebuilding dams, retaining walls, and bulkheads.

The list varies, depending on the nature of recreational facilities in the community.

Some financial experts also recommend that your HOA reserve money to cover insurance deductibles and copays. Then if your condo association experiences damage from a fire, a hurricane, a tornado, or earthquake, owners wouldn’t have to scramble to come up with hundreds or thousands of dollars out of pocket to pay for non-covered insurance expenses.


The case for HOA reserves

It’s a well-known fact that most condo, co-op, or homeowners association reserve accounts fall short of the funds needed to repair and replace common elements when needed.

When that happens, the two most likely outcomes are:

  • deferred maintenance, deterioration of the community, and decreasing property values, or
  • the HOA must raise the funds needed through special assessments or loans, if they qualify.

Of course, neither outcome is favorable for most homeowners.

So the HOA-industry recommends that all HOA-governed communities conduct periodic reserve studies, at least every three to five years. Based upon the study, the HOA is supposed to follow the expert’s recommendations and begin the process of collecting money and funding a reserve account.

In general, it’s a good idea to save money for a rainy day.

But first, each HOA must answer two critical questions.

How much money should your HOA save? Where should your HOA keep its reserve account?


How much money to save in HOA reserve account

Here’s where things get complicated.

The first thing homeowners need to consider is how “replacement cost” estimates are determined for your HOA community.

To avoid conflicts of interest, it’s essential that your reserve specialist has no direct ties to the HOA management company, the developer, construction companies, or service vendors that would do repair and replacement work for the community.

If the professional inspecting the common elements and crunching the numbers has professional relationships with anyone other than HOA homeowners (the housing consumers), then beware of inflated or understated replacement cost estimates.

Think about it.

A reserve specialist who works for a developer, at the time of HOA turnover, is more likely to understate the recommendation for replacement reserves. That’s because the lower the perceived “need” for reserves, the less money the developer is expected to contribute at the time of turnover.

Conversely, if a reserve specialist works in tandem with your management company or in conjunction with construction or restoration vendors, watch out for inflated repair and replacement cost estimates.

Keep in mind that, unlike your city or county government, most HOAs are not required by law to follow a competitive bid process for contracts. And, even in states with legal requirements for at least two or three bids, there’s no specific process for soliciting, handling, or awarding bids.

The end result — ample opportunities for “referral” fees and kickback schemes, which inflate the cost of contracts, as well as future estimates used in reserve planning.


Where to safely keep HOA reserve accounts?

As countless examples of HOA corruption and embezzlement illustrate, bank accounts aren’t necessarily secure.

The key consideration is limiting and securing access to your HOA’s bank accounts.

If your HOA board allows your management company or agent to deposit funds in their account, or a management company affiliated financial institution, beware.

Such an arrangement removes important safeguards against theft and misappropriation of funds. This is especially true if your HOA management agent has bank accounts in its name, with signature authorization, and sole access to all bank statements.

It becomes incredibly easy for an opportunistic manager, bookkeeper, or accountant to move money out of your HOA account, and then present the board with fake financial reports to hide the missing money.

For the same reasons, it’s unwise to give a single board member, such as the Treasurer, sole access to all of the HOA’s money — especially a reserve account.

In some cases, two or more board members, or a board member and a management agent work in tandem to skim money from HOA bank accounts. And by the time homeowners figure out that something’s wrong, a large chunk of the Association’s money is gone.

The bigger your HOA’s reserve account, the more likely it is to be viewed by a thief as the pot of gold at the end of the rainbow.


Take Precautions to protect HOA reserve account

If your HOA chooses to have a reserve account, be sure to institute multiple layers of security to prevent loss.

Require at least two board member signatures on all checks and payments, but send the bank statements to a third board member for review and reconciliation. Actual disbursements and invoices should match bank transactions.

Make sure that your board members visit the bank where you deposit funds, and get to know the manager and staff personally. Update signature cards each time there’s a transition in board members.

Arrange for board members to have online access to account information, and set up automatic alerts for suspicious transactions.

Conduct regular independent audits, and be sure to choose an auditor who is not affiliated with the management company, the developer, or a board member.

These and other essential tips are easily found by doing an internet search on “preventing embezzlement” or “fraud prevention.”


Why so many HOAs don’t bother saving money in reserve

Put simply, some owners prefer to hold onto their cash as long as possible, and pay special assessments only when absolutely necessary.

Consider the following types of HOA members.

Short-term owners: This group could include investors, landlord-owners, or owner-occupants who anticipate selling their property within a few years. They aren’t concerned about saving money for a roof replacement or private road replacement in 15 or 20 years. The less money they spend on HOA assessments now, the better the return on their investment when they sell.

Owners with high net worth: Most of these owners don’t live in the community full-time. They’re likely to be seasonal residents, or might only use the property occasionally for vacation. Most of their money is tied up in investments with a favorable rate of return. They’d rather not park any of their money in the HOA’s reserve account, where they won’t earn any interest or dividends. They can well afford a special assessment when needed.

Older adults, retirees: Living on fixed incomes, most of these owners will balk at paying even $20 a month extra to set aside for HOA reserves. Besides, many assume (incorrectly) that they’ll be long gone before the HOA imposes a special assessment.

Insiders: This includes the developer, business affiliates, board members and other in-the-know owners. They know the when the HOA plans to begin a major construction or renovation project, before all the other HOA members. They’ll put their house on the market and sell before that happens, dumping the financial burden on new homeowners.


The HOA assessment trap

Clearly, most HOA-governed communities have a sufficient number of the above reserve-fee-resistant property owners. More often than not, these members exert political pressure in the community to keep HOA assessments as low as possible, for as long as possible.

It’s no wonder so many homeowners with limited financial resources get caught in the HOA special assessment trap.

The situation is made even worse when the HOA approves over-priced contracts, or when HOA vendors successfully up-sell the board with unnecessary “improvements” or “upgrades.”

(This is one of the most common complaints I hear from homeowners.)

An expensive HOA project gets approved, and high HOA fees are assessed. The owner who cannot afford to pay high fees may be forced to sell at a loss. It could be the only way to avoid foreclosure by the HOA or the lender.

Which brings us back to the need for a “well-funded” HOA reserve account.

If only everyone in the HOA could agree on exactly what that means. ♦




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