How Much Should Condo Associations Have in Reserves?
This is a question that is asked frequently by condo association board members and homeowners. There is really no scientific formula that is applicable to address this question. There are however a number of key factors that help determine the answer.
- Determine Funding Methodology. Does the association want to operate on the principle of full funding, partial funding or under funding for larger scale projects? Ideally, the association should have full funding for ALL projects so that a special assessment would never be required. Practically speaking, this is an unlikely scenario. The worst case scenario is under funding where all projects result in a special assessment. This leaves the partial funding scenario as the most realistic and most typical.
- Reserve Study. Is there a reserve study available? This report typically advises the association on how much to fund the reserves. But most smaller associations don’t have a reserve study. So then what?
- 5 Year Capital Plan. In lieu of a reserve study, have a professional complete a 5 year capital plan. This plan will help the board determine the amount of reserves necessary to properly fund the projects and to most importantly plan ahead.
- Assessment Level/Proper Budgeting. It is essential to properly budget for operational expenses and fund the reserves. The operating budget should result in an excess every year to fund the reserves. This excess is based on the reserve study and/or the 5 year capital plan. In addition, you should fund the reserves with at LEAST 10% of the annual assessment income as a rule of thumb.
- Operating Account Balance. How much should the operating account contain? $500, $5,000 or $25,000? Some experts suggest about 1 month of assessment income for the operating account. It may or may not be sufficient depending on the day to day bills of the association and depending on the number of units in the association. For example, if the association has a boiler system and common hot water tank, this typically means that the association pays a larger amount of money towards the gas utility bills. As a result the operating account will need a larger amount of money versus a building that has individual gas forced air heating units for all the condos.
- Reserve Account Balance. So now that you have a sense of how much should be in the operating account, let’s determine how much should be in the reserves. The exact number is based on the factors that we have discussed above such as the dollar amount of capital projects planned over the next 5 years and perhaps over the next 25 years if you are choosing to strictly follow a reserve study recommendation. And its a function of the type of funding methodology that was discussed in #1.
- Reality is a Factor. Does your association have homeowners on fixed income? Is your association struggling with high delinquency rates? Are you still dealing with developer “abandoned” units? Or in a worst case scenario, perhaps your association doesn’t have the funds to send non paying homeowners to a law firm to initiate the collections process? These are factors that also affect the amount of reserves and savings for condo associations.
- Communication. One of the most important factors to take into account is to make sure all homeowners are kept informed of the situation. This is accomplished by holding properly noticed condo association meetings in accordance with the IL Condo Act.
- Proactive Planning. Assuming all the above steps are properly followed, this will ensure proactive planning. The benefit of this approach is that it will cost the association the LEAST amount of money to take on projects in a planned manner. The most expensive approach is to wait until the last minute when there is a CRISES. This reactive approach will cost the association the MOST amount of money.
- Fiduciary Responsibility. As a former board member, I can honestly say that it is not easy drawing a line in the sand and planning years in advance and stating what high dollar projects will take place. But on the other hand, it is the responsibility of the board to operate the association in the most fiscally responsible manner.
In summary, condo association boards must take into account a number of factors in order to properly fund the association operating budget and reserves. And proper planning and funding results in the least amount of surprises and stress for ALL the homeowners.
About the Author:
Salvatore J. Sciacca aka “Condoboss” is one of the nation’s leading experts in the community property management industry. He is also the President and Founder of Chicago Property Services, Chicago’s #1 community property management company specializing in management and operations of condos/townhomes/HOA’s of 100 units and under. Salvatore is also the founder of managmycommunity.com (MMC), which is a state-of-the-art online support portal for community associations.
With over 20 years of industry experience, Salvatore is recognized for his extensive knowledge of capital planning, preventative maintenance, cost-saving measures and community building techniques. He holds industry stature as a Certified Manager of Community Associations (CMCA), the designation of Association Management Specialist (AMS) and is fully licensed as a manager (License #: 261.001386) through the State of IL.
Salvatore’s contact information is: