For a community to last for generations, its major components – like elevators, clubhouses and swimming pools – all need major maintenance or replacement eventually. The funding for these capital improvements comes from putting a portion of the community’s money into a reserve fund determined by a reserve study. It is more than just another budget item. All board members have to know how to manage their reserve study successfully so that they have enough funding when the time comes to begin a repair or replacement, and board members in Hawai'i specifically need to know how to follow their state laws to remain compliant.
The points below cover both, serving as a primer for new board members or a refresher for seasoned board members leading communities in the Aloha state.
1. Complete or update the reserve study annually. Hawai'i state law requires that the board prepare or update the budget annually, and because the reserve study is considered part of that annual budget it also must be done – or at least updated – annually. Did you re-roof the clubhouse this year? How much did it cost and was the estimate for the expense correct? Information like this needs to be included in your budget every year so that the community can continue to properly fund the reserve fund, even though many boards misunderstand and think that they only need to perform a new reserve study every five years and leave it at that.
2. Indicate which funding method is used in the study. Hawai'i state law requires that associations make it clear whether they use percent funded or cash flow funding analysis for calculating their reserve contribution toward meeting the financial needs of future projects.
Percent funded and cash flow plans are calculated differently in accordance with national standards. With the percent funded method, the replacement costs are calculated per component, and an analysis shows the percentage of the replacement cost that is already funded at a single point in time. For a simple example that doesn’t take inflation or interest into account, let’s say you knew that your association needed to raise $100,000 total in 10 years: $30,000 for painting by 2021 and $70,000 for roofing by 2028. You decided that the funding contributions for 2018 would be $10,000 for painting (a third of the cost since it’s coming up in three years) and $7,000 for roofing (a tenth of the cost since it’s coming up in 10 years). This makes your total reserve fund contribution for 2018 $17,000. If the board actually collects $17,000, you’ll achieve 100 percent funding for the reserve study this year. If the board only collected $8,500 this year due to emergencies or other circumstances, it would have achieved 50 percent funding, which is Hawai'i’s state law minimum.
With the cash flow method, the costs for every asset that will need to be replaced in the next 20 years are estimated. Instead of funding each asset individually, this method treats the reserves as one big pool of money. The board would know that they need to collect $100,000 in 10 years for painting and roofing and would simply aim to collect $10,000 every year for 10 years.
3. Disclose your assumptions and set aside a set amount annually for components of unknown condition. While the board is responsible for obtaining a forecast of the remaining useful life of each community component and its replacement cost in future years, for some items this is impossible. Waste water pipes are a common example, as their condition can’t be easily and economically investigated. In these cases, boards should allocate a set amount of money toward these components annually and disclose that they don’t actually know the true cost, condition or remaining life of the item. This shows that the board is making a good faith effort to prepare the association for all upcoming expenses, even those they can’t accurately define.
4. Separate reserve contributions from maintenance fees as income. Many communities are in the habit of combining regular assessments and reserve study contributions in their accounting. However, by noting each as two separate items on your income sheet, boards can see where each account stands more accurately and homeowners receive a higher level of transparency. The bottom line is that the community will always know how much money is going into reserves on a regular basis.
5. Define reserve contributions on the financial statement as an expense. On the expense side of the accounting equation, make sure your financials include a line item for reserve contributions. This is another way to disclose that the board is meeting this part of their fiduciary duty to the community.
6. Identify all necessary components that should be part of the reserve study no matter what. Sometimes it’s tempting for the board to leave certain community components out of their reserve study in order to make it look more funded. But to have an accurate reserve study, every necessary component must be included. Don’t give in to the temptation to manipulate the numbers.
By following these reserve study recommendations for your Hawai’i association, you’ll ensure that your board stays compliant with state laws and that your community is well-prepared for the future.