Boards and owners alike must balance the need to keep adequate savings for future projects with the desire to keep monthly or quarterly fees at reasonable levels. Most association boards see the importance of savings but often are not sure how much to save.
The Federal Housing Administration (FHA) has weighed in by requiring approved condominium projects to have at least 10% of the annual operating budget set aside for reserves. However, that percentage is arbitrary and is usually never enough for an association that has to paint and replace roofs. Others believe that a community should be at least 70% funded (that is, have 70% of the fully funded balance in a savings account) at all times. However, we have found that 70% funded reserves is insufficient for some communities while others can fund all of their needs by being just 20% funded. Depending on the makeup of the community, its age, and the life cycle of its components, the amount of reserves needed in the bank can vary widely from year to year.
That’s why, in order to answer this question, a board must examine its overall path or plan based on the specific needs of their community. Their current position is certainly an important detail on laying out the path. However, instead of setting a funding goal at a target percent funded level (position), Associations should conduct a cash flow analysis to determine the path they are going to need to take in order to fulfill the long-term needs of the community.
Adequate reserves must be calculated based on the replacement costs and useful lives of the common elements with consideration of the strategic goals of the community. Once the Association determines the likely expenses through a physical analysis of the property, they can look at the cash flow of expenses over time to determine adequate and stable contribution levels for each budget year. The cash flow of contributions should ensure that the reserve balance never drops below a reasonable threshold. The Board should consult with a professional reserve analyst to determine reasonable balance thresholds in these critical years. In some states, Associations are required to keep the balance in these years above zero dollars but a prudent Board will consider a higher threshold as a safety cushion against special assessments. Some Boards will even consider a potential insurance deductible expense and make sure that they have funds in the reserves for emergencies even in their critical years.
While unexpected expenses like insurance deductibles make it difficult to determine exactly how much savings is enough, a prudent cash flow analysis will help guide a Board through their budget planning efforts. Focusing on an arbitrary percent funded value may result in too much or too little in the bank for the predictable expenses.