How to Use a Reserve Study

Seth Frumkin, Vice President, Operations
Kipcon

The Lay of the Land

A reserve study is a budgeting tool that helps boards plan for the replacement of all of the common-area components when they reach the end of their useful lives. These include mechanical systems, roofing, facades, and parking decks, all of which will ultimately need to be replaced over the course of a 30-year period. When dealing with mechanical systems, it’s a great idea to look at high-efficiency replacements, which will translate into savings in energy costs that far outweigh the minimal increase in cost.

A reserve study takes into consideration the useful lives and the replacement costs of all of these items. It then combines them into a holistic view and makes recommendations as to how much should be set aside each month to reduce the likelihood that the building will run into a deficit, which will lead to a special assessment or the need to borrow money.

A reserve study is divided into two parts – a physical analysis and a financial analysis. First, it’s important to identify which items the board is responsible for. Then we visit the site and examine all of those items. We use a combination of industry-accepted estimates and our experience to determine each component’s estimated remaining useful life.

After the physical analysis is prepared, we use our custom software to divide the components into categories with clarifying notes and photos for each item. With the roof, for example, the report will include the size of the roof, the estimated remaining useful life, and the cost of replacement to determine how much money needs to be set aside over the remaining life of the roof.

Now What?

Next come the funding plans:

1. Current funding. This plan shows what the reserves will look like over the course of a 30-year period, assuming the current yearly funding level is maintained. This can be very scary for a board because it may be exposed to potential deficits when large capital projects, such as roof and boiler replacements, will likely be needed.
2. Full funding. This is the most conservative plan. It involves setting aside the money needed to replace each item, spread over the course of its useful life. So if you know that pavement will need to be replaced in 10 years at a cost of $10,000, full funding advises you to set aside $1,000 per year for the next 10 years.
3. Baseline funding. This plan allows the reserve balance to drop to zero in its lowest year. Baseline funding comes with the greatest risk, especially considering the numerous variables that can arise.
4. Threshold funding. This plan is generated around designating a “no less than” value for the reserve fund, using either a dollar amount or a “percentage funded” amount. This option gives boards the flexibility to determine how much risk they want to take.

Funding plans can be changed as needed. They’re a guide to getting what the board considers as adequate funding. In many cases, minimal incremental increases in funding are used for a number of years so that a big jump is not needed. This is why a professional well versed in preparing these types of studies should always be consulted.

The difference between a reserve study and a capital-needs assessment is that while the reserve study looks at all the elements over a 30-year time period and gives budget numbers for all of the common elements, the capital-needs assessment generally only projects needed replacements for the next five years. In either case, when actually doing the replacement work, boards should consult with an engineer or architect to develop the project’s scope and oversee the work.