Reader Questions - Can We Skip the Reserve Account?

Dear Mr. Richardson,

I am wondering, are HOAs required to have a “Reserve” account or it is just recommended?

Thank you,

P.P. Rancho San Diego

Dear P.P.,

Reserve accounts are intended to be a critical protection for common interest development homeowners, particularly in attached housing developments. The Davis-Stirling Common Interest Development Act has many requirements regarding reserve accounts.

Associations must have a reserve study every third year, under Civil Code 5550, identifying the estimated replacement date and cost of major components which are association responsibility. Under Civil 5550(b)(5), the study must include a funding plan indicating how the association will fund the annual contribution needed to amass the funds needed for replacement of the items.

Under Civil 5560, association boards are required to adopt the funding plan at an open meeting of the board, along with any consequent assessment increase. Civil 5570 requires a detailed disclosure report detailing how close are the major components to requiring replacement, along with how much reserve fund has been accumulated to meet that future cost. The Annual Budget Report (Civil 5300) contains seven different disclosures associations must make annually to the members, including a summary of the reserves (5300(b)(2)), and a summary of the board’s funding plan (5300(b)(3). Civil Code 5500 requires the board review association operating and reserve accounts (and deposits and withdrawals) at least quarterly.

All of these statutes imply that associations must have a reserve fund in place, since the various requirements all assume a reserve account is in place.

There is no law specially requiring reserve accounts to be actually funded in any particular amount. This is sensible, since there is no “one size fits all” answer for common interest communities, and so many factors bear upon what is a properly funded association. The condominium lending guidelines of FHA/FNMA require at least 10% of the annual budget to go into the reserve account, a reflection that those lending organizations consider reserves to be critical.

Many associations do not follow their reserve study preparer’s recommended reserve account contributions because the board is trying to “hold the line” on monthly assessments. However, this misleads the homeowners, since the association is then quietly slipping into debt, and the members are likely to be hit with a special assessment and/or loan payments when major replacement work is needed.

Each month the roofs, asphalt, paint, decks and other items deteriorate. For example, a “ten year roof” probably has an expected life of 120 months. If the association is not depositing 1/120 of the cost each month into reserves, it is falling into a deficit each month on that item. The fact that homeowners don’t feel it, or see it on a financial summary, does not mean it is not a financial fact.

Homebuyers need to be very careful to review the association’s reserve status before they decide to buy, and should be aware of the fact that their appraisal will not take into account the health of the HOA’s reserve fund. This means that the true value of the property may not be presented in the appraisal, since unfortunately the marketplace does not adequately devalue the price of underfunded condominium association residences.

Urge the board to faithfully attend to the association’s reserves.

Thanks for your question,
Kelly

Written by Kelly G. Richardson

Kelly G. Richardson Esq., CCAL, is a Fellow of the College of Community Association Lawyers and a Partner of Richardson | Ober | DeNichilo LLP, a California law firm known for community association advice. Submit questions to [email protected]. Past columns at www.hoahomefront.com. All rights reserved®.