The Critically Important Reserve Account

Unfortunately, in common interest developments the reserve account is often overlooked or even deliberately ignored as unnecessary. This is unwise, because the reserve fund is a critical component of the healthy HOA. Several major myths persist.

MYTH – It’s not required by law, so it is optional

California law does not expressly require that associations put money into a reserve account. However, it does require that such an account exist, that the board review it at least quarterly, that the association periodically obtain an analysis report (“Reserve Study”) of the reserve funds needed, and that detailed disclosures be made annually to members and to prospective buyers.

While state law does not require funding, federal lending guidelines since 2009 do. One requirement for condominium projects to be eligible for FanniMae or FHA loans is that 10% of the annual budget is deposited into the reserve account.

California Realtors® have been concerned for years that the price of HOA residences was unaffected by the presence or absence of reserve funds, despite that logic would dictate that homes in well-funded HOAs would be worth more than poorly funded HOAs. This led to several new laws (thanks to C.A.R. sponsorship) – expansions in disclosure requirements, including more detailed disclosure of the money it has actually accumulated for each building component (Civil Code 1365.2.5) and requiring boards have a plan regarding how it will accumulate the money recommended by its reserve study (Civil Code 1365.5(e)(5)).

MYTH – We can’t afford it

Many associations suspend reserve fund deposits, based on the belief that this helps hold assessments down and protects the members. However, every day, the project components (roofs, paint, decks, and so on) are deteriorating, and there is a cost accumulating for the HOA each and every day – there isn’t a bill, but it is a hidden debt being incurred. If money is not set aside, the HOA steadily falls into debt and endangers the members – and the day will come when the bill “becomes due” and new roofs are needed.

MYTH – We should put that money to good use, it isn’t doing any good.

I attended a meeting once where someone stood up and said the board was doing a horrible job, because that “reserve money is just sitting there” and should have been put to better use. But the money IS being put to good use — it is protecting the HOA (and you).

MYTH – We’ll address it all later

Many associations, like Scarlett O’Hara, would simply rather deal with it all later. But when major repairs are needed, if the HOA has not accumulated refurbishment funds, it has two choices – have the members pay a major special assessment, or get a bank loan (officially putting the HOA into debt). The assumption is that a loan can be obtained, but what if the HOA is not approved for a loan?

State Consumer Warning (!)

On September 21, the California Department of Real Estate issued a “Consumer Warning: Underfunded Homeowner Associations” (read it at www.dre.ca.gov or www.hoahomefront.com). It is worthwhile reading for Realtors, HOA directors, managers, and, yes, anyone thinking about buying into an HOA.

We know that it is a bad idea to live on credit cards, building up debt, so why is it OK for HOA’s? Of course, it is not OK. Boards must take responsibility and protect their associations’ solvency.

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®.