Reserve Study – What It Is And Why You Need One

Any home buyer considering a property subject to a homeowners’ association (HOA) should be concerned about whether the HOA has sufficient “reserves”.  Reserves are a HOA’s savings or rainy day fund.  The reserves can be used to fund unexpected expenses or expenses above and beyond routine costs.  In order to assess whether the HOA has sufficient funds to cover anticipated (and unanticipated) expenses, a prudent home buyer should insist upon obtaining a reserve study during the escrow process.

What Is A HOA?

A HOA is a legal entity that creates and enforces rules governing a common interest development, e.g. a building containing condominium units or a complex containing townhomes.  Prior to subdividing and selling units of a common interest development, the developer will generally incorporate a HOA and record the Covenants, Conditions, and Restrictions (CC&Rs) that set forth the rules governing the development.  Each unit is subsequently sold subject to the authority of the HOA to enforce the CC&Rs.  The rules vary, but often contain restrictions on how a property can be used, restrict how and when modifications can be made to the property, and set forth the procedure for the HOA to enforce the CC&Rs.  HOAs are also often responsible for maintenance and upkeep of common areas and services such as the building structure, exterior paint, walkways, gates, roofs, pools, gyms, and parking lots.

How Does A HOA Pay For Its Expenses

In order to generate the funds necessary for the HOA to execute its duties, HOAs impose a monthly fee on each subdivided unit.  Each HOA’s monthly fee varies depending on the services it is required to provide.  A HOA that simply maintains walkways and plants will often charge as little as $100 per month, while HOAs that provide luxury services such as valet, pool cleaning, gym maintenance, etc. often charge in excess of $1,000 per month.  The fee is typically designed to cover expected maintenance costs as well as to build a reserve fund to pay for unexpected or atypical significant expenses.

In addition to paying for routine costs, HOAs are also generally required to pay for other significant and less routine expenses, such as replacing a roof or retrofitting a building’s structure.  HOAs have two methods of generating the funds necessary to pay for these expenses: (1) impose a “special assessment” on all the HOA members, i.e. collect a specified fee in addition to the monthly HOA fee or (2) tap into the HOA’s reserve account.

Importance Of A Reserve Study For Buyers

Given that owners of units subject to a HOA are required to fund the HOA, any purchaser of a property subject to a HOA should be aware of the monthly HOA fee as well as the funds available to the HOA in its reserve.  Purchasing a property subject to a HOA that does not have sufficient reserves presents the risk that the purchaser will be subject to a significant and unexpected special assessment shortly after purchasing the property.

One of the ways to determine whether the HOA has sufficient funds in its reserve is to obtain a reserve study.  According to Wikipedia, a reserve study is “a budget planning tool which identifies the current status of the reserve fund and a stable and equitable funding plan to offset ongoing deterioration, resulting in sufficient funds when those anticipated major common area expenditures actually occur.”  A reserve study typically involves an analysis of the physical components of a building for which the HOA is responsible, as well as an analysis of the potential cost of replacement of those components and whether the HOA has sufficient funds to cover those costs.

California Civil Code section 5550 requires that every HOA conduct a reserve study at least once every three years.  There are various exceptions to this rule for commercial properties, developments with no common areas, and developments with minimal replacement costs.  However, there is no “reserve study police” that enforces the reserve study requirement, and thus many HOAs, particularly in smaller developments, do not obtain a reserve study every three years.

Make The Reserve Study A Component Of Your Due Diligence

Sellers are typically required to make disclosures regarding any HOA governing a property.  Buyers should be on the lookout for the reserve study in those disclosures.  In the event the reserve study is not included, a prudent buyer should ask for one to be completed, or should simply retain a service to conduct the reserve study.  While it may create a headache during the escrow process, it may prevent an even larger headache down the road.

If you would like to further discuss how Esquire Real Estate Brokerage, Inc. can help you in the Los Angeles real estate market, feel free to give us a call at 213-973-9439 or send us an email at info@esquirereb.com.