Are Reserve Studies Required?

Yes! California Civil Code 5550 requires that most community associations perform a reserve study every three years with annual reviews of current reserve status:

http://www.davis-stirling.com/MainIndex/Statutes/CivilCode5550/tabid/3816/Default.aspx#axzz2CgHrcBrn

a) At least once every three years, the board shall cause to be conducted a reasonably competent and diligent visual inspection of the accessible areas of the major components that the association is obligated to repair, replace, restore, or maintain as part of a study of the reserve account requirements of the common interest development, if the current replacement value of the major components is equal to or greater than one-half of the gross budget of the association, excluding the association’s reserve account for that period. The board shall review this study, or cause it to be reviewed, annually and shall consider and implement necessary adjustments to the board’s analysis of the reserve account requirements as a result of that review.

(b) The study required by this section shall at a minimum include:

(1) Identification of the major components that the association is obligated to repair, replace, restore, or maintain that, as of the date of the study, have a remaining useful life of less than 30 years.

(2) Identification of the probable remaining useful life of the components identified in paragraph (1) as of the date of the study.

(3) An estimate of the cost of repair, replacement, restoration, or maintenance of the components identified in paragraph (1).

(4) An estimate of the total annual contribution necessary to defray the cost to repair, replace, restore, or maintain the components identified in paragraph (1) during and at the end of their useful life, after subtracting total reserve funds as of the date of the study.

(5) A reserve funding plan that indicates how the association plans to fund the contribution identified in paragraph (4) to meet the association’s obligation for the repair and replacement of all major components with an expected remaining life of 30 years or less, not including those components that the board has determined will not be replaced or repaired.

(Added by Stats. 2012, Ch. 180, Sec. 2. Effective January 1, 2013. Operative January 1, 2014, by Sec. 3 of Ch. 180.)

SOME VERY SMALL ASSOCIATIONS ARE EXEMPT

Notice we said most associations are required to do a reserve study...

The reason reserve studies are required for most, but not all, associations comes from the phrase: “…if the current replacement value of the major components is equal or greater than one half of the gross budget of the association which excludes the association’s reserve account for that period.”

This phrase generally exempts small associations that have minimal common area capital assets from being required to do reserve studies. Typically these might be associations having only a common area green space to maintain and no exterior structural maintenance or roads. For most all other associations, reserve studies are required.

As an example, suppose you have a small planned unit development association with 5 single-family homes sharing a small 6000 square foot asphalt street and driveways and a small area of common landscaping. Homeowners maintain their own homes and their residence lot landscaping.

You might think they'd be exempt from the requirement to do a reserve study, Right?

Let's review the numbers and see:

●　Gross Budget excluding Reserve Budget (Operating Budget) = $300/month or $3,600 per year for insurance, minor landscaping for small common green space areas, etc. This is a typical operating budget for a small association with minimal maintenance.

●　Current Replacement Value of all Reserve Components:
+ $6,600 = Cost of asphalt petromat overlay for 6,000 SF of streets at $1.10/SF (note we're not even factoring in ultimate remove & replace efforts which may be more than 30 years into the future).
+ $720 = Cost of asphalt sealcoating at $0.12/SF (high cost-per-SF for a small job) every three years.
+ $1,500 = Replacement cost of all the common area landscaping & trees in the common area.

$8,820 = Total reserve component replacement cost.

Clearly, the $8,820 total reserve component replacement cost exceeds one half of the $3,600 annual operating budget.

So unless a small association only has a green space and has no roads or exterior structure maintenance responsibilities, Civil Code 1365.5 most likely requires that they do a reserve study just like medium and large associations.

Of course, to verify whether or not your particular association is not required to do a reserve study, you need to go through the calculations shown above.

Whether or not a reserve study is required, board members and property managers have a fiduciary responsibility to perform due diligence in the budgeting process so that their associations properly maintain their property.

A reserve study and its recommended funding plan provide are often indispensable in this process and show due diligence on the part of the board or management company.

(Why it is sensible to do a reserve study in the first year of an association's existence...)

When a new association is built, the State of California requires the developer to have a "Department of Real Estate Form 623" (DRE-623) prepared. A DRE-623 is the initial budget prepared for the developer usually by a third-party company or reserve study company. Think of it as a "primordial budget" because it is hasn't yet been tested in real use until the association's inception. Based on the calculations in the DRE-623, the initial monthly member fees are determined for new condominium units being sold to new buyers.

The DRE-623 contains an operating budget and a reserve budget. The reserve calculations in most DRE-623's are usually based on takeoffs from building plans or blueprints, so there are usually no site visits, measurements, or inspections.

Most new associations approach a reserve specialist during their third year of existence and state they need their "first" reserve study. After doing many reviews of original DRE-623 budgets for new associations, we have concluded that more often than one would like, they lack detail or have errors & omissions.

These inaccuracies in initial reserve funding can put an association on an insufficient reserve funding trajectory. By the time the reserve specialist does the first on-site physical inspection and reserve analysis in the third year of its existence, the association's reserves are already underfunded.

The intent here is not to belittle the work of the DRE-623 preparers. Without question, it is difficult for anyone to perform a good "primordial" DRE-623 reserve study without having physically measured and inventoried all of the reserve components via an on-site visit. But that's how things are done at the initial stages of the condominium development process as on-site inspection and inventory simply doesn't seem to happen.

Some of the types of DRE-623 errors we've encountered are:

●　Lack of attention to specifics in the site plans Most DRE-623's list a reserve component called "paved surface area" includes all paved surfaces, which often includes both concrete driveway aprons, sidewalks, and asphalt private streets. An association having 40,000 SF of concrete driveways & sidewalks and 60,000 SF of asphalt was correctly shown to have 100,000 SF of "paved surfaces," which is what the blueprint says. Yet in the DRE-623 budget calculation, they assumed 100,000 SF of paved surfaces needing asphalt sealcoat every 3 years and asphalt overlay every 18-20 years, when only 60,000 SF of that 100,000 SF represents asphalt paving. This is one of the few errors that resulted in overfunding reserves.

●　Inaccurate inventory of reserve components. The DRE-623 reserve component measurements & totals of items such as exterior light fixtures, paved surfaces, painting surface areas can be inaccurate because some of these items are difficult to tally when viewing the as-built plans. Occasionally, however, there are some egregious errors such as stating that there is only one elevator when there happen to be two elevators side-by-side in the same building. An on-site inspection would, no doubt, catch this type of error.

●　Omission of numerous reserve components. Some DRE-623 reserve budgets tend to be overly generalized in that they only calculate reserve funding for large expense items, but forget to include a lot of essential reserve components such as wrought iron replacement, termite treatment, siding replacement, custom nameplate entry signs, paving patchwork, future dryrot repairs, etc.

CONCLUSION: The key point here is that it is usually not a waste of money for an association to contract a reserve specialist to do a comprehensive site-visit & inspection to produce an accurate reserve study during the first year of its existence. This will set the association off on a proper reserve funding trajectory from the start.