Ensuring Adequately Funded Reserves

…and Preparing for the Unknown

By Kumar S. Raja & Shelby D. Bennett

Throughout the state, many older common interest developments (CIDs) are struggling with costly repairs and large maintenance projects as buildings age. Is your CID prepared to replace major components without a special assessment? Do you have funds available to finance a roof replacement project? This article will review the importance of adequately funding reserves and identify future considerations that might impact current planning.

SETTING MINIMUM RESERVE REQUIREMENTS

California law requires that CIDs conduct reserve studies every three years – and yet it does not set forth minimum funding requirements for reserve accounts. This means that a CID can conduct a reserve study and still not be prepared for replacing major components, such as common area roofs and structural components. The law provides some direction regarding reserve account maintenance. In short, boards must exercise prudent fiscal management in maintaining the integrity of reserve accounts (Civil Code section 5515 (e)). Central to that statement is an action – the act of responsibly managing homeowner assessments for future rainy day projects. Boards must make financial review of reserve accounts a priority. Neglecting to do so could lead to breach of fiduciary duty claims and public relations challenges.

One way to ensure that CID reserves are adequately funded is to adopt a policy that reminds boards about the importance of funding reserve accounts. A policy will provide direction so that boards remain focused on funding reserve accounts on a regular basis. Since boards change frequently and not every board member has the same goals, a policy can guide incoming board members by establishing standards to safeguard reserve accounts.

A reserve funding policy should include a few cornerstones. One foundational requirement is that boards should resolve to engage a qualified reserve analysist to perform the reserve inspection and prepare the reserve study. Board reliance on expert opinions demonstrates prudent oversight of CID assets. Another policy consideration is to develop a minimum funding requirement. For example, the policy might state that the board should strive to ensure that CID reserves are funded at or above 50 percent at the time of the annual reserve study. If reserves fall below a certain threshold, for example, 40 percent, the board must then consider taking certain measures to achieve the minimum requirement, such as adjusting the funding plan to restore reserves within a certain time frame and/or discussing the possibility of bank loans and assessment increases.

PREPARING FOR THE UNKNOWN

California faces extreme weather conditions, including severe storms, unprecedented snowfall, and droughts. If major common area components are prematurely failing because of extreme weather, it may be wise to start planning now. If reserves are adequately funded, the board can make thoughtful decisions regarding component replacement – and, more importantly, homeowners are reassured that property values are protected because their board was wise to think ahead.

In addition to unpredictable weather conditions, CIDs are encouraged to prepare for new legislation, which potentially affects reserve balance sheets. SB 326, the balcony inspection law, expressly provides that inspections must be coordinated with reserve study inspections. Last year, the legislature enacted AB 1738, which requires that the Department of Housing and Community Development create a plan to install EV chargers in existing multifamily dwellings, hotels, and motels. At some point, CIDs may be subject to mandates to install EV chargers, especially in multifamily dwellings with parking structures. As part of its reserve planning, boards should consider consulting with electricians to assess the electrical capacity of their community and whether the community’s electrical infrastructure needs to be upgraded to accommodate EV chargers in the future.

In conclusion, many associations have been around for 30 plus years and the common area components are likely reaching the end of their lifespan. The best way to ensure happy, healthy, and thriving communities is to ensure that reserves are properly funded. Boards should work with management, legal counsel, and experienced reserve analysts to develop tailored reserve funding strategies that align with the specific needs of their communities.

Kumar S. Raja is a partner at Beaumont Tashjian, where he primarily handles the firm’s litigation and enforcement matters. He also provides general counsel services for its diverse community association clientele on a wide array of subjects, including risk management and corporate governance. His passion is developing creative solutions that foster community harmony.

Shelby D. Bennett is an associate attorney with Beaumont Tashjian, where she devotes her time to providing general counsel services to the firm’s clients. Bennett also assists in the firm’s governing documents department with the preparation and redrafting of CC&Rs, bylaws, and related documents.