Reserve funds best practices

Building finances
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March 9, 2022
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Reserve funds best practices

Condo and co-op boards exist to help make their buildings a place everyone loves to live in. As a board member, you understand all the expenses that really go into keeping your building running smoothly. What you might not know is how to manage the money and actually make that happen.

Don’t worry! Maintaining your building’s finances is easier than you might think. With a proper reserve fund, your board will be prepared to take on anything the world throws at it … local laws, snowstorms, burst pipes, and more.

What is a reserve fund?

It’s an unfortunate fact of life that everything is temporary. Equipment and appliances break, sidewalks crack, and buildings degrade. It seems like important systems and appliances always sense the worst possible time to break down too. You may have noticed that major emergencies usually seem to crop up right after you’ve spent a lot of money on something and drained your resources.

That’s what reserve funds are intended to prevent. A reserve fund is a specific account or collection of accounts with money set aside for major expenses. It’s basically your condo or co-op’s emergency savings account. When large expenses come up, like essential upgrades or emergency repairs, the reserve fund is there to cover the cost.

Why do you need a reserve fund?

What can reserve funds be used for? In short, they exist for emergencies and for maintenance. Emergencies happen, and expenses come up. It’s just good practice to have a stash that you can dip into to take care of unexpected (or expected but large) bills.

Hence, reserve funds. Every building needs routine maintenance. Roofs need to be replaced, lobbies need to be remodeled, and windows require upgrading. These expenses don’t happen every year, but they do occur regularly in their own ways. And they can get expensive fast. The reserve funds can be used to take care of these types of routine-but-widely-spaced costs.

A percentage of your residents’ condo and co-op monthly fees should go toward your reserve fund, separate from your operating fund. Just because the reserve fund is used for less specific tasks doesn’t mean that you can neglect it. When you use a portion of the fees to contribute regularly, you’ll keep your reserve fund full, and you won’t need to levy special charges except in true emergencies.

Five best practices for reserve fund management

Keeping your reserve fund full and well-managed is some of your best insurance against unexpected expenses. The following five accounting best practices will help you keep the fund topped off, your residents happy, and your building community safe and secure.

1. Set rules for the fund

A reserve fund isn’t the same as a slush fund. You shouldn’t dip into it for random, small expenses, like holiday tips for the building staff or buying pizza for board meetings. However, having a large amount of money that seems to be just “sitting there” can be tempting. If you want to make sure your reserve fund is only used for its intended purpose, you should have some rules for it.

Your governing documents will usually detail your reserve fund requirements. For example:

  • What kind of expenses the fund can be used to cover (e.g., emergencies and large costs only)
  • ‌Who chooses when the reserve fund can be used (typically, a majority of the board needs to agree)
  • ‌How much of the residents’ fees are contributed to the fund each month
  • ‌Where the fund is stored (is it in a bank account or in an investment account)
  • ‌How the reserve is monitored

‌With these rules in place, you and everyone else on the board will have a clear idea about how the reserve fund works and what it’s truly for. That will help you avoid the biggest risk facing a reserve fund: being forgotten about.

2. Maintain the right reserve level

Once you’ve committed to managing your reserve fund, you’ll immediately run into a problem. How much money should your fund contain? That’s an excellent question. The short answer: it depends on your building. 

A general rule of thumb for building your reserve fund is to set monthly fees such that 20-40% of the total amount goes to the fund. For example, if you charge fees of $100 a month, then $20 to $40 should go directly to your reserve. Obviously, the exact amount depends on your building and the other fees that you collect.

‌This still doesn’t answer how much money should actually be in your fund. That’s because your fund’s size will vary. Sometimes it will be higher or lower depending on the expenses you’ve recently faced. Still, you can run a few simple calculations to figure out how much you should be saving for your reserve fund each year.

First, list your organization’s major capital systems. Depending on your association, these can include common areas, a shared rooftop, a gym, and even the lobby and exterior area. Basically, anything that’s a permanent asset of the community and needs to be kept in good condition counts.

Second, estimate how much it will cost to repair or replace these systems. It’s better to estimate high because you want to make sure you have more than enough money in your fund. As you know, things get very expensive very quickly. This step can take some time since you could have a lot of systems to research. However, a good property management company should be able to lead that effort for you.

Next, estimate how long you have until you need to repair each system. Once again, your property management company should know or be able to determine this. Divide the cost to repair or replace each item by the time you have until the next repair is needed for that same item. This gives you the amount you need to save for each system each year.

Finally, add up the yearly savings amounts for each system into one big number. This is the ideal amount you should be setting aside each year for your reserve fund. Including this number and process in your reserve fund guidelines will help you keep your fund full at all times.

3. Perform regular reserve studies

The method above is useful to get a general estimate for your reserve fund, but it’s not very precise. After all, you’re probably not an expert in roofing and façade and landscaping and safety requirements. You’re just doing your best to estimate costs, and you might be wrong.

That’s why it’s worthwhile to perform reserve studies. A reserve study is a large research project done by an expert, best led by your property management company, who looks over your building assets and determines exactly what you need to do to keep your fund in good health.

While you don’t need to make annual studies part of your reserve fund requirements, it’s a good idea to have them done at least every couple of years to keep an eye on things. Your property management company should be able to spot risks and upcoming expenses that you may not have noticed, giving you the chance to save up in advance instead of getting a loan or forcing special assessments.

4. Implementing proper financial reporting

You might be able to get by in your personal finances by keeping a running total of expenses and income in your head. That’s just not possible (or smart!) for any kind of organization, though. You’re accountable to your residents, and you need to keep good records of how you’re spending the money in the reserve fund. The easiest way to accomplish that is by implementing proper financial reporting.

Every property management company, or whatever accounting team your building employs, should put together the following reports:

  • Balance sheet
  • ‌Income statement
  • ‌Cash flow statement
  • ‌General ledger
  • ‌Accounts payable report
  • ‌Account delinquency report
  • ‌Cash disbursements ledger

‌‌Your reserve fund will be included in all of these statements. You can also put together a specific reserve fund report to highlight how you’re keeping the fund in good health. When you take the time to be thorough with your accounting, you’ll have a better understanding of your building's true financial standing.

5. Consider investing wisely

You can leave your reserve fund in a bank savings account, or you can consider investing it. Both have their pros and cons. On the one hand, keeping your fund in a bank account keeps it safe. You’ll never risk a crash tanking your fund right when you need it most. On the other hand, you also can’t earn any money from your fund. It remains stagnant, gathering less than a percent of interest each year.

‌Investing condo and co-op reserve funds is riskier, and you’re more vulnerable to stock market dips. However, you’ll also, on average, grow your fund over time as long as you invest wisely.

‌The right choice depends on your building community and the amount of risk you’re willing to take on. A good compromise might be a split: setting aside some money for investing reserve funds in conservative money markets or low-risk stocks and leaving the rest safely in the bank. You’ll earn some growth, but you won’t risk your entire fund.

‌General concerns

‌Separate operating and reserve funds. Does your board keep all its money in the same account? That’s a problem. The money you use for weekly and monthly upkeep should never be stored with your reserve funds as it makes it way too easy to lose track of what’s what. 

By keeping your reserves separate from your operating funds, they’ll be more secure. You’ll have a better idea of how much reserve money you actually have, and you won’t risk spending it on something other than a major expense.

Perform special assessments quickly. Sometimes you’ll need to shore up your reserve funds with special assessments. If you face an unexpected emergency like damage from a massive storm that isn’t covered by insurance, you might need to dip into your reserve fund to cover repairs. Afterward, you’ll need to rebuild the fund to make sure you still have enough to cover planned expenses and repairs. 

‌Special assessments are unpleasant, but they’re necessary. Your residents are less likely to complain if you perform the assessment quickly. Try to decide on and inform your residents about special assessments within a month of the event. This way, the emergency is still fresh in their minds, and they won’t be confused about why they need to pay more.

Allow for open monitoring of spending. You don’t need to let the entire world see your association’s bank accounts, but it’s good practice to let more than two or three people at least monitor your accounts. Even if those people can’t make transactions, they can still keep an eye on how money is entering and leaving the reserve. This kind of oversight is a straightforward way to prevent problems like embezzlement from ever getting started.

Manage your reserve fund the right way with Daisy

Having a sound and strategic financial plan will ensure your building is set up for success in the future, not just be able to repair an emergency issue with the boiler. If you feel like you or your board members could use more help with strategic financial planning, Daisy property management could be a great partner for you. Learn more here about how Daisy can help your building thrive, and make your life as a board member better!

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