Understanding the Differences Between a New Building Reserve Fully Funded vs Threshold Funded

Threshold Funding for Reserves

One of the most critical elements for ensuring the long-term success and stability of a community is an informed reserve fund. This fund is designed to cover large expenses, such as infrastructure repairs, replacements of commonly owned assets, and other projects that cannot be covered by regular operating funds. In order to maintain a well-managed and financially stable community, it is essential to apply an appropriate threshold funding strategy for a reserve account. In this article, we'll explore what threshold funding is, why it matters, and how to manage it effectively.

What is Threshold Funding for Reserve Accounts?

Threshold funding for reserve accounts refers to a funding strategy that focuses on the minimum amount of money a community must have in its reserve fund to meet future repair and replacement costs. This threshold amount is designed to ensure a community can cover the cost of unexpected repairs or replacements without having to assess homeowners beyond monthly dues or borrow money from lenders at exorbitant rates. As most commonly owned assets deteriorate at different rates, threshold funding ensures reserve funds are healthy at all times. Proper threshold funding provides a financial buffer allowing a community to manage significant long-term projects without endangering their financial standing.

In short, threshold funding sets the baseline amount of money that should be kept in reserve to handle expenses like repaving roads, replacing roofs, or painting wood siding. 

Why Threshold Funding for Reserve Accounts matters?

1. Prevents Special Assessments: One of the most important reasons for ensuring proper threshold funding for reserves is to avoid special assessments. Special assessments are additional, one-time fees homeowners are required to pay to cover unexpected or significant expenses. Without enough reserve funds, a community may have to implement special assessments, which can create dissatisfaction among homeowners and cause financial strain. Threshold funding ensures that the reserve account has enough money to cover major expenses, reducing the likelihood of needing such assessments.
   
   
2. Supports Long-Term Community Sustainability: A well-funded reserve account provides the financial stability required to maintain and improve shared community assets. Common assets like roofs, pools, fences, and landscaping can incur large repair and replacement costs. Without adequate funding in place, a community may struggle to maintain these assets properly, resulting in accelerated deterioration over time. Having the necessary reserve funding ensures that the community can continue to thrive, property values stay strong, and homeowners continue to enjoy the amenities they pay for.
   
   
3. Plan for Future Expenses: Reserve funds are not only for immediate repairs—they also help plan for long-term expenses. By setting aside money now for expected repairs or replacements a community can avoid scrambling for funds in the future. This proactive approach to funding ensures residents can maintain a high standard of living without facing financial surprises.
   
   
4. Ensures Financial Transparency: Properly funded reserve accounts build trust between homeowners and the HOA. Homeowners are more likely to feel comfortable paying their regular dues and supporting long-term goals when they know there is a clear financial plan in place. Transparent communication about how reserve funds are managed and the importance of threshold funding fosters a positive relationship between the board and residents.
   
   
5. Legal and Regulatory Requirements: In some jurisdictions, HOAs are required by law to maintain a certain level of reserve funding. For example, many states mandate communities conduct a reserve study to determine how much money should be set aside for future repairs and replacements. Not meeting the required funding levels can result in legal consequences or make the community vulnerable to financial mismanagement claims. By ensuring the reserve account meets or exceeds the threshold funding requirement, an HOA can remain compliant and avoid potential legal issues.

Methods and Strategies

Building Reserves utilizes the Cash Flow Method to calculate the minimum recommended annual reserve contribution to determine adequate, but not excessive annual reserve contributions using a minimum threshold. The Cash Flow Method pools all reserve expenditures into one cash flow. 

With Building Reserves, threshold funding implements the following funding strategies:

• Sufficient reserve funds are maintained above a specified threshold
• Stable and equitable reserve contribution rate over future years, whenever possible
• Goal of timely, prioritized project execution
• Avoid reliance of supplemental funding, whenever possible

How to Calculate Threshold Funding for Reserve Accounts

Calculating threshold funding for a reserve account requires a thorough understanding of the community’s assets, their expected lifespans, and the cost of replacing or repairing them. Here are the key steps to determine the amount of reserve funding needed:

      1. Conduct a Reserve Study

A reserve study is an essential tool for calculating an HOA’s funding needs. This study provides an in-depth assessment of the community’s physical assets, their current condition, and how much money will be needed to repair or replace them over time. A reserve study typically includes:

• An inventory of common elements (e.g., roads, roofing, pools, fences, clubhouses).
  
• Estimates for repair and replacement costs for each asset.
  
• Expected lifespans for each asset (e.g., a pool may last 20 years, but roads might need repaving every 10 years).
  

By understanding these factors, the reserve study allows the community to predict future expenses and set aside an appropriate amount of money each year.

        2. Set a Funding Goal

Once the reserve study is complete, an HOA can establish a funding goal for its reserve account. This goal is based on the projected costs of future repairs and replacements, ensuring that the community will be able to cover these expenses when they arise. The funding goal typically takes into account:

• Immediate needs: The most pressing expenses that need to be addressed within the next 5–10 years.
  
• Future needs: Projects and replacements that may not be required for another 10, 20, or even 30 years.
  

The goal is to ensure that the reserve account contains enough money to meet both short-term and long-term funding needs.

       3. Account for Inflation and Market Changes

It’s important to consider that inflation can increase the costs of repairs and replacements over time. When calculating threshold funding, it’s wise to factor in inflation to ensure the reserve fund will keep pace with rising costs. A good reserve study will include a projected inflation rate to account for these increases.

       4. Follow a Funding Plan

Once the minimum threshold has been determined, the HOA needs to establish a funding plan to reach this amount. This might involve increasing monthly dues, transferring a higher percentage of monthly dues to reserves, or prioritizing community needs over their desires.

Benefits of Proper Threshold Funding for Reserve Accounts

1. Avoids Financial Crisis: Adequate threshold funding for reserve accounts allows the HOA to be prepared for large, unexpected expenses without the need to scramble for funds. This reduces the risk of financial crises and ensures that repairs can be made promptly.
   
2. Increases Property Values: Well-maintained communities with up-to-date infrastructure and amenities generally see higher property values. By ensuring there are sufficient funds for repairs and replacements, an HOA can help maintain the community’s attractiveness and, in turn, preserve or increase property values.
   
3. Reduces the Need for Special Assessments: When a reserve account is properly funded, the need for special assessments is minimized. This keeps financial burdens consistent and predictable for homeowners, avoiding the negative sentiment that often comes with sudden, unexpected fees.
   
4. Promotes Long-Term Planning: Threshold funding encourages HOAs to take a proactive approach to their financial planning. By carefully evaluating future repair and replacement costs, the HOA ensures that no project is overlooked, and that funding is always available when needed.
   

Challenges of Threshold Funding for Reserve Accounts

1. Homeowner Resistance: Some homeowners may resist increases in monthly dues, especially if they don’t immediately see the need for a large reserve. Clear communication and education about the importance of reserve funding can help alleviate concerns.
   
2. Estimating Long-Term Costs: It can be challenging to accurately estimate the long-term costs of repairs and replacements, especially when dealing with older infrastructure or assets that may have unpredictable lifespans.
   
3. Economic Uncertainty: Economic downturns, inflation, or unexpected events (such as natural disasters) can affect both the costs of repairs and the HOA’s ability to collect dues. Regular updates to the reserve study are important to keep the reserve fund on track.
   

Why Building Reserves?

Building Reserves is one of the world’s leading reserve study companies. Our experienced team, tested methodology, and commitment to our clients makes us the best option for your community’s needs. When you conduct a reserve study with us, your community is in good hands. Through the use of threshold funding, we ensure every aspect of your community is accounted for and your residents can continue to enjoy a well-maintained, thriving environment for years to come.

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Written by James Newby, Architectural Engineer