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How the Pooling Method Can Help Bring Your Property Value to Greater Safety

Oct 24, 2016

Reserves. Those who have ever served on an association board probably know the word. Some of them may even fear the word. For responsible unit owners with sound budgeting practices, reserves can often provide peace of mind that the property will be safely maintained and that the association may be able to avoid special assessments. Whether they are required by law or electively set aside by the association, reserves provide a financial “life preserver” for the property’s value.

Staying Afloat: Reserve Calculation Methods for Homeowner Associations

Condominium associations in Florida are required to maintain reserves for roofing, painting, paving, and any other deferred maintenance project with an estimated cost of more than $10,000. Associations may calculate these required reserves using the component (straight-line) method or the pooling (cash flow) method. Some associations prefer the pooling method because it provides greater flexibility if the:

  1. actual costs of a maintenance project exceed the amount estimated in the reserve study, or the
  2. timing of a maintenance or replacement project is accelerated due to unforeseen circumstances.

This latitude can provide board members with valuable decision-making ability so long as they remain fiscally responsible.

Regardless of the method used, the proposed budget must disclose the full amount of the annual contribution as calculated, even if the association members approve a reduced funding amount or even waive funding. If the association elects to use the pooling method to determine the amount of funding needed for the reserves, then how is the contribution amount calculated?

Jumping into the Waters of the Pooling Method for Homeowner Associations

The pooling method is conducted with the following steps:

  1. Start with the estimated costs set out in the most recent reserve study for each component (or asset): roofing, paving, painting, etc. If the reserve study was completed in a previous year, then an inflation factor may be applied to the cost estimates.
  1. Identify the estimated total and remaining useful life of each component. If the reserve study was completed in a prior year, then the remaining estimated useful life will need to be adjusted to reflect the time elapsed since the last reserve study.
  1. Using the information from step 2, calculate the estimated cash flows over the remaining useful life of each component. Note that reserve funding must be scheduled out over the remaining useful life of the asset with the longest life, as exemplified in the chart below:
Replacement Item Total Estimated Life Remaining Life Estimated Cost Projected Cash Flows
Year 1 Year 2 Year 3 Year 4
Roof Replacement 20 1 $25,000 $25,000 $0 $0 $0
Painting 5 2 12,000 $0 $12,000 $0 $0
Parking Lot Paving 20 4 10,000 $0 $0 $0 $10,000
Tennis Court Resurfacing 10 3 14,000 $0 $0 $14,000 $0
Total Projected Cash Outflows $(25,000) $(12,000) $(14,000) $(10,000)
  1. Review the cash balance on hand at the beginning of the budget period. For example, if the budget established in August will go into effect on January 1, then the cash activity for September through December should be estimated to come up with the projected cash balance as of January 1.
  1. Add the annual expected cash inflows (i.e., the annual reserve requirement). Under this method, the association can also opt to include estimated investment earnings on reserve balances in the cash inflow amount. The net result of steps 4 and 5 are shown in the chart below.
Replacement Item Total Estimated Life Remaining Life Estimated Cost Projected Cash Flows
Year 1 Year 2 Year 3 Year 4
Roof Replacement 20 1 $25,000 $25,000 $0 $0 $0
Painting 5 2 $12,000 $0 $12,000 $0 $0
Parking Lot Paving 20 4 $10,000 $0 $0 $0 $10,000
Tennis Court Resurfacing 10 3 $14,000 $0 $0 $14,000 $0
Total Projected Cash Outflows $(25,000) $(12,000) $(14,000) $(10,000)
Beginning Cash Balance $33,000 $15,000 $10,000 $3,000
Annual Reserve Requirement $7,000 $7,000 $7,000 $7,000
Ending Cash Balance $15,000 $10,000 $3,000 $0

 

In calculating the annual reserve requirement, the board may adjust the amount each year in response to changes in the cost estimates and any current-year spending. The reserve (i.e., cash balance) may not go below zero. The pooling method may expose the association to some variability in the annual assessment amounts due to the unpredictable nature of the replacement/deferred maintenance cycle of the components. However, with careful budgeting and spending, the association should most likely be able to maintain relatively level reserve requirements. The table below shows an example of the pooled reserve calculation in the year after the roof replacement project.

Replacement Item Total Estimated Life Remaining Life Estimated Cost Projected Cash Flows
Year 1 Year 2 Year 3 Year 4
Roof Replacement 20 20 $25,250 $0 $0 $0 $0
Painting 5 1 $12,120 $12,120 $0 $0 $0
Parking Lot Paving 20 3 $10,100 $0 $0 $10,100 $0
Tennis Court Resurfacing 10 2 $14,140 $0 $14,140 $0 $0
Total Projected Cash Outflows $(12,120) $(14,140) $(10,100) $(0)
Beginning Cash Balance $15,000 $10,030 $3,040 $90
Annual Reserve Requirement $7,150 $7,150 $7,150 $7,150
Ending Cash Balance $10,030 $3,040 $90 $7,240

 

CRI Can Help You Use the Pooling Method to “Buoy” Your Homeowner Association

Most associations will attempt to budget for a more stable reserve requirement, incorporating increases at a modest rate. However, there are many variables that could affect the reserve calculation – all of which should be considered when preparing the association’s budget. In doing so, you may be able to help your association abide by homeowner association industry requirements and state laws. Contact CRI if you need further guidance keeping your association’s compliance “above water.”

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