You Have a Replacement Reserve…Now How About an Operating Reserve?

It happens to most associations in one form or another every year. That new larger insurance deductible of $5,000 has kicked in for a fire loss claim for the association. More small snowfalls or really cold weather requires many more ice melt applications than anticipated and has resulted in additional expense of $7,000. More rotten wood to replace in the painting cycle than was planned costs over $4,000. More landscape died as a result of a very hard winter or some foreign insect costs the association an additional $10,000 in shrub removal and replacement. A co-owner was foreclosed by their mortgage company while owing $6,000 in past due assessments and collection costs thereby eliminating any hope of collecting that money. Since most associations budget by balancing their assessments and expenses to zero, there is often little or no extra money available to pay for these “surprises”.

When this occurs, it usually places tremendous pressure on cash flow, creating problems for the board treasurer, the community manager, and the payables clerks who are not able to provide checks to bellowing contractors who call daily in order to meet their payroll at the end of the week. Ultimately, these situations could result in losing good contractors or getting priced higher in anticipation of slow payment.

Problem: No $
Where does the association get the funds to pay these unanticipated costs?

Unfortunately, often it is “borrowed” from the replacement reserve account which really is a “no-no”. In fact, in some states, it is simply not permitted by statute. Even in states where it may not be addressed in the law, since the need for extra money was not budgeted, there is no repayment plan or interest in repaying it to the replacement reserve account - - even with perhaps the best intentions of doing so. The result, of course, is that the replacement reserve remains under-funded when those physical components need to be replaced. Since the necessary funds are not available, we end up in an additional assessment for replacement situations that were thought previously to have been planned for.

Another scenario might include the board of directors levying a special or additional assessment to directly pay for the unbudgeted expense. This is usually an unpopular choice resulting in ill will, much administrative and bookkeeping work, payment timing problems and, in many cases, additional cost.

Solution: Planned Operating Reserves

It seems more business-like and prudent to accept that these surprises are going to occur and to plan ahead to have operating funds available to cover them. An Operating Reserve Account or Contingency Reserve can be created and budgeted with money contributed monthly just as we fund the Replacement Reserve accounts. A set amount each month put into a money market account will gain some interest while being liquid and accessible when needed.

How Large an Operating Reserve?

How much should be targeted for the fund? Perhaps 10% of the operating budget on a non-cumulative basis, with a $10,000 minimum. Or perhaps set aside an amount equal to one month's assessment income as a target. Once that is attained you could stop contributing until funds are required for one of the surprises, then begin contributing again. Larger associations are prone to more surprises and smaller ones seem to be impacted more by a surprise (a large and small association can have the same deductible on their respective insurance policies which would impact the smaller association by a larger percentage than the large association) and may want to contribute and maintain a higher percentage level of reserve. $10,000 can go quickly with an insurance claim, a hard winter, and a few delinquencies.

So, as you are creating your budget, now is the time to get started on funding the Operating Reserve. Any prudent business owner budgets contingency funds. We must remember that we are running a business with millions in assets when we deal with the typical homeowner association. Your next budget year and subsequent years will be far less stressful with this planned solution to the inevitable surprises we face each year.

Association Times' Staff Writer