Question: How much are condominiums associations required to hold in their reserve accounts?
Answer: The answer depends partly on what your state’s condominium statute mandates or what your condominium’s governing documents say, but most importantly on the board’s understanding of the critical role reserves play in ensuring the community’s financial health.
We’ll start with the statutory requirements, because in New England, there isn’t much to say about them. The New Hampshire, Maine, Vermont and Rhode Island statutes impose no reserve requirements. The Massachusetts statute is the only one that requires condominiums to maintain reserves, and it requires only that they be “adequate,” leaving it to individual boards to determine what that should be.
Some condominium documents establish specific reserve requirements, but most do not. The only requirements that apply uniformly to condominium associations, regardless of where they are located, are those established by Fannie Mae, Freddie Mac for the condominium loans they purchase from mortgage lenders. They require associations to have a budget item allocating at least 10 percent of the annual budget for reserves.
The secondary market requirements have become something of an industry benchmark since they were adopted about eight years ago. But they provide a flawed benchmark, at best. The purpose of reserves is to ensure that associations will have the funds needed to repair and replace essential building components (roofs, HVAC systems, siding, etc.) as they wear out over time. But the 10 percent calculation will produce different results in different communities, depending on their age and stage, the quality of their construction, their maintenance records and, of course, the size of their budgets.
Ten percent of a very large budget will produce a larger sum than 10 percent of a very small one. For a relatively new community, or recently renovated one, with a large budget and already well-funded reserves, the 10 percent allocation might be excessive and unnecessary. A community with scant reserves, facing large-scale capital repairs in the relatively near term should probably be aiming for a much larger allocation than the secondary market rules require.
Special assessments and bank loans (to the association) are both options for closing reserve funding gaps. But in most cases, they should be viewed as strategies for supplementing the reserves if necessary, not as a substitute for accumulating them.
If the goal is to maintain reserves that are adequate for your community’s needs, the secondary market’s 10 percent requirement won’t necessarily get you there. It might force the board to make an annual contribution to reserves, because if you don’t, prospective buyers may not be able to obtain a mortgage to purchase units in your community and owners may not be able to refinance their loans.
But the only way to reasonably estimate your community’s reserve requirements is by commissioning a reserve study. (If you already have a study, industry experts suggest that you update it every three- to five years).
This comprehensive analysis identifies all the major components in your community, estimates their useful life, and projects the likely cost of replacing those components when that time comes. The reserve study provides the blueprint trustees need to calculate the community’s reserve requirements and develop a plan for meeting them. But having a reserve plan isn’t enough; boards also have to implement it. And that won’t happen consistently unless board members recognize that reserve planning isn’t just a secondary market requirement; it is a financial imperative for the community.