Understanding Reserve Studies

Understanding the reserve study process first requires that you understand what a reserve study is. While we have observed that almost everybody in the community association industry believes that they understand what a reserve study is; the problem is that not everybody agrees.  But you would certainly expect that all reserve preparers would agree on what a reserve study is since they are the "experts."  Unfortunately you would probably be disappointed.

The reserve study is a budget, it is a financial projection.  It is NOT a maintenance plan, an engineering study, a property condition assessment, or an appraisal.

One thing that reserve preparers agree on is that the reserve study process consists of two parts; the component analysis and the financial analysis.  Unfortunately many reserve preparers don't take the next logical step to acknowledge that this reserve study process consists of three separate processes representing three distinct disciplines each requiring separate skills and knowledge.  In other words, the reserve study process is a multi-disciplinary process.  Many reserve preparers don't want to acknowledge that because it would then require that they have the skills in all three areas.

The three processes or activities are plainly visible if you just think about the reserve study workflow:

Step one is the component analysis, which is the identification of, quantification of, and evaluation of the physical components.  This requires knowledge about the components, but more specifically the maintenance of the components.  While engineering, architectural, or construction (the experience and skill set of most "component centric" reserve preparers) knowledge is certainly very useful, maintenance knowledge is the skill set most directly applicable to the reserve study process.  It is notable that there are numerous colleges that provide for majors in facilities management yet few of those individuals have yet found their way into the community association industry.

Step two is the valuation or pricing of components.  This can be easy if there are existing contractor bids or recent projects completed but simple Google searches on pricing often fall short because people fail to consider sales tax, delivery and installation costs, and disposal of existing components.  It gets far more complicated if the association self-constructs using their own employee maintenance staff as it then involves accounting decisions regarding cost allocation of payroll and related costs and probable inter-fund allocations.  No matter what other factors are considered, pricing will always be the most subjective measure of the reserve study simply because there are so many variables and cost sources to consider.

Step three is the financial analysis.  This step actually consists of three subparts; (1) financial modeling of the funding plan, (2) financial calculations, and (3) financial reporting.  Note the emphasis on "financial" and the complete lack of any other discipline.  Unfortunately, the majority of reserve preparers place little value on this critical factor and pay little attention to financial considerations.  Until ICBI (International Capital Budgeting Institute) established standards for financial factors of reserve studies in 2015 there was absolutely no guidance for reserve practitioners.  The predictable result is that there are widely varying practices amongst reserve preparers. 

The three biggest complaints about reserve studies in general we have heard from managers and others within the community association industry are; (1) why are reserve study reports so different depending on which reserve preparer is used to perform the study and prepare the report, and (2) why can't reserve preparers use the same terminology and classifications in summarizing the component list, and (3) why do some preparers exclude certain items from the reserve study that other preparers will allow to be included in the reserve study? 

Let's address each of these three items because they are very important.

(1) Many reserve preparers follow a set of standards referred to as NRSS (National reserve Study Standards).  These NRSS standards require certain specific reporting elements be included in the reserve study, but do not require any specific financial exhibits.  Again, the predictable result is that each reserve preparer, most of them using "self-developed" proprietary software (mostly Excel templates they created) decided on their own preferred formats and exhibits.  Knowing that the reserve study report is a financial report, although it is based on a component analysis, and that the majority of reserve preparers are component-centric individuals with little or no financial training or expertise, it is very common to observe that their reports fail to conform to common financial reporting protocols.  The reserve preparers who designed the reports are generally not even aware that certain financial reporting protocols exist.

ICBI established standardized financial reporting formats in 2015 that include (a) specific financial exhibits to address the most critical aspects of a reserve study financial projection, (b) uniform calculation standards, (c) a written narrative preparer report to explain the overall report, and (d) required narrative disclosure guidelines that describe all considerations of the reserve study financial exhibits including (1) a list of any components NOT included in the funding plan and the reason why they are excluded, (2) a list of conditions that are beyond the scope of the reserve study, and (3) a list of significant assumptions on which the reserve study is based.  The result is that reserve study reports produced under ICBI standards provide Clarity, Consistency, and Comparability.  See the ICBI website for their comprehensive reserve study standards - https://www.capitalbudgeting.org/reserve-standards 

Facilities Advisors was the driving and guiding force behind ICBI and the development of Generally Accepted Reserve Study Standards. Facilities Advisors CEO Gary Porter, RS, FMP, CPA, RRC is the founder and president of ICBI.  He is the only reserve preparer with documented licenses, credentials or recognized expertise in all three of the disciplines that comprise the reserve study process.

(2) The lack of consistent use of terminology and classification of components in the reserve study is a long standing problem and will probably never go completely away.  However, most of the ICBI members who are reserve preparers also participate in the development and use of a shared common component database.  This common database is a joint project of ICBI and ARP (Associated Reserve Planners - a trade organization for reserve preparers who follow ICBI reserve study standards) that allows members to contribute to and use the database as part of their reserve study practice.  The database attempts to establish the most common use terms to identify (name) components and establish common classification categories.  Although regional differences exist the database also provides guidelines on useful life and component cost ranges - but all reserve preparers are advised to challenge both those useful life and component cost factors.  It is helpful for reserve preparers to have this information available. Certainly no one can be forced to use the terminology or classifications suggested, but this is the first attempt within the reserve study world to establish some commonality and respond to the valid criticisms of managers and others regarding consistency of information in naming and classifications of components.

Again, the Facilities Advisors team was the driving force behind this effort in which a number of other reserve study companies have now joined.   

(3) NRSS established a "four part test" in order for a component to be included in a reserve study; (1) association maintenance responsibility, (2) significant in cost, (3) predictable useful life, and (4) predictable remaining life.   In the opinion of many, the last two factors create arbitrary limitations of what can be included in a reserve study.  As an example, what is the predictable life of landscaping?  Yet, many associations expend large amounts of money on landscape refurbishment and replacement.  Again, the result is predictable in that some reserve preparers firmly adhere to the four part test and refuse to allow landscape replacement or other items to be included in the reserve study, yet these same items are routinely paid for by associations from their reserve funds.  Other preparers following NRSS see that these arbitrary limitations of predictable useful and remaining life make no sense so they will include landscape replacement in the reserve study (and we can provide numerous examples of both positions in reserve study reports we have seen).  This has resulted in inconsistency amongst reserve preparers and has not served the community association industry well.

To address this inconsistency ICBI standards established a different four part test for a components which may be summarized as follows; (1) association maintenance responsibility, (2) significant in cost, (3) maintenance related activity, and (4) nonannual expenditure.  This provides a far more comprehensive approach in allowing what can be included in a reserve study and eliminate the arbitrary limitations imposed under the NRSS approach.