Replacement Reserve Study

What is a Replacement Reserve Study?

Replacement reserves are a way of identifying, quantifying, and budgeting monies to fund future major building repairs and replacements. As properties age, expenditures for replacements and improvements are imperative to maintaining the asset and its competitive position in the market. Insufficient funding of replacement reserves may result in significant physical deterioration, functional obsolescence, more costly future expenditures, and will impact value, use, and aesthetics.

Why Establish Replacement Reserves?

- Sound Business Practice – Homeowner associations have a fiduciary obligation to unit owners to properly plan and budget for future expenditures in a way that is fair and equitable. Municipalities should properly budget for replacement expenditures.

(With respect to investment, corporate or municipal owned properties, required future replacement expenditures can significantly impact cash flow, preferred returns to investors, strategic capital budgeting, the value of an asset, and ownership’s image in the marketplace.)

- State Law Requirements – California, Florida, Hawaii, and Illinois were first and now many other states have laws or pending legislation addressing replacement reserve funding requirements for condominium and homeowner associations.

- CPA Reporting Requirements – The AICPA has established new guidelines for the review of Common Interest Realty Associations (“CIRA”). A CPA has to disclose not only the existence of a replacement reserve fund, but its adequacy.

- Lender Requirements – Many lending institutions, Fannie Mae, and the structured financed market require that a modified replacement reserve schedule be prepared for the mortgage term as part of the underwriting procedures and for establishing escrow funds.

- Assist in Estimating Market Value – A comprehensive replacement reserve study, which identifies annual expenditures over the holding period, assists appraisers in estimating market value by the income approach.

What are the types of replacement reserve studies?

Type 1 – Full: A Reserve Study in which the following five Reserve Study tasks are performed:

• Component Inventory
• Condition Assessment (based upon on-site visual observations)
• Life and Valuation Estimates
• Fund Status
• Funding Plan

Type 2 – Update, With-Site-Visit/On-Site Review: A Reserve Study update in which the following five Reserve study tasks are performed:

• Component Inventory (verification only, not quantification)
• Condition Assessment (based on on-site visual observations)
• Life and Valuation Estimates
• Fund Status
• Funding Plan

Type 3 – Update, No-Site-Visit/Off-Site Review: A Reserve Study update with no on-site visual observations in which the following three Reserve Study tasks are performed:

• Life and Valuation Estimates
• Fund Status
• Funding Plan

What is Included in the Report?

• Field inspection
• Condition assessment
• Quantification of all components
• Cost estimates
• Projections of future replacement costs
• Projection of the remaining useful life of study elements
• Financial analysis including funding plan and funding status

In addition, we note on the study any needed maintenance or repair work we observe along with recommendations for rehabilitation to extend the life of the construction.