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Reserve Studies Pt. 2: The Build-Out | Ep. 61
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Welcome to the second episode of our HOA Management Podcast series on Reserve Studies, part of The Uncommon Area! In this episode, our host, Matthew Holbrook, is joined by Reserve Analyst Derek Eckert and Board Member J Parsons. This conversation jumps right into the deep-end, exploring the more complex details of reserve studies and how to use them in a more advanced and effective way. If you’re a board member or manager, this episode is essential for preparing your HOA for long-term financial stability.
Key Topics Discussed
Transitioning from basic reserve studies to advanced strategies
Effective budgeting for major repairs and replacements
The role of reserve studies in safeguarding the financial health of HOAs
Common challenges and how to avoid them
Real-life examples of the impact of reserve studies
Meet our Special Guests
Derek Eckert is the Northern CA President at Association Reserves. With over 20 years of experience, Derek has extensive knowledge on Reserve Study budgets and disclosures for Common Interest Developments.
Connect with Derek on LinkedIn
Check out Association Reserves
J Parsons is the Board President at The Infinity San Francisco, a condominium high-rise in San Francisco. J has dealt with the challenges of running a Board first-hand and offers practical insight into what Board members regularly face.
Connect with J on LinkedIn
If you missed the first episode of the series, check it out here. It covers the fundamentals of reserve studies and sets the foundation for this episode.
Read Transcript
J Parsons (00:00)
In the past, we never really saw the reserve study as something that you budgeted. It was you did the 30-year analysis and you hoped you had enough money when you needed to repair something. Now we’re looking at it as we’re really budgeting for these kind of special repair projects or replacement projects, if you will.
Matthew Holbrook (00:20)
Most people are not equipped to understand the seemingly endless facets of an HOA.
That’s why we’re here, to help you become uncommonly prepared to serve your HOA.
Whether you are a board member or a manager, join us in The Uncommon Area.
Matthew Holbrook (00:41)
Welcome to the Uncommon Area. am Matthew Holbrook and this episode is kind of an advanced discussion around reserve studies and how to think about and use reserve studies in an effective way. And I’m particularly excited about this episode where I am joined by two guests. First, Derek Eckert, who is the president of Association Reserves.
And we are also joined by a homeowners association board member, Jay Parsons, who is the board president of the infinity owners association in San Francisco. And together, the three of us have a conversation around a whole variety of topics.
that are relevant to reserve studies and how to think through these budgeting tools more effectively and to use them more effectively to benefit your homeowners association. So I hope that you watch this episode and I think that you will find a lot of helpful things in the coming discussion. Well, Derek and Jay, appreciate you both being a part of this episode and we are going to dive into talking about reserve studies and how to most effectively use a reserve study.
And Derek, I want to start with you. ⁓ We are going to be talking again about reserve studies and maybe you could just explain what is a reserve study and then taking that a step further, what makes a good reserve study from your perspective.
Derek Eckert (02:02)
Yeah, sure. So a reserve study is a long-term ⁓ budgeting tool for community associations just to identify all their common area assets, identify what the life expectancies are, what the remaining lives are, and the cost estimates, ⁓ and then identify how much cash modeling you need moving forward over the next, you know, duration of years. The forecast covers a 30-year period, but that doesn’t necessarily exclude ⁓ items, components.
that might have a longer life than 30 years. What makes a good reserve study is obviously identifying all of the common area ⁓ items or assets and making sure you have good quantities for each of those items and then good cost estimates. And what can make even a reserve study even better is making sure that you get your subject matter experts involved and helping identify the true scope ⁓ and what the project actually would entail and the cost estimates as well.
Matthew Holbrook (03:01)
Yeah. And Jay, you’ve been on a board of directors for quite a while. You’ve been on finance committees. You’ve been involved in a lot of reserve studies. ⁓ When you’re looking at a reserve study, what’s important to you and where do you see that maybe a reserve study is not as helpful as you’d like it to be?
J Parsons (03:20)
I see one of the things that we found, especially when our building first opened 15 years ago, is that a reserve study sometimes has very low growth rates at the beginning and accelerating growth rates at the end. And what you see is a redistribution of investment where I can live here for five to 10 years and pay a very low rate on the consumables, if you will, the stuff you’re using up. And somebody who moves in 10 years later pays a lot. So I try to see things where the
payment is fairly allocated to the participants and where there’s sufficient cash to meet all of the big years.
Matthew Holbrook (03:53)
Yeah. So Derek, what, what’s behind that? Why do we see that, that kind of uneven distribution over the life of a building? Yeah.
Derek Eckert (04:03)
It’s an interesting question. It’s just interesting philosophy. ⁓ When properties and buildings are new, ⁓ reserves oftentimes get forgotten about ⁓ just because everything’s new, shiny, bright, doesn’t need to be done for a long time. ⁓ But the very nature of the reserve study is fairness. And these items, these components are truly agent in place from the get go.
⁓ And so develop this fairness plan within a reserve study. You need to start setting aside reserves from the beginning.
Matthew Holbrook (04:33)
Is that resulting just that are the DRE budgets ⁓ inadequate sometimes and then the reserve analyst comes in and you have to make some adjustments?
Derek Eckert (04:43)
So
oftentimes the DRE, Department of Real Estate, budget that helps get ⁓ initial developments off the ground and running are oftentimes insufficient. ⁓ They use generic numbers that are applicable ⁓ to different types of locations. So whether it be Fresno, Los Angeles, San Francisco, they’re using the same numbers and estimates within those ⁓ budgets. And the same is true with different types of developments. So high rises would use the same ⁓
factor or figure for a roofing system or mechanical system as ⁓ your townhome community. And so oftentimes these are deficient as far as how much funds they set aside. So you should ultimately bring on a professional reserve analyst within a community association right away, as soon as it’s turned over to the board and have those numbers reevaluated.
Matthew Holbrook (05:35)
Yeah. Jay, what are some of the challenges you’ve seen as a board member as far as getting that reserve study accurate? I know you’ve worked really hard at the infinity to get as accurate of numbers as possible.
J Parsons (05:47)
I was actually going to, along that line, I actually going to ask Derek, how does a reserve analyst ensure that they’re using numbers that are relevant to the building they’re looking at? So we’re a large high rise in San Francisco, and it’s hard to get people even to come into San Francisco to work on buildings, ⁓ let alone figure out how much it’s going to cost to have them do a repair. We have on a couple of occasions had to replace elements in the building where what we had reserved for that
was completely irrelevant to what it ultimately cost. And unfortunately, it’s never too high.
Derek Eckert (06:24)
Yeah, it’s so true in today’s environment. Lots happened since the COVID pandemic. ⁓ Cost estimates have changed quite a bit. And then in San Francisco, there’s some different pressures and elements as far as pricing modeling goes for projects. ⁓ So how we ⁓ take a look at it and try to factor it in and best prepare clients is first and foremost, we look to their actual cost history. So if you have multiple towers and you have two things, so let’s call them
boiler and you replace one boiler and one tower, the boiler in the second tower is probably going to be similar in cost. So we would factor that in and price it out in that sort of way. ⁓ The other thing we do is we have a lot of clients, some in San Francisco specifically. And so we take that data, that information, and we break it down into a per unit cost estimate, and we apply that factor to your particular building. So we’re looking like for like similar projects for similar projects.
and then applying those factors.
J Parsons (07:25)
But we were one of the first high rises in San Francisco. we’re kind of running into obsolescence ahead of a lot of others. So they don’t necessarily have that history. How as a board member can I be certain that the number they’re applying to a very long list of assets is relevant?
Derek Eckert (07:46)
Yeah, that’s a great point. So you’re setting the trend for other newer high rise properties within San Francisco. So what I would suggest is you get your subject matter experts involved. If you have an exterior waterproofing expert, bring them out to the property. them walk the property with you. Have them better kind of understand the scope of the project. And maybe they have just a ballpark estimate. The project might not be due for a few years, but oftentimes they’re willing to give you an estimate just to shore up the fact that
the true cost estimate is ⁓ correctly identified within the reserves.
J Parsons (08:20)
That’s actually one thing we’re thinking about doing is for our larger elements, like say elevators, actually going to Otis or to Mitsubishi and saying, what would it cost us to put all new elevators in today? And attempt to get life for life, 12 steps of upgrade in terms of technology or capability, just to see if we’re even in the ballpark. But it’s often
We often find it hard to induce a company to give you a bid that they know you’re not acting on. So it’s a difficult step.
Derek Eckert (08:59)
Yeah, a lot of vendors have been very busy the last couple of years, specifically elevator vendors. There’s a couple of year wait lists for modernizations right now. So if you sense your modernization is coming due soon, you should probably get in line and start to develop a timeline for that.
Matthew Holbrook (09:16)
Derek, is it a, a reasonable expectation to look to the reserve analyst to maybe highlight the components in a building that might be most volatile? So, ⁓ in particular it’s the, it’s the large assets and the ones where there may be, ⁓ a certain amount of volatility in what the actual cost could be. And maybe giving that feedback back to the board to say, Hey, these are the, these are the assets that it’s worth doing some extra homework.
to try to get the replacement cost dialed in. that a reasonable expectation of the analyst to provide that input? ⁓
Derek Eckert (09:53)
try to do that as part of my kickoff meeting when we do the site inspection. ⁓ I verbally go over those type of components. In a high-rise project, it’s going to be ⁓ major mechanical systems, so elevators, boilers, HVAC systems, probably roofs on a high-rise as well. ⁓ It’s going to be different for a townhome community, like a condo complex. ⁓ Those are going to be exterior siding projects, roofing ⁓ streets.
Those are the items that you should probably get experts involved early on.
J Parsons (10:26)
Do you ever have ⁓ like ⁓ a blank list of like typical buildings should have these items in their reserve study to kind of compare against versus the asset list that you see?
Derek Eckert (10:38)
yeah, so we do that behind the scenes. We have those lists. ⁓ We oftentimes, if it’s a first engagement, so we call it a full reserve study, we’ll show up with a template. It helps us keep us on track, make sure we’re not missing anything. ⁓ And then obviously if something’s not on the template, then we will add it to our notes and make sure that we include it as part of the list. But yeah, we have those lists.
Matthew Holbrook (11:01)
I know where Jay is ⁓ getting at here is even 15 years in for his particular building. ⁓ The board is still discovering new assets that have never been reserved before. And, ⁓ you know, just this challenge of identifying what those assets are earlier on in the process so they can be adequately reserved for. ⁓ It sounds like having a template like that can be helpful. Any other suggestions or input you could give to help minimize that that challenge for a board?
Derek Eckert (11:31)
Yeah, unfortunately Jay, you’re not alone. ⁓ A lot of projects that we work on, even our own projects, have items that need to be added at a later date. ⁓ I like to look at a reserve study as this living, breathing document that kind of gets better and evolves in time. And so ⁓ these items ⁓ will kind of stand up with you, within your community and say, hey, I need some attention. Maybe a board of director or a manager.
identifies them and then we start to have some dialogue and some conversation.
J Parsons (12:05)
guess the one that really sticks out to me is about, I guess it’s almost six years ago now, we got a new GM and she looked at the reserve study for the first time and realized all of our fire extinguishers in our four buildings were nowhere to be found on the reserve study. And you kind of think that would be a pretty standard item. we had like, I think in the neighborhood of 500 fire extinguishers, so wasn’t a small item.
that wasn’t reserved for it. Part of it was 10 years in, kind of time to change all your fire extinguishers. ⁓ So just to try and avoid that.
Matthew Holbrook (12:45)
Yeah, it seems like that would be the kind of thing that might be on one of those standard templates that you’re referring to, Derek.
Derek Eckert (12:51)
Yeah, we have those, again, behind the scenes and we try to take them out to the site and then make sure we actually include them.
Matthew Holbrook (12:58)
So Derek, could you talk for a minute about this idea of percent funded in a reserve study? And I’ll give you a little bit of a heads up. Jay is not a particular fan of the idea of the percent funded model, but maybe you can go ahead and explain that. And then Jay, I’ll have you go ahead and jump in and we can discuss where your concerns are with that from a model standpoint.
Derek Eckert (13:25)
So percent funded is a ratio between the fully funded balance, which is the deteriorated portion of all the components, versus cash on hand. And it’s a calculation that happens at the beginning of each and every year. And so our clients that are 30 % funded and under are considered weekly funded. For these clients, we oftentimes see them needing special assessments or having deferred maintenance.
And then clients that are 70 % funded and above, this is considered a strong funding position. And those are clients that oftentimes can avoid the need for any kind of a special assessment and take care of their projects on time.
Matthew Holbrook (14:07)
So before Jay jumps in on his concerns on that, one common question I hear from board members on what you just said, Derek, is if you’re not 100 % funded, then…
how can you have the funds needed when you’re going to need them? In other words, 100 % funded seems to mean you have exactly the right amount of dollars available so that when the time comes to replace assets, you have what you need to replace those assets. And you are indicating right now that if you’re at like 70%, you might still have all of the funding you need when you need to replace those assets. So how do you reconcile those differences?
Derek Eckert (14:51)
It’s a misconception that 100 % funded means that you have ⁓ enough funds to take care of all the projects in a given time. ⁓ What 100 % funded means is that you have enough funds set aside to cover all the deteriorated portion of your components. ⁓ So you can have less than 100 % funded and be just fine, be able to take care of the projects as they come due, because you’re going to continuously
⁓ contribute into reserves and have additional funds when projects that aren’t due for a number of years ⁓ all of a sudden become due.
Matthew Holbrook (15:28)
And that’s assuming probably an escalated contribution rate that you’re continuing to increase that rate so that you kind of make up that difference when the time is needed.
Derek Eckert (15:38)
Yeah,
that’s right. Most funding plans, most funding programs have ⁓ an annual increase model within it. You should at least have three to five percent ⁓ increases built into that.
Matthew Holbrook (15:53)
So Jay, you have concerns with that model.
J Parsons (15:56)
just think
it’s very simplistic because it ignores not only the funding rate that you have going forward, it also ignores any interest that you’re earning on your income, which helps to contribute toward that also. So it’s a very simplistic snapshot in time that I think leads people to take a great deal of comfort in a reserve study without looking at it in greater depth where there could be…
things that would concern me like a study that has very low growth right now, good funding, but then suddenly expects very sharp 10 to 20 % increases in annual, increases in the amount of annual funding in order to hit those, ⁓ hit those points. You know, we like to look at kind of how much money do we have in the big years ⁓ against the big, against the big expected costs and make sure that
It’s never going to be that it’s that perfect year. you kind of want a couple years before and a couple years after to know that you have the assets to replace your elevators when they’re likely to come to replace as one of the big typical ones. We like to look at those kind of crisis years, especially the ones that are like 10 years out, 15 years out versus ones that are 30 years out and ensure that you have proper funding there, which will have no relationship necessarily to what your funding status is today.
Derek Eckert (17:16)
Yeah, that’s a great point, Jay. I think it’s just so important that you also look at the 30 year cash model as well, ⁓ which I think that’s kind of what you’re pointing out. And it also includes what the annual expenditures are just to make sure that you’re on track as well, because ⁓ the percent funded is a slice in time at the start of the beginning of the fiscal year. Whereas the cash model moving forward ⁓ oversees the next 30 years and can identify some of these like.
these years where you have significant expenses.
J Parsons (17:49)
So talking about that, we have different ways of optimizing or solving for what that growth rate should be for our study. How do you determine what ⁓ those growth rates should be in a study? How do you make that cashflow model?
Derek Eckert (18:03)
Yeah, so obviously you need sufficient cash when the projects come due. So we take that into consideration. We want it to be fairly distributed amongst all owners, so current day owners and future owners. And we want it to be fiscally responsible. So these are some of the factors that we take into consideration. It also depends on where their starting point is. A model that we would set up for a 30 % funded client would be a lot different than a model we would set up for a 70 % funded client.
Matthew Holbrook (18:33)
And when you’re factoring in the incorporation of ⁓ inflation, where does that fit into your modeling? Especially as we look at what’s happened over the last couple of years.
Derek Eckert (18:43)
Yeah, inflation has been such a key topic lately. And so you have to disclose the assumption that you’re using. We’re back down to about a 3 % assumption for inflation within our studies. But there was some trending there for a while where cost estimates were going up 20 or 30 % each and every year. And we were having to make those manual adjustments to all the component estimates.
J Parsons (19:10)
And then what do you do for your interest assumption?
Derek Eckert (19:15)
Yeah, luckily ⁓ associations are now earning more interest all of a sudden, ⁓ as many people are. So right now we’re using something like three and a half percent ⁓ interest assumption in our studies, but it’s not uncommon for big communities, big high rises with millions of dollars to be earning five, five and a half percent.
J Parsons (19:39)
And you would actually, but you’re not gonna assume that for 30 years, are you?
Derek Eckert (19:43)
So that’s why we back it down. Instead of using five, five and a half percent, we’re using an average, something more like 3%, three and a half percent for the interest in some assumption.
Matthew Holbrook (19:54)
So I think just to clarify for anybody listening or watching to this, ⁓ when you are making your interest assumptions or your inflation assumptions, you’re looking at that on an average basis over a 30 year period, correct? As opposed to just what’s happening right now or in the next couple of years.
Derek Eckert (20:14)
Yeah, that’s correct. Yeah, the modeling needs to be shown over a 30 year period and not just what’s happening today.
J Parsons (20:20)
Right. So we try and take a very conservative approach to that and we’ll adjust our inflation assumption. So we went up as high as three and a half. We’re back down to two and a half now, assuming that that’s a good long term rate. But then we always set our interest rate to be equal to our inflation rate because we don’t want to make any assumption that we have a real positive rate of return because that leads to a lower contribution rate. Yeah.
Derek Eckert (20:48)
That’s a good point. One thing I want you to ⁓ be aware of is the interest only affects cash on hand. So if you’re funded less than 100 percent, the amount of interest you’re earning isn’t necessarily going to be offset by inflation. So inflation factors in all the items, all the components and increases by three percent. But if you only have 50 percent funding, the interest rate is only going to be affected by 50 percent of the overall cash value.
J Parsons (21:18)
Correct. Yeah. We just assume being the more conservative we can be in those assumptions, the better funded we will be and we won’t. As a large ⁓ HOA, many years in, our reserve funds are very large now. So we actually have, you know, significant interest every year. And so it’s becoming a significant component contributing each year.
and we want to make sure that our assumption out for 30 years especially is a very conservative one because it can cause you, I believe it could cause you to make bad assumptions about what your contribution rate should be.
Derek Eckert (21:56)
Yeah, being conservative is extra important when it comes to reserve study. There’s a lot of still unknowns. We try to take current day information, ⁓ information from your experts, all this data that we have at our hands, but there’s still some unknowns out there. So when you can be conservative, it really puts you in a better position long term.
Matthew Holbrook (22:18)
Derek, can you talk a little bit about ⁓ maintenance practices that extend the useful life of an asset? So sometimes a board is facing a choice where an asset may be coming to the end ⁓ of its remaining life, ⁓ but ⁓ there’s an opportunity to do certain maintenance functions that will buy you a few extra years versus just replacing the asset right now.
How do you think through those kinds of things in developing the reserve study and what advice might you give to boards in looking at those kinds of situations?
Derek Eckert (22:55)
Yeah, first and foremost, I have a conversation with the board because I want their buy-in. You know, what’s their approach going to be? If I think about a roof and maybe it’s got a leak here or there and they need to be able to do a cash benefit model to determine whether it’s worth it to spend, let’s make up a number, $50,000 to repair the roof or if it makes more sense to just spend $500,000 to replace the roof altogether. The $50,000 might buy you a year or two.
And in this modeling, you might be able to say, hey, there’s a benefit to actually spending $50,000 to repair the roof to buy us two more years versus replacing it right away. Or you might spend $50,000 and it might give you two months of additional life. And it might just be beneficial to just go ahead and spend the $500,000 to replace the roof. So it’s just something to consider.
Matthew Holbrook (23:48)
Derek, most of our board members are not as in tune with what’s happening financially and with the reserve studies as Jay is. And the, the scenario that you just described, ⁓ may not be one that is at the forefront of most boards minds. We’re talking about people who are lay board members. They don’t have expertise in, ⁓ in these types of things.
What should a manager do and what can a reserve analyst do to make sure that these types of things are bubbling up into the board’s consciousness to have those kinds of discussions when they need to have them?
Derek Eckert (24:30)
So
I think it just comes back to getting the experts involved. I’m not a roofing expert. I’ve seen a lot of roofs in my career. And I was just thinking as you were telling that story, a lot of board members don’t even go up on the roof. They have no idea even what the roof looks like. So get these experts involved, have them take photos, have them write some descriptive notes as to what the condition is and what kind of additional life they believe that they’ll get out of it if they were to spend the $50,000 on the roof.
so that they can have information at hand to help make some of these decisions.
Matthew Holbrook (25:05)
Yeah, I’m thinking even as, as I’m listening and thinking about how we train our managers and how we function. ⁓ it seems that there should be some extra steps, put in place for managers to, to be one very specifically aware of the, significant assets in a community. I think there’s obvious ones like the roof and so forth, but there are,
there’s the opportunity for there to be significant assets that might not be on the manager or the board members radar that really should be reviewed regularly to make sure the funding is, is sufficient. And so, ⁓ it seems like it might be a worthwhile exercise for everyone, every one of our associations to identify what are the ⁓ X number of top, ⁓ you know, most significant assets in the community and what are the steps that need to be done every year.
or with whatever frequency to ensure that there is adequate funding for those assets.
J Parsons (26:05)
And I’ll share a couple of real world examples that we kind of learned at the time by kind of running face into it of things that you should look for. We had a boiler up on top of the roof that needed replacing. Only problem, there was no way to get a boiler of that size onto the 36th floor of a building without helicoptering it in, which would be a huge, huge cost. So luckily we had a very good engineering staff and
our chief engineer identified that there was a process to reline the boiler that would extend the life of the boiler pretty close to the same extension of a new boiler, precluding us from having to have a Huey helicopter lift something up on the boiler. look at things that may not be accessible. Look at things that may not be like, I got to replace that up there, but how do I actually get up there to replace it?
Matthew Holbrook (27:01)
Yeah,
these real life examples, ⁓ that’s where the rubber meets the road. And I’m just thinking as you’re describing that boiler situation, we certainly have had buildings where they have had to use helicopters to replace the boilers. Derek, is that a reasonable expectation that the reserve analyst should be giving consideration in a particular building ⁓ for the cost, not just of a new boiler, but actually what some of these extra steps might be?
to put that boiler in place or whatever the asset might be.
Derek Eckert (27:34)
Yeah, we try to build in soft cost estimates within the estimate itself. So things like a construction manager to oversee a major project, helicoptering up a boiler or a cooling tower onto the roof, or permitting for a city, right, or a municipality. So these are all factors that are considered and built in.
Matthew Holbrook (27:58)
Are they broken down in the reserve study itself?
Derek Eckert (28:00)
Usually, no.
Matthew Holbrook (28:03)
Is there any value to doing that? So a board might understand that, okay, when it comes to doing the, you know, replacing the boiler, these are the types of things that we probably need to be taking into consideration.
Derek Eckert (28:15)
So oftentimes we’ll write it into what we call our component notes. So if someone wants to get into the details and read the notes, they can find out what the makeup is of the expense within the component. But you would have to get down deep into the report to go ahead and read that. But I think the main reason why we don’t include some of these soft costs as individual components is the list would get very long and at some point in time it would become unmanageable.
⁓ And so we try to keep it within reason so that the board can digest the information pretty quickly and make some of their decisions that they need to make.
J Parsons (28:58)
And some of them are very ⁓ ambiguous, I guess, and subject to subject to change. We had to reline our fireball water tank under the building. And one fire chief was going to require us to have a tanker truck parked outside the building for the entire time that our fireball was empty. ⁓ And then fortunately, he got reassigned and a new fire chief said, No, you’re blocked from the firehouse. You’re good. But that would have been a substantial cost to basically
pay the city for the parking permit, block the street, have this huge, I forget how many thousands of gallon water tank was going to have to sit out there the whole time that they were working on the vault and the thing. And that came and went based on just the belief of the local fire chief who had the authority to make that decision. And so you’re always going to have… And this is why I think it’s good to be conservative and have a little extra because you’re always going to have those kinds of just real like, oh, who would thought that?
type of activities on the soft card.
Matthew Holbrook (30:01)
you and I were in a meeting just last night where reserve studies were being discussed. And, um, there was a discussion around a, uh, kind of a new line item in the reserve study that, um, uh, that the board was, was considering it to talk to the reserve analyst about that was essentially, um, uh, I want to say a kind of a catch all line item, but that’s not a fair way to put it. Um, but, uh, a, a line item that would take into consideration.
various different projects that would be captured altogether. ⁓ You want to maybe talk a little bit about kind of what the thinking is on that and then have Derek respond.
J Parsons (30:39)
we’ve
done is ⁓ our treasurer has done all this work. I didn’t do the work. He’s done a tremendous amount of work on this. He’s looked at the different things that we’re reserving for and said some of them are necessary repair and replacement and some of it is really keeping the remodeling. We want to maintain ourselves as an A-list property. ⁓
To do that, our club lounge has to always look nice. And so every 10, 15 years, we have to put in a new club lounge. The existing club lounge may not necessarily be completely ⁓ used up as it were, right? In a reserve study standpoint, it could be still functionally fine and the equipment could be fine in it, but we feel that we’ll need to replace it. So what we’ve done is actually split those projects into two elements. One is necessary.
repair and replacement. And that’s kind of no question, know, a carpet needs replacing, you replace the carpet. But then we call it discretionary projects, which are more of these kind of keeping the building current. But we have it separated out primarily for the reason that it makes it easier for the board to understand what we’re saying and what we’re expecting. ⁓ So our lobbies need to be remodeled in two years.
Okay, when it was buried in the reserve study, we knew that we were accumulating money for lobbies and we knew the expected life on some parts were five years and some parts were seven years. Now by pulling them into projects, we have them more clearly aligned and the board can then get involved in deciding, well, is the club lounge really two years away from its expected life or do we need to move that out a little bit or move it in a little bit? ⁓
And so I’m kind of excited about the conversation. think it’ll drive on the board’s respect. In the past, we never really saw the reserve study as something that you budgeted. It was you did this you did a 30 year analysis and you hope you had enough money when you needed to repair something. Now we’re looking at it as we’re really budgeting for these kind of special repair projects or replacement projects, if you will.
Matthew Holbrook (32:55)
Yeah, I think that it’s, really taking a, ⁓ an ultra practical approach to how to, how to use the reserve study as an actual budgeting tool in real life situations, as opposed to it just being broken down into these, ⁓ you know, multiple different components that really are all related and should all be addressed together. And, ⁓ and when they’re all separated into these different components, it’s, you have the academic exercise, but it’s not practical in how to, ⁓
to budget in a real life situation when you care about the overall presentation of ⁓ your community.
J Parsons (33:30)
And it also broke a mine dam, if you will, that we had run into as a board where we kept thinking, carpets is a classic example, we’re going to replace all the carpets in five years.
So we weren’t allocating money to repair problems with the carpets. ⁓ Because why should I put a whole new carpet on this floor when it’s just going to get torn up in a couple of years? And by breaking it into these projects where we actually looked at it, we realized, no, that’s not actually what we’re going to do. We should be repairing the carpet right now. And maybe that’s all we ever do is just continue to repair the carpet. We don’t ever have a complete new, know, blue for green change on the carpet. We just continue to use.
⁓ what we have and it’s allowed us to make decisions, recognize that we might’ve been to avoid doing the whole thing, missing doing the small things. ⁓ And now that we look at it, we go, now we should be doing this, this and this. And then we can do the whole thing in five years, but in meantime, we need to be working on this other stuff. And so I think it’s really helped us segment between what we need to be doing right now versus the bigger projects of changing something.
Derek Eckert (34:40)
I think that’s a great approach. When I look at a reserve study and a client, I’m always trying to tailor it towards their particular property, their building and their approaches. ⁓ And to me, it sounds like you’re up allowances to take care of interior remodel projects and that works for you. That’s a good fit for your building. And so I think it’s a really good thing that you’re doing that.
J Parsons (35:05)
Yeah. And it also has made it clear in our minds when we’re doing a capital addition, which is not a reserve, you we’re adding something new versus replace or repairing something that exists. And that was always a fuzzy area for us ⁓ also, you know, mentally from a board standpoint, I’m sure it wouldn’t be from a reserve standpoint as a board member to sign. Like, you know, if I want to do put a new bar in a room,
Is that a upgrade to that room or is it a capital improvement or is it a reserve asset? Those lines were often blurry for us.
Matthew Holbrook (35:41)
Yeah. And I think that maybe leads us into the last section that I wanted to address here. And that is, ⁓ do you have guidance, Derek, on how boards should think about where that line does get blurred between, ⁓ our reserve expenditure and ongoing maintenance expenditures? ⁓ I know that those are conversations that come up all the time and, ⁓
wanted to get your feedback on how should a board and management think through those kind of blurry line scenarios.
Derek Eckert (36:15)
Yeah, I think it’s case by case basis. One test that I always put into consideration is if the expenses of substance, right? So is it a significant expense to this particular property? J’s property, it’s the infinity, it’s a big project. And so a thousand bucks would not be of substance, right?
but a smaller community of two units, thousand bucks might be definitely a project, a component within the reserve study that should be included. So that’s really the test that I look at and take into consideration. And then the second test that I also take into consideration is just predictability. ⁓ Is there an understood trend as to whether or not this project will have some kind of a cycle? ⁓
Will this maintenance need to continue? Will it need to happen every few years? And if it can, then I can apply a useful life and a remaining life to that.
Matthew Holbrook (37:16)
Yeah, I’ve heard a lot of boards use kind of an annual test on this. If it’s something that needs to be done every year, then that’s more of a maintenance expense. But if it’s something where it’s going to be addressed more or less frequently than every year, then it probably should be reserved for.
J Parsons (37:32)
But why would that be the exciting factor? Because if I’m doing maintenance on a boiler every year, to me, that’s a reserve. ⁓ I’m maintaining a reserve asset. I should be paying from that from the reserve. ⁓ I think the only thing we really consider ongoing maintenance is like our plants and landscaping. Because if we’re working on a reserve asset, wouldn’t you take the view that that is a reserve expense?
Derek Eckert (38:00)
So for your boiler if you have a service vendor that comes once a month and takes a look at it and make sure it’s functioning and needs oil or whatever I would consider that a maintenance expense ⁓ But if you’re improving the boiler in some kind of way and you’re giving it additional longevity like you’re spending $5,000 to replace the burner at the bottom of the boiler then I would consider that ⁓ a reserve project
Matthew Holbrook (38:27)
Well, I think that wraps up our time here and ⁓ that’s been a very helpful discussion. A lot of really ⁓ important and helpful things that board members and managers can give consideration to. So ⁓ thank you both. Really appreciate your time and your input. And just want to encourage those of you who have been watching or listening to this episode to check out other episodes of The Uncommon Area.
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Welcome to the second episode of our HOA Management Podcast series on Reserve Studies, part of The Uncommon Area! In this episode, our host, Matthew Holbrook, is joined by Reserve Analyst Derek Eckert and Board Member J Parsons. This conversation jumps right into the deep-end, exploring the more complex details of reserve studies and how to use them in a more advanced and effective way. If you’re a board member or manager, this episode is essential for preparing your HOA for long-term financial stability.
Key Topics Discussed
Transitioning from basic reserve studies to advanced strategies
Effective budgeting for major repairs and replacements
The role of reserve studies in safeguarding the financial health of HOAs
Common challenges and how to avoid them
Real-life examples of the impact of reserve studies
Meet our Special Guests
Derek Eckert is the Northern CA President at Association Reserves. With over 20 years of experience, Derek has extensive knowledge on Reserve Study budgets and disclosures for Common Interest Developments.
Connect with Derek on LinkedIn
Check out Association Reserves
J Parsons is the Board President at The Infinity San Francisco, a condominium high-rise in San Francisco. J has dealt with the challenges of running a Board first-hand and offers practical insight into what Board members regularly face.
Connect with J on LinkedIn
If you missed the first episode of the series, check it out here. It covers the fundamentals of reserve studies and sets the foundation for this episode.
Read Transcript
J Parsons (00:00)
In the past, we never really saw the reserve study as something that you budgeted. It was you did the 30-year analysis and you hoped you had enough money when you needed to repair something. Now we’re looking at it as we’re really budgeting for these kind of special repair projects or replacement projects, if you will.
Matthew Holbrook (00:20)
Most people are not equipped to understand the seemingly endless facets of an HOA.
That’s why we’re here, to help you become uncommonly prepared to serve your HOA.
Whether you are a board member or a manager, join us in The Uncommon Area.
Matthew Holbrook (00:41)
Welcome to the Uncommon Area. am Matthew Holbrook and this episode is kind of an advanced discussion around reserve studies and how to think about and use reserve studies in an effective way. And I’m particularly excited about this episode where I am joined by two guests. First, Derek Eckert, who is the president of Association Reserves.
And we are also joined by a homeowners association board member, Jay Parsons, who is the board president of the infinity owners association in San Francisco. And together, the three of us have a conversation around a whole variety of topics.
that are relevant to reserve studies and how to think through these budgeting tools more effectively and to use them more effectively to benefit your homeowners association. So I hope that you watch this episode and I think that you will find a lot of helpful things in the coming discussion. Well, Derek and Jay, appreciate you both being a part of this episode and we are going to dive into talking about reserve studies and how to most effectively use a reserve study.
And Derek, I want to start with you. ⁓ We are going to be talking again about reserve studies and maybe you could just explain what is a reserve study and then taking that a step further, what makes a good reserve study from your perspective.
Derek Eckert (02:02)
Yeah, sure. So a reserve study is a long-term ⁓ budgeting tool for community associations just to identify all their common area assets, identify what the life expectancies are, what the remaining lives are, and the cost estimates, ⁓ and then identify how much cash modeling you need moving forward over the next, you know, duration of years. The forecast covers a 30-year period, but that doesn’t necessarily exclude ⁓ items, components.
that might have a longer life than 30 years. What makes a good reserve study is obviously identifying all of the common area ⁓ items or assets and making sure you have good quantities for each of those items and then good cost estimates. And what can make even a reserve study even better is making sure that you get your subject matter experts involved and helping identify the true scope ⁓ and what the project actually would entail and the cost estimates as well.
Matthew Holbrook (03:01)
Yeah. And Jay, you’ve been on a board of directors for quite a while. You’ve been on finance committees. You’ve been involved in a lot of reserve studies. ⁓ When you’re looking at a reserve study, what’s important to you and where do you see that maybe a reserve study is not as helpful as you’d like it to be?
J Parsons (03:20)
I see one of the things that we found, especially when our building first opened 15 years ago, is that a reserve study sometimes has very low growth rates at the beginning and accelerating growth rates at the end. And what you see is a redistribution of investment where I can live here for five to 10 years and pay a very low rate on the consumables, if you will, the stuff you’re using up. And somebody who moves in 10 years later pays a lot. So I try to see things where the
payment is fairly allocated to the participants and where there’s sufficient cash to meet all of the big years.
Matthew Holbrook (03:53)
Yeah. So Derek, what, what’s behind that? Why do we see that, that kind of uneven distribution over the life of a building? Yeah.
Derek Eckert (04:03)
It’s an interesting question. It’s just interesting philosophy. ⁓ When properties and buildings are new, ⁓ reserves oftentimes get forgotten about ⁓ just because everything’s new, shiny, bright, doesn’t need to be done for a long time. ⁓ But the very nature of the reserve study is fairness. And these items, these components are truly agent in place from the get go.
⁓ And so develop this fairness plan within a reserve study. You need to start setting aside reserves from the beginning.
Matthew Holbrook (04:33)
Is that resulting just that are the DRE budgets ⁓ inadequate sometimes and then the reserve analyst comes in and you have to make some adjustments?
Derek Eckert (04:43)
So
oftentimes the DRE, Department of Real Estate, budget that helps get ⁓ initial developments off the ground and running are oftentimes insufficient. ⁓ They use generic numbers that are applicable ⁓ to different types of locations. So whether it be Fresno, Los Angeles, San Francisco, they’re using the same numbers and estimates within those ⁓ budgets. And the same is true with different types of developments. So high rises would use the same ⁓
factor or figure for a roofing system or mechanical system as ⁓ your townhome community. And so oftentimes these are deficient as far as how much funds they set aside. So you should ultimately bring on a professional reserve analyst within a community association right away, as soon as it’s turned over to the board and have those numbers reevaluated.
Matthew Holbrook (05:35)
Yeah. Jay, what are some of the challenges you’ve seen as a board member as far as getting that reserve study accurate? I know you’ve worked really hard at the infinity to get as accurate of numbers as possible.
J Parsons (05:47)
I was actually going to, along that line, I actually going to ask Derek, how does a reserve analyst ensure that they’re using numbers that are relevant to the building they’re looking at? So we’re a large high rise in San Francisco, and it’s hard to get people even to come into San Francisco to work on buildings, ⁓ let alone figure out how much it’s going to cost to have them do a repair. We have on a couple of occasions had to replace elements in the building where what we had reserved for that
was completely irrelevant to what it ultimately cost. And unfortunately, it’s never too high.
Derek Eckert (06:24)
Yeah, it’s so true in today’s environment. Lots happened since the COVID pandemic. ⁓ Cost estimates have changed quite a bit. And then in San Francisco, there’s some different pressures and elements as far as pricing modeling goes for projects. ⁓ So how we ⁓ take a look at it and try to factor it in and best prepare clients is first and foremost, we look to their actual cost history. So if you have multiple towers and you have two things, so let’s call them
boiler and you replace one boiler and one tower, the boiler in the second tower is probably going to be similar in cost. So we would factor that in and price it out in that sort of way. ⁓ The other thing we do is we have a lot of clients, some in San Francisco specifically. And so we take that data, that information, and we break it down into a per unit cost estimate, and we apply that factor to your particular building. So we’re looking like for like similar projects for similar projects.
and then applying those factors.
J Parsons (07:25)
But we were one of the first high rises in San Francisco. we’re kind of running into obsolescence ahead of a lot of others. So they don’t necessarily have that history. How as a board member can I be certain that the number they’re applying to a very long list of assets is relevant?
Derek Eckert (07:46)
Yeah, that’s a great point. So you’re setting the trend for other newer high rise properties within San Francisco. So what I would suggest is you get your subject matter experts involved. If you have an exterior waterproofing expert, bring them out to the property. them walk the property with you. Have them better kind of understand the scope of the project. And maybe they have just a ballpark estimate. The project might not be due for a few years, but oftentimes they’re willing to give you an estimate just to shore up the fact that
the true cost estimate is ⁓ correctly identified within the reserves.
J Parsons (08:20)
That’s actually one thing we’re thinking about doing is for our larger elements, like say elevators, actually going to Otis or to Mitsubishi and saying, what would it cost us to put all new elevators in today? And attempt to get life for life, 12 steps of upgrade in terms of technology or capability, just to see if we’re even in the ballpark. But it’s often
We often find it hard to induce a company to give you a bid that they know you’re not acting on. So it’s a difficult step.
Derek Eckert (08:59)
Yeah, a lot of vendors have been very busy the last couple of years, specifically elevator vendors. There’s a couple of year wait lists for modernizations right now. So if you sense your modernization is coming due soon, you should probably get in line and start to develop a timeline for that.
Matthew Holbrook (09:16)
Derek, is it a, a reasonable expectation to look to the reserve analyst to maybe highlight the components in a building that might be most volatile? So, ⁓ in particular it’s the, it’s the large assets and the ones where there may be, ⁓ a certain amount of volatility in what the actual cost could be. And maybe giving that feedback back to the board to say, Hey, these are the, these are the assets that it’s worth doing some extra homework.
to try to get the replacement cost dialed in. that a reasonable expectation of the analyst to provide that input? ⁓
Derek Eckert (09:53)
try to do that as part of my kickoff meeting when we do the site inspection. ⁓ I verbally go over those type of components. In a high-rise project, it’s going to be ⁓ major mechanical systems, so elevators, boilers, HVAC systems, probably roofs on a high-rise as well. ⁓ It’s going to be different for a townhome community, like a condo complex. ⁓ Those are going to be exterior siding projects, roofing ⁓ streets.
Those are the items that you should probably get experts involved early on.
J Parsons (10:26)
Do you ever have ⁓ like ⁓ a blank list of like typical buildings should have these items in their reserve study to kind of compare against versus the asset list that you see?
Derek Eckert (10:38)
yeah, so we do that behind the scenes. We have those lists. ⁓ We oftentimes, if it’s a first engagement, so we call it a full reserve study, we’ll show up with a template. It helps us keep us on track, make sure we’re not missing anything. ⁓ And then obviously if something’s not on the template, then we will add it to our notes and make sure that we include it as part of the list. But yeah, we have those lists.
Matthew Holbrook (11:01)
I know where Jay is ⁓ getting at here is even 15 years in for his particular building. ⁓ The board is still discovering new assets that have never been reserved before. And, ⁓ you know, just this challenge of identifying what those assets are earlier on in the process so they can be adequately reserved for. ⁓ It sounds like having a template like that can be helpful. Any other suggestions or input you could give to help minimize that that challenge for a board?
Derek Eckert (11:31)
Yeah, unfortunately Jay, you’re not alone. ⁓ A lot of projects that we work on, even our own projects, have items that need to be added at a later date. ⁓ I like to look at a reserve study as this living, breathing document that kind of gets better and evolves in time. And so ⁓ these items ⁓ will kind of stand up with you, within your community and say, hey, I need some attention. Maybe a board of director or a manager.
identifies them and then we start to have some dialogue and some conversation.
J Parsons (12:05)
guess the one that really sticks out to me is about, I guess it’s almost six years ago now, we got a new GM and she looked at the reserve study for the first time and realized all of our fire extinguishers in our four buildings were nowhere to be found on the reserve study. And you kind of think that would be a pretty standard item. we had like, I think in the neighborhood of 500 fire extinguishers, so wasn’t a small item.
that wasn’t reserved for it. Part of it was 10 years in, kind of time to change all your fire extinguishers. ⁓ So just to try and avoid that.
Matthew Holbrook (12:45)
Yeah, it seems like that would be the kind of thing that might be on one of those standard templates that you’re referring to, Derek.
Derek Eckert (12:51)
Yeah, we have those, again, behind the scenes and we try to take them out to the site and then make sure we actually include them.
Matthew Holbrook (12:58)
So Derek, could you talk for a minute about this idea of percent funded in a reserve study? And I’ll give you a little bit of a heads up. Jay is not a particular fan of the idea of the percent funded model, but maybe you can go ahead and explain that. And then Jay, I’ll have you go ahead and jump in and we can discuss where your concerns are with that from a model standpoint.
Derek Eckert (13:25)
So percent funded is a ratio between the fully funded balance, which is the deteriorated portion of all the components, versus cash on hand. And it’s a calculation that happens at the beginning of each and every year. And so our clients that are 30 % funded and under are considered weekly funded. For these clients, we oftentimes see them needing special assessments or having deferred maintenance.
And then clients that are 70 % funded and above, this is considered a strong funding position. And those are clients that oftentimes can avoid the need for any kind of a special assessment and take care of their projects on time.
Matthew Holbrook (14:07)
So before Jay jumps in on his concerns on that, one common question I hear from board members on what you just said, Derek, is if you’re not 100 % funded, then…
how can you have the funds needed when you’re going to need them? In other words, 100 % funded seems to mean you have exactly the right amount of dollars available so that when the time comes to replace assets, you have what you need to replace those assets. And you are indicating right now that if you’re at like 70%, you might still have all of the funding you need when you need to replace those assets. So how do you reconcile those differences?
Derek Eckert (14:51)
It’s a misconception that 100 % funded means that you have ⁓ enough funds to take care of all the projects in a given time. ⁓ What 100 % funded means is that you have enough funds set aside to cover all the deteriorated portion of your components. ⁓ So you can have less than 100 % funded and be just fine, be able to take care of the projects as they come due, because you’re going to continuously
⁓ contribute into reserves and have additional funds when projects that aren’t due for a number of years ⁓ all of a sudden become due.
Matthew Holbrook (15:28)
And that’s assuming probably an escalated contribution rate that you’re continuing to increase that rate so that you kind of make up that difference when the time is needed.
Derek Eckert (15:38)
Yeah,
that’s right. Most funding plans, most funding programs have ⁓ an annual increase model within it. You should at least have three to five percent ⁓ increases built into that.
Matthew Holbrook (15:53)
So Jay, you have concerns with that model.
J Parsons (15:56)
just think
it’s very simplistic because it ignores not only the funding rate that you have going forward, it also ignores any interest that you’re earning on your income, which helps to contribute toward that also. So it’s a very simplistic snapshot in time that I think leads people to take a great deal of comfort in a reserve study without looking at it in greater depth where there could be…
things that would concern me like a study that has very low growth right now, good funding, but then suddenly expects very sharp 10 to 20 % increases in annual, increases in the amount of annual funding in order to hit those, ⁓ hit those points. You know, we like to look at kind of how much money do we have in the big years ⁓ against the big, against the big expected costs and make sure that
It’s never going to be that it’s that perfect year. you kind of want a couple years before and a couple years after to know that you have the assets to replace your elevators when they’re likely to come to replace as one of the big typical ones. We like to look at those kind of crisis years, especially the ones that are like 10 years out, 15 years out versus ones that are 30 years out and ensure that you have proper funding there, which will have no relationship necessarily to what your funding status is today.
Derek Eckert (17:16)
Yeah, that’s a great point, Jay. I think it’s just so important that you also look at the 30 year cash model as well, ⁓ which I think that’s kind of what you’re pointing out. And it also includes what the annual expenditures are just to make sure that you’re on track as well, because ⁓ the percent funded is a slice in time at the start of the beginning of the fiscal year. Whereas the cash model moving forward ⁓ oversees the next 30 years and can identify some of these like.
these years where you have significant expenses.
J Parsons (17:49)
So talking about that, we have different ways of optimizing or solving for what that growth rate should be for our study. How do you determine what ⁓ those growth rates should be in a study? How do you make that cashflow model?
Derek Eckert (18:03)
Yeah, so obviously you need sufficient cash when the projects come due. So we take that into consideration. We want it to be fairly distributed amongst all owners, so current day owners and future owners. And we want it to be fiscally responsible. So these are some of the factors that we take into consideration. It also depends on where their starting point is. A model that we would set up for a 30 % funded client would be a lot different than a model we would set up for a 70 % funded client.
Matthew Holbrook (18:33)
And when you’re factoring in the incorporation of ⁓ inflation, where does that fit into your modeling? Especially as we look at what’s happened over the last couple of years.
Derek Eckert (18:43)
Yeah, inflation has been such a key topic lately. And so you have to disclose the assumption that you’re using. We’re back down to about a 3 % assumption for inflation within our studies. But there was some trending there for a while where cost estimates were going up 20 or 30 % each and every year. And we were having to make those manual adjustments to all the component estimates.
J Parsons (19:10)
And then what do you do for your interest assumption?
Derek Eckert (19:15)
Yeah, luckily ⁓ associations are now earning more interest all of a sudden, ⁓ as many people are. So right now we’re using something like three and a half percent ⁓ interest assumption in our studies, but it’s not uncommon for big communities, big high rises with millions of dollars to be earning five, five and a half percent.
J Parsons (19:39)
And you would actually, but you’re not gonna assume that for 30 years, are you?
Derek Eckert (19:43)
So that’s why we back it down. Instead of using five, five and a half percent, we’re using an average, something more like 3%, three and a half percent for the interest in some assumption.
Matthew Holbrook (19:54)
So I think just to clarify for anybody listening or watching to this, ⁓ when you are making your interest assumptions or your inflation assumptions, you’re looking at that on an average basis over a 30 year period, correct? As opposed to just what’s happening right now or in the next couple of years.
Derek Eckert (20:14)
Yeah, that’s correct. Yeah, the modeling needs to be shown over a 30 year period and not just what’s happening today.
J Parsons (20:20)
Right. So we try and take a very conservative approach to that and we’ll adjust our inflation assumption. So we went up as high as three and a half. We’re back down to two and a half now, assuming that that’s a good long term rate. But then we always set our interest rate to be equal to our inflation rate because we don’t want to make any assumption that we have a real positive rate of return because that leads to a lower contribution rate. Yeah.
Derek Eckert (20:48)
That’s a good point. One thing I want you to ⁓ be aware of is the interest only affects cash on hand. So if you’re funded less than 100 percent, the amount of interest you’re earning isn’t necessarily going to be offset by inflation. So inflation factors in all the items, all the components and increases by three percent. But if you only have 50 percent funding, the interest rate is only going to be affected by 50 percent of the overall cash value.
J Parsons (21:18)
Correct. Yeah. We just assume being the more conservative we can be in those assumptions, the better funded we will be and we won’t. As a large ⁓ HOA, many years in, our reserve funds are very large now. So we actually have, you know, significant interest every year. And so it’s becoming a significant component contributing each year.
and we want to make sure that our assumption out for 30 years especially is a very conservative one because it can cause you, I believe it could cause you to make bad assumptions about what your contribution rate should be.
Derek Eckert (21:56)
Yeah, being conservative is extra important when it comes to reserve study. There’s a lot of still unknowns. We try to take current day information, ⁓ information from your experts, all this data that we have at our hands, but there’s still some unknowns out there. So when you can be conservative, it really puts you in a better position long term.
Matthew Holbrook (22:18)
Derek, can you talk a little bit about ⁓ maintenance practices that extend the useful life of an asset? So sometimes a board is facing a choice where an asset may be coming to the end ⁓ of its remaining life, ⁓ but ⁓ there’s an opportunity to do certain maintenance functions that will buy you a few extra years versus just replacing the asset right now.
How do you think through those kinds of things in developing the reserve study and what advice might you give to boards in looking at those kinds of situations?
Derek Eckert (22:55)
Yeah, first and foremost, I have a conversation with the board because I want their buy-in. You know, what’s their approach going to be? If I think about a roof and maybe it’s got a leak here or there and they need to be able to do a cash benefit model to determine whether it’s worth it to spend, let’s make up a number, $50,000 to repair the roof or if it makes more sense to just spend $500,000 to replace the roof altogether. The $50,000 might buy you a year or two.
And in this modeling, you might be able to say, hey, there’s a benefit to actually spending $50,000 to repair the roof to buy us two more years versus replacing it right away. Or you might spend $50,000 and it might give you two months of additional life. And it might just be beneficial to just go ahead and spend the $500,000 to replace the roof. So it’s just something to consider.
Matthew Holbrook (23:48)
Derek, most of our board members are not as in tune with what’s happening financially and with the reserve studies as Jay is. And the, the scenario that you just described, ⁓ may not be one that is at the forefront of most boards minds. We’re talking about people who are lay board members. They don’t have expertise in, ⁓ in these types of things.
What should a manager do and what can a reserve analyst do to make sure that these types of things are bubbling up into the board’s consciousness to have those kinds of discussions when they need to have them?
Derek Eckert (24:30)
So
I think it just comes back to getting the experts involved. I’m not a roofing expert. I’ve seen a lot of roofs in my career. And I was just thinking as you were telling that story, a lot of board members don’t even go up on the roof. They have no idea even what the roof looks like. So get these experts involved, have them take photos, have them write some descriptive notes as to what the condition is and what kind of additional life they believe that they’ll get out of it if they were to spend the $50,000 on the roof.
so that they can have information at hand to help make some of these decisions.
Matthew Holbrook (25:05)
Yeah, I’m thinking even as, as I’m listening and thinking about how we train our managers and how we function. ⁓ it seems that there should be some extra steps, put in place for managers to, to be one very specifically aware of the, significant assets in a community. I think there’s obvious ones like the roof and so forth, but there are,
there’s the opportunity for there to be significant assets that might not be on the manager or the board members radar that really should be reviewed regularly to make sure the funding is, is sufficient. And so, ⁓ it seems like it might be a worthwhile exercise for everyone, every one of our associations to identify what are the ⁓ X number of top, ⁓ you know, most significant assets in the community and what are the steps that need to be done every year.
or with whatever frequency to ensure that there is adequate funding for those assets.
J Parsons (26:05)
And I’ll share a couple of real world examples that we kind of learned at the time by kind of running face into it of things that you should look for. We had a boiler up on top of the roof that needed replacing. Only problem, there was no way to get a boiler of that size onto the 36th floor of a building without helicoptering it in, which would be a huge, huge cost. So luckily we had a very good engineering staff and
our chief engineer identified that there was a process to reline the boiler that would extend the life of the boiler pretty close to the same extension of a new boiler, precluding us from having to have a Huey helicopter lift something up on the boiler. look at things that may not be accessible. Look at things that may not be like, I got to replace that up there, but how do I actually get up there to replace it?
Matthew Holbrook (27:01)
Yeah,
these real life examples, ⁓ that’s where the rubber meets the road. And I’m just thinking as you’re describing that boiler situation, we certainly have had buildings where they have had to use helicopters to replace the boilers. Derek, is that a reasonable expectation that the reserve analyst should be giving consideration in a particular building ⁓ for the cost, not just of a new boiler, but actually what some of these extra steps might be?
to put that boiler in place or whatever the asset might be.
Derek Eckert (27:34)
Yeah, we try to build in soft cost estimates within the estimate itself. So things like a construction manager to oversee a major project, helicoptering up a boiler or a cooling tower onto the roof, or permitting for a city, right, or a municipality. So these are all factors that are considered and built in.
Matthew Holbrook (27:58)
Are they broken down in the reserve study itself?
Derek Eckert (28:00)
Usually, no.
Matthew Holbrook (28:03)
Is there any value to doing that? So a board might understand that, okay, when it comes to doing the, you know, replacing the boiler, these are the types of things that we probably need to be taking into consideration.
Derek Eckert (28:15)
So oftentimes we’ll write it into what we call our component notes. So if someone wants to get into the details and read the notes, they can find out what the makeup is of the expense within the component. But you would have to get down deep into the report to go ahead and read that. But I think the main reason why we don’t include some of these soft costs as individual components is the list would get very long and at some point in time it would become unmanageable.
⁓ And so we try to keep it within reason so that the board can digest the information pretty quickly and make some of their decisions that they need to make.
J Parsons (28:58)
And some of them are very ⁓ ambiguous, I guess, and subject to subject to change. We had to reline our fireball water tank under the building. And one fire chief was going to require us to have a tanker truck parked outside the building for the entire time that our fireball was empty. ⁓ And then fortunately, he got reassigned and a new fire chief said, No, you’re blocked from the firehouse. You’re good. But that would have been a substantial cost to basically
pay the city for the parking permit, block the street, have this huge, I forget how many thousands of gallon water tank was going to have to sit out there the whole time that they were working on the vault and the thing. And that came and went based on just the belief of the local fire chief who had the authority to make that decision. And so you’re always going to have… And this is why I think it’s good to be conservative and have a little extra because you’re always going to have those kinds of just real like, oh, who would thought that?
type of activities on the soft card.
Matthew Holbrook (30:01)
you and I were in a meeting just last night where reserve studies were being discussed. And, um, there was a discussion around a, uh, kind of a new line item in the reserve study that, um, uh, that the board was, was considering it to talk to the reserve analyst about that was essentially, um, uh, I want to say a kind of a catch all line item, but that’s not a fair way to put it. Um, but, uh, a, a line item that would take into consideration.
various different projects that would be captured altogether. ⁓ You want to maybe talk a little bit about kind of what the thinking is on that and then have Derek respond.
J Parsons (30:39)
we’ve
done is ⁓ our treasurer has done all this work. I didn’t do the work. He’s done a tremendous amount of work on this. He’s looked at the different things that we’re reserving for and said some of them are necessary repair and replacement and some of it is really keeping the remodeling. We want to maintain ourselves as an A-list property. ⁓
To do that, our club lounge has to always look nice. And so every 10, 15 years, we have to put in a new club lounge. The existing club lounge may not necessarily be completely ⁓ used up as it were, right? In a reserve study standpoint, it could be still functionally fine and the equipment could be fine in it, but we feel that we’ll need to replace it. So what we’ve done is actually split those projects into two elements. One is necessary.
repair and replacement. And that’s kind of no question, know, a carpet needs replacing, you replace the carpet. But then we call it discretionary projects, which are more of these kind of keeping the building current. But we have it separated out primarily for the reason that it makes it easier for the board to understand what we’re saying and what we’re expecting. ⁓ So our lobbies need to be remodeled in two years.
Okay, when it was buried in the reserve study, we knew that we were accumulating money for lobbies and we knew the expected life on some parts were five years and some parts were seven years. Now by pulling them into projects, we have them more clearly aligned and the board can then get involved in deciding, well, is the club lounge really two years away from its expected life or do we need to move that out a little bit or move it in a little bit? ⁓
And so I’m kind of excited about the conversation. think it’ll drive on the board’s respect. In the past, we never really saw the reserve study as something that you budgeted. It was you did this you did a 30 year analysis and you hope you had enough money when you needed to repair something. Now we’re looking at it as we’re really budgeting for these kind of special repair projects or replacement projects, if you will.
Matthew Holbrook (32:55)
Yeah, I think that it’s, really taking a, ⁓ an ultra practical approach to how to, how to use the reserve study as an actual budgeting tool in real life situations, as opposed to it just being broken down into these, ⁓ you know, multiple different components that really are all related and should all be addressed together. And, ⁓ and when they’re all separated into these different components, it’s, you have the academic exercise, but it’s not practical in how to, ⁓
to budget in a real life situation when you care about the overall presentation of ⁓ your community.
J Parsons (33:30)
And it also broke a mine dam, if you will, that we had run into as a board where we kept thinking, carpets is a classic example, we’re going to replace all the carpets in five years.
So we weren’t allocating money to repair problems with the carpets. ⁓ Because why should I put a whole new carpet on this floor when it’s just going to get torn up in a couple of years? And by breaking it into these projects where we actually looked at it, we realized, no, that’s not actually what we’re going to do. We should be repairing the carpet right now. And maybe that’s all we ever do is just continue to repair the carpet. We don’t ever have a complete new, know, blue for green change on the carpet. We just continue to use.
⁓ what we have and it’s allowed us to make decisions, recognize that we might’ve been to avoid doing the whole thing, missing doing the small things. ⁓ And now that we look at it, we go, now we should be doing this, this and this. And then we can do the whole thing in five years, but in meantime, we need to be working on this other stuff. And so I think it’s really helped us segment between what we need to be doing right now versus the bigger projects of changing something.
Derek Eckert (34:40)
I think that’s a great approach. When I look at a reserve study and a client, I’m always trying to tailor it towards their particular property, their building and their approaches. ⁓ And to me, it sounds like you’re up allowances to take care of interior remodel projects and that works for you. That’s a good fit for your building. And so I think it’s a really good thing that you’re doing that.
J Parsons (35:05)
Yeah. And it also has made it clear in our minds when we’re doing a capital addition, which is not a reserve, you we’re adding something new versus replace or repairing something that exists. And that was always a fuzzy area for us ⁓ also, you know, mentally from a board standpoint, I’m sure it wouldn’t be from a reserve standpoint as a board member to sign. Like, you know, if I want to do put a new bar in a room,
Is that a upgrade to that room or is it a capital improvement or is it a reserve asset? Those lines were often blurry for us.
Matthew Holbrook (35:41)
Yeah. And I think that maybe leads us into the last section that I wanted to address here. And that is, ⁓ do you have guidance, Derek, on how boards should think about where that line does get blurred between, ⁓ our reserve expenditure and ongoing maintenance expenditures? ⁓ I know that those are conversations that come up all the time and, ⁓
wanted to get your feedback on how should a board and management think through those kind of blurry line scenarios.
Derek Eckert (36:15)
Yeah, I think it’s case by case basis. One test that I always put into consideration is if the expenses of substance, right? So is it a significant expense to this particular property? J’s property, it’s the infinity, it’s a big project. And so a thousand bucks would not be of substance, right?
but a smaller community of two units, thousand bucks might be definitely a project, a component within the reserve study that should be included. So that’s really the test that I look at and take into consideration. And then the second test that I also take into consideration is just predictability. ⁓ Is there an understood trend as to whether or not this project will have some kind of a cycle? ⁓
Will this maintenance need to continue? Will it need to happen every few years? And if it can, then I can apply a useful life and a remaining life to that.
Matthew Holbrook (37:16)
Yeah, I’ve heard a lot of boards use kind of an annual test on this. If it’s something that needs to be done every year, then that’s more of a maintenance expense. But if it’s something where it’s going to be addressed more or less frequently than every year, then it probably should be reserved for.
J Parsons (37:32)
But why would that be the exciting factor? Because if I’m doing maintenance on a boiler every year, to me, that’s a reserve. ⁓ I’m maintaining a reserve asset. I should be paying from that from the reserve. ⁓ I think the only thing we really consider ongoing maintenance is like our plants and landscaping. Because if we’re working on a reserve asset, wouldn’t you take the view that that is a reserve expense?
Derek Eckert (38:00)
So for your boiler if you have a service vendor that comes once a month and takes a look at it and make sure it’s functioning and needs oil or whatever I would consider that a maintenance expense ⁓ But if you’re improving the boiler in some kind of way and you’re giving it additional longevity like you’re spending $5,000 to replace the burner at the bottom of the boiler then I would consider that ⁓ a reserve project
Matthew Holbrook (38:27)
Well, I think that wraps up our time here and ⁓ that’s been a very helpful discussion. A lot of really ⁓ important and helpful things that board members and managers can give consideration to. So ⁓ thank you both. Really appreciate your time and your input. And just want to encourage those of you who have been watching or listening to this episode to check out other episodes of The Uncommon Area.
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