5 Common Mistakes HOAs Make with Reserve Funds (And How to Avoid Them)

Managing HOA reserve funds is a critical responsibility that ensures the long-term financial stability of a community. Reserve funds cover major repairs, replacements, refurbishments and unforeseen expenses, safeguarding homeowners from special assessments and financial strain. 

Recently with the sudden collapse of the Champlain Towers Condominium, located in Surfside Florida, a new emphasis on Infrastructure has hastened legislators to focus on Reserve Funding to hopefully avoid a repeat of this most unfortunate and deadly occurrence.

Despite their importance, many HOAs fall into common pitfalls that compromise the effectiveness of their reserve fund management. This article explores five frequent mistakes and provides actionable strategies to avoid them, drawing insights from CAI’s Reserve Studies and Funds and industry best practices.

Mistake 1: Failing to Conduct Regular Reserve Studies

The Problem: Reserve studies are the foundation of effective financial planning. However, many HOAs neglect to update these studies regularly, leading to inaccurate projections and funding shortfalls.

The Impact: Without up-to-date reserve studies, boards may underestimate future expenses, leaving the community unprepared for major costs.

Solution:

1. Schedule Regular Updates: Reserve studies should be updated at least every three to five years or after major projects.
2. Engage Professionals: Work with experienced reserve analysts who can provide detailed and accurate assessments.
3. Incorporate Findings: Use the study’s recommendations to adjust reserve contributions and investment strategies.

Mistake 2: Overly Aggressive Investments

The Problem: In an attempt to maximize returns, some HOAs allocate reserve funds to high-risk investments such as stocks, mutual funds, or other speculative ventures. Many well-meaning Board Members will engage their personal advisors thinking they can help.

The Impact: Market volatility can result in significant losses, jeopardizing the availability of funds for essential projects. Many financial advisors are focused on individual portfolio management and not HOAs. This can create a potential conflict of interest and inappropriate recommendations for HOAs.

Solution:

1. Prioritize Security: Focus on low-risk, conservative investments such as FDIC-insured accounts, government backed bonds and insured or guaranteed money market funds.
2. Create an Investment Policy Statement (IPS): Define risk tolerance, allowable investment types, and liquidity requirements.
3. Engage Financial Advisors: Partner with professionals who specialize in HOA reserve fund management to ensure compliance and prudence.

Mistake 3: Neglecting Liquidity

The Problem: Some HOAs lock up too much of their reserve funds in long-term investments, making them inaccessible when needed. Some Banks make enormous profits by liquidating CDs prior to stated maturities.

The Impact: Lack of liquidity can force boards to rely on loans, special assessments, or premature liquidations to cover immediate expenses.

Solution:

1. Ladder or Structure Investments: Implement a Structured Asset Management Systems® process for investments so that funds mature at intervals aligned with projected expenses.
2. Maintain Cash Reserves: Keep a portion of funds in highly liquid insured money fund accounts for emergencies.
3. Regularly Review Liquidity Needs: Assess the timing of major projects and adjust investment strategies accordingly.

Mistake 4: Insufficient Reserve Contributions

The Problem: Many HOAs fail to allocate adequate funds to their reserves, either due to poor planning or reluctance to raise homeowner dues. Unfortunately, this is an age-old problem now under scrutiny at the state and federal levels.

The Impact: Underfunding leaves the community vulnerable to financial crises and can lead to deteriorating property conditions and values at best. At worst, catastrophe, and unanticipated loss of life as we have seen recently.

Solution:

1. Adopt Incremental Increases: Gradually raise reserve contributions to avoid sudden financial burdens on homeowners.
2. Communicate Transparently: Educate homeowners about the importance of reserves and how contributions protect life, health safety and property values.
3. Follow Funding Models: Use cash flow or component funding methods based on the reserve study’s recommendations.

Mistake 5: Lack of Transparency and Communication

The Problem: Boards that fail to communicate their financial strategies and decisions can face distrust, potential legal liability, and pushback from homeowners.

The Impact: Lack of transparency erodes homeowner confidence and can lead to resistance against necessary dues increases or projects.

Solution:

1. Provide Regular Updates: Share financial reports, reserve study findings, and investment strategies and performance with homeowners.
2. Hold Informational Meetings: Create opportunities for homeowner education and to ask questions and understand reserve fund management.
3. Leverage Technology: Use HOA websites or newsletters to keep the community informed.

Best Practices for Effective Reserve Fund Management

To avoid these common mistakes and ensure the financial health of the community, HOA boards should follow these best practices:

1. Engage Experts: Work with reserve analysts, financial advisors, and investment firms experienced in HOA management.
2. Develop a Comprehensive Investment Policy Statement: An IPS provides a clear framework for investment decisions, ensuring alignment with the community’s goals and needs.
3. Conduct Regular Reviews: Schedule annual or quarterly reviews of reserve funds, investment strategies, and funding levels.
4. Educate Board Members: Provide training on fiduciary responsibilities and reserve fund management to empower informed decision-making.
5. Plan Proactively: Anticipate future needs and adjust funding strategies to stay ahead of potential challenges.

Case Study: Learning from Mistakes

The Lakeside HOA Experience

Lakeside Villas HOA, a 250-unit community in San Diego California, faced multiple challenges due to poor reserve fund management. Initially, the board neglected to update their reserve study for over seven years, leading to a significant underestimation of repair costs. Additionally, they invested a substantial portion of their reserves in high-risk equities, resulting in a 20% loss during a market downturn.

To recover, Lakeside HOA took the following steps:

1. Updated Their Reserve Study: Engaged a professional analyst to provide an accurate assessment of future needs.
2. Shifted to Conservative Investments: Reallocated funds to low-risk instruments such as Treasury bills and CDs.
3. Improved Communication: Held regular homeowner meetings to explain their recovery plan and gain support for increased dues.

Within five years, Lakeside HOA’s reserves improved from 50% to 78% funded, restoring financial stability and homeowner confidence.

Conclusion

Effective reserve fund management is essential for the long-term success of an HOA. By avoiding common mistakes such as neglecting reserve studies, pursuing overly aggressive investments, or failing to communicate transparently, boards can protect their communities from financial hardships.

As highlighted in Reserve Studies and Funds, a proactive and informed approach to reserve fund management ensures that HOAs are prepared to meet their financial obligations while fostering trust and confidence among homeowners. For boards seeking to enhance their financial planning, prioritizing best practices, and learning from past mistakes is the key to long-term stability.