The Pooled and Component Methods of Reserve Funding for Community Associations
Florida law requires reserve funding for certain community association common elements. Condominium associations are required to fund reserve accounts for roof replacement, building painting, pavement resurfacing and any other item that has a maintenance expense or replacement cost exceeding $10,000. Fla. Stat. § 718.112(2)(f). Homeowners’ associations are required to fund reserve accounts for any item where a statutory reserve account has been established. If the HOA developer initially established reserve accounts prior to turnover, or the members affirmatively elected to provide for reserves post-turnover, then an HOA must fund those reserve items in future budgets. Fla. Stat. § 720.303(6)(b).
Two types of reserve funding methods are prescribed by Florida law: one is called the pooled method (also referred to as the “cash flow” method), and the other is the component method (also referred to as the “straight-line” method). This means reserve funding can be based on a separate analysis of each reserve asset with the component method, or, with the pooled method, reserve funding can be based on a pooled analysis of two or more reserve assets. F.A.C. 61B-22.005(3). The annual funding required for each reserve item is based on a calculation that takes the estimated replacement cost less the current reserve balance and then divided by the remaining useful life of the reserve asset. Fla. Stat. § 718.112(2)(f). There are companies that provide reserve study analysis to community associations using these methods and calculations.
With the component method, an association must establish a separate account for each reserve asset. The association must fully fund each component reserve account every year based on the reserve study analysis. However, the members can vote each year to either reduce or waive the funding of reserve accounts. The reserve funds within each component reserve account can only be used for that specific reserve asset unless the members vote to use the funds in one component account for another purpose. Fla. Stat. § 718.112(2)(f).
A benefit of using the component method is that the funds in each component account can only be used by the association for that specific reserve item. The association cannot use those funds for any other purpose without a majority of the members voting in favor of that. A disadvantage of using the component method becomes apparent when a component reserve account for a specific asset is underfunded and that asset needs immediate replacement. In that scenario, the Association must either (1) delay the replacement/maintenance of that reserve item until that component account is fully funded (which may not be practical); (2) levy a special assessment on the members to cover the deficit; or (3) hold a member vote to move funds from another component account to the underfunded component account.
A pooled account is where an association has one reserve account (as opposed to multiple component accounts) to cover the expenses for all the association’s reserve assets. The amount of annual funds contributed to the pooled account each year, combined with the pooled account balance estimated at the start of each year, must be enough to cover all expected expenses that year, based on the reserve study. In other words, the annual aggregate reserve assessment for the pooled account must be an amount sufficient to cover the estimated expenses from the pooled account to ensure the pooled account does not have a negative ending balance during any year of the reserve study analysis. The pooled account calculations cannot include a planned future balloon payment either.
A benefit of pooled account funding is the flexibility in how reserve funds are spent. The funds can be used to cover expenses for any of the reserve assets at any time without member approval. The pooling method allows for projects to be completed in order of need at the time the need arises. Member approval is only required when planning to use pooled funds to pay for an item not included within the reserve pool.
A disadvantage of the pooled method is that a board of directors may not be cost-sensitive on a project, resulting in overspending on certain reserve assets just because it has a large pool of funds available. For example, if an association’s pooled account balance is $500,000 and the clubhouse needs repairs and maintenance, a board may be tempted to splurge on unnecessary upgrades that results in overspending by thousands of dollars. Unnecessary overspending may deplete the pooled account balance, leading to a substantial increase in reserve assessments the next year in order to fully fund the reserve account per the requirements of Florida law. It could also lead to a special assessment if another reserve asset unexpectedly needs maintenance or replacement.
For the average association, a reserve study should be obtained every 3 – 5 years depending upon the reserve assets involved and to ensure estimated costs remain accurate. If there is a concern that your association is not properly funding reserves, or not utilizing reserve funds properly, then consult with your licensed manager or an experienced attorney. If your association has never had a reserve study, or it has been a significant amount of time since the last reserve study, then it may want to schedule one in the near future.