Replacement reserves are those funds that a property owner sets aside with the specific intention of using the money to pay for the renovation (renewal) and replacement of capital assets.
Homeowner associations that maintain adequate replacement reserves throughout the life of the community will realize higher resale values when the homes in the community are sold to second and third generation buyers.
By accumulating reserves during the service life of the assets property owners can avoid expensive recapitalization loans which makes the property more attractive as a buy and hold investment.
The correlation between funding of the reserve account and the rate at which the assets are depreciating is well understood by investment property owners who depreciate capital assets as part of a tax planning strategy. Whereas, for property owners who are not profit-motivated there are other reasons for establishing a replacement reserve fund.
The term “reserve study” is used throughout the homeowner association service industry to refer to a process that is more properly called a replacement reserve study.
The replacement reserve study is a planning exercise that results in a schedule of annual contributions that must be made to fund the replacement reserve account sufficiently to support the reserve spending that is anticipated over the period of time that is covered by the analysis.
In a perfect world funding of the reserve account should occur at a rate that is synonymous with the rate at which the assets that will be renewed or replaced with the reserve funds are depreciating.
The theory that replacement reserves should offset the value of assets that is being lost to depreciation is often lost on institutional and non-profit ownership entities that are less concerned with the tax implications of reserve planning and more concerned with generating funds to pay for ongoing maintenance of the property through a systematic funding process.
Whether your objective is long-term ownership of an investment property or creating a financially sustainable common interest community, CRC can assist you with your reserve planning needs.
To learn more, please contact our offices or use the Request a Proposal link to request a proposal.