One key feature that a reserve study should indicate is how well funded an association is. The way that is measured is by a term called percent funded. In Lehman’s terms, percent funded means how much money you have in reserves versus how much money you should have in reserves. The Community Associations Institute defines percent funded as “The ratio, at a particular point in time related to the fiscal year end, of the actual (or projected) reserve balance to the fully funded balance, expressed as a percentage.”
Generally speaking, percent funded measures the health of an association. It helps associations from guessing how they are doing versus knowing how they are doing. If someone on association board says “we have plenty of money in reserves. We have $800,000”, this may or may not be true. If they have $800,000 and are 90% funded, now there is a quantitative measure to show they are doing well. Conversely, if they have $800,000 in reserves and have a big roofing project that dwarfs their reserve balance coming due in two years and are only 25% funded, they do not have plenty of money in reserves. A seemingly large account balance alone does not guarantee proper reserve funding.
The higher the percent funded, the more likely an association is to avoid a special assessment. The following chart classifies the different funding ranges:
0-30% funded: poorly funded
30-70% funded: fairly funded
70-100% funded: well funded
100+% funded: very well funded
Real World Example
A straight-forward way to look at this is if a reserve item is 60% through its lifespan, then it should have 60% of its replacement value. Using real examples, let’s say an asphalt shingle roofing job has a lifespan when new of 20 years, has a remaining life of 8 years, and an expected cost of $200,000. Let’s now say that the association has $96,000 in reserves for this item. To figure out how much depreciation there is, the calculation would be ((20-8)/20)=60%. So, if the item is 60% depreciated, we should have $120,000, which is calculated (60% x $200,000). Since we only have $96,000, we are 80% funded ($96,000/$120,000).
In many situations, percent funded is very useful statistic. It clearly shows where an association stands in their funding in one simple number. The more reserve items that a community has, the more likely that percent funded is likely to be a very reliable indicator of financial health. An association with 50-100 reserve items and that is in the well-funded range is very unlikely to have a special assessment.
Percent funded is even more important when associations used the pooled (cash flow) method of funding reserves, where the account balance can be used for any of the items in the reserve schedule. If the replacement years for each of the items are staggered, then the association does not need to be 100% funded to pay for all of the replacements.
In rare situations, percent funded can show a “false positive.” This is the case when an association only has a couple reserve items, or has one very large item like roofing that makes up most of the reserves. An association may be 90% funded with their roofing, but if that is the only reserve item that they have and the roofing is coming due in the next year, that 10% shortage still may trigger a special assessment.
Every reserve study should show the percent funded of the association. It is a concise estimate of how good of a job the association is doing and if the association needs to improve their funding. It is a snapshot of the current balance versus the overall depreciation of the reserve items. Percent funded is not meant to be the only measure of the association’s reserve fund, rather it is one key piece of the puzzle to identifying the proper amount of reserve funding.