One of the best ways to gauge the health of a planned community association such as Recreation Centers of Sun City West is to gauge the association’s reserves.
How much money an association has in reserves, as a percentage of its overall asset replacement requirements is the best way to determine whether a special assessment is likely in the future. special assessments are unexpected expenses and, of course, unpopular. Proper planning helps avoid these headaches.
How much an association has in reserves is the real question. The industry standard for reserves involves what is known as a “range of risk.” If the reserve funds are at 100% (a fully funded balance), there would be cash to pay for all the capital replacement needs at any given moment. The chance of every capital item needing replacement at the same time is exceptionally low. The larger the association, the more money it has to absorb large capital expenses, so a lower percentage in its range of risk is still proper.
Our association has always budgeted and invested conservatively. Our appetite for risk in our reserves is no different. Industry standard says reserves of 30%-70% are satisfactory, depending on several factors. Because we have planned well and budgeted conservatively in the past, those factors weigh in our favor. Our association is debt free. Our revenues are strong and do not vary much from year to year. We have a consistent membership base and our real estate weathers market fluctuations very well.
Years ago, the Governing Board and Budget and Finance Committee set a high reserve target, one that would make sense for smaller HOAs that don’t enjoy the economies of scale that we do. Since that time, we have updated and refined our reserve study, which means there is a very small chance of an unexpected expenditure that we can’t handle. A lower target withinb the 30%-70% makes more sense for an organization our size.
Let’s look closer at our reserve study.
There are currently about 1,200 items that are tracked by their financial tool over a 30-year projection, and those line items include equipment, irrigation, asphalt, roofs, flooring, HVACs, vehicles and many others. The key components for each item are the current replacement cost, estimated life expectancy and the acquisition date/expected replacement date.
An example of one item within the list of 1,200 would be a mower that would cost $10,000 to replace. It was acquired four years ago and carries an estimated life expectancy of 10 years. Within the tool, the formula would state that for each of the 10 years, $1,000 must be funded to have the full amount available at the time the asset needs to be replaced. Som after four years, for example, we would need $4,000 in the reserves in order to stay on track with our fully funded balance. By 2025, we would have the $10,000 available.
The calculation is done for each of the 1,200 items, and it usually includes an inflationary factor (about 3%) so the true replacement cost is reached at the time of replacement. Of course, if at the end of the estimated life cycle the asset can be used another couple of years, it may not be replaced right away. Additionally, some items don’t make it to the end of their life cycle and must be replaced early. For those reasons, the reserve study is a fluid document based upon frequent updates of the line items.
Our policies state that reserve funds can only be used for capital items (anything with a life span more than five years and a cost more than $5,000).
Day-to-day operational expenses are covered primarily by member dues, golf fees and other revenues. So where does the money for the reserves come from? Let’s look at the four distinct sources.
Asset Preservation Fees — The APF is currently $3,500. This fee is collected whenever a property within Sun City West is sold (some exceptions are made for current residents moving within the community).
Excess revenue over(under) expenses plus depreciation and amortization — The Recreation Centers of Sun City West fiscal year is July 1-June 30, so by policy, the income statement is audited and the transfer of the audited amount of excess/loss is made in November of December from the operating account to the reserve fund account (an overly simplistic way t think of this is that we use dues, golf fees and other revenues to cover our operational expenses; at the end of the fiscal year, any extra revenue or savings we have left over goes into the reserves and at that point can only be used for capital expenditures).
Interest and dividends on the reserve fund — Per policy, these must stay in the reserve funds for the sole purpose of capital expenditures.
Stock and band market valuation changes — RCSCW’s funding needs can be increased or decreased with fluctuations within the funds. Per Governing Board policy, the current allocation of such funds is a split of 60% bonds and 40% equities to allow for some diversification of risk.
Knowing our revenue sources and the policies governing our expenditures, we have a very good handle on how much we expect to bring in and how much we expect to spend every year. That means the likelihood of special assessment here in Sun City West is extremely low. That’s good news for all our members.
You can expect the association to be constantly vigilant of our reserve levels and ensuring we are within the 30%-70% range of fully funded. As we do every year, we also will look at our fee schedule, including APF rates and dues, as well as our investment strategy, and whether any of those need to be adjusted.
We want you to be part of the conversation, so we encourage you to attend a mid-year report 9 a.m. Friday, Jan. 17 in the Summit Hall at Palm Ridge Recreation Center, 13800 W. Deer Valley Drive. The future of water in Arizona and in Sun City West also will be discussed, as both items will impact our planning. We encourage you to attend for insight into this important component of RCSCW’s ability to replace its capital needs.
Editor’s Note: Mr. Finelli is RCSCW chief financial officer.