Reserve Study

This independent research report was developed under contract for the California Department of Real Estate by Eva Eagle, PhD, and Susan Stoddard, PhD, AICP, Institute for the Study of Family, Work and Community and David H. Levy, MBA, CPA. Janet Andrews, MBA, was responsible for the original design, layout, and typography. The Department of Real Estate revised this publication in September 2000. The report does not necessarily reflect the position of the Administration of the State of California.

NOTE: Before a homeowners' association decides to prepare its own Reserve Study, it should consider seeking professional advice on that issue. There are issues concerning volunteer board member indemnification, reliance on expert advice, and other factors that should be considered in that decision. The goal of this manual is to help the reader better understand Reserve Studies. It is not the intent of this manual to define the "standard of care" for Reserve Studies or to interpret the California Civil Code.

Table of Contents
Preface
1. Introduction Importance of Reserve Studies Content of Reserve Studies
2. How Do Reserves Fit into the Overall Financial Plan?
3. What Are the Steps in Doing a Reserve Study?

Resolve to Have a Reserve Study
Identify the Work Products
Develop a Work Plan
Conduct the Component and Funding Studies
Accept, Disclose, and Implement the Results

Criteria for Components 18
Developing a Component List 18
Specifying the Quantity of Each Component 19
Determining the Useful and Remaining Life of Each Component 20
Determining the Cost of Replacement
Using Component Data to Develop the Funding Study
Documenting Maintenance Assumptions

Determining the Funding Goal for Replacement Reserves
Estimating Association Reserve Fund Income
Projecting Expenditures and Reserve Funding Needs
Estimating Interest Earnings of Reserve Account Over Funding Study Period
Statement of Limitations and Assumptions
Updating

Physical Analysis Products for Consultants
Funding Analysis Products for Consultants
Information the Board Should Provide

Appendix A - Major Components Usually Included 48
Appendix B - Major Components Frequently Overlooked
Appendix C - Sources for Inflation Rate Estimates

1,1 California Civil Code Sections 1365 and 1365.5 3
3.1 Steps in Providing for Adequate Reserves 12
4.1 Steps in the Physical Analysis Process 17
4.2 Determining the Replacement Schedule 22
4.3 Physical Analysis Checklist 24
5.1 Steps in the Funding Analysis Process 28
5.2 Calculating the Reserve Deficit 30
5.3 Determining the Future Cost of Replacement 34
5.4 Funding Study, Estimated Cash Requirements by Year 37
5.4 Funding Study, Major Component Liability by Year (continued). 38
5.5 Funding Study Checklist 39
6.1 Interview Guide for Physical Analysis Preparers 44
6.2 Interview Guide for Funding Analysis Preparers 46

California's Common Interest Development Act requires that associations prepare and distribute financial information, including a plan for funding future replacement of major components (roofs, exterior paint, and so on). "Reserve Study Guidelines for Homeowners' Association Budgets" has been developed to assist boards of directors of California common interest developments (CIDs) to better understand the preparation of the reserve study portion of the association's annual pro forma operating budget, as this document is defined in California Civil Code Section 1365, and to assist buyers in understanding the financial implications of an association's replacement reserve funding. The term "reserves" as used in this context refers to the funds set aside to cover these replacement costs. The board of directors must make decisions about the funding goals of the association. These guidelines should enable readers to answer the following questions:

? How do reserves fit into the overall financial plan?
? What are the steps in doing a reserve study?
? What are the steps in conducting a Physical Analysis of common area major components?
? What is involved in developing a Funding Analysis?
? How do boards hire qualified professionals to perform reserve studies?
? What are the "red flags" that signal potential problems?

These guidelines were developed with the assistance of numerous industry professionals, association board members and managers and the Department of Real Estate. The approach described in these pages has been developed from examples of current reserve studies, and from the comments and suggestions of industry leaders. In following the suggestions presented here, a board should consult with the association's own attorney, accountant, or other advisors, as necessary.

Common interest developments (CIDs) are defined by shared property and restrictions in the deed on use of the property. A CID is governed by a mandatory association which administers the property and enforces its restrictions. The association is responsible for repairing, replacing, or maintaining the common areas. The owner of each separate interest is responsible for maintaining that separate interest and any exclusive use common area appurtenant to the separate interest. (California Civil Code Section 1364)

A reserve study provides a current estimate of the costs of repairing and replacing major common area components (such as roofs or pavement) over the long term. Ideally, all major repair and replacement costs will be covered by funds set aside by the association as reserves, so that funds are there when needed. This requires:

? examination of the association's repair and replacement obligations;
? determination of costs and timing of replacement; and
? determination of the availability of necessary (reserve) cash resources.

Because the board has a fiduciary duty to manage association funds and property, a replacement reserve budget is very important. Not only does this information supplement the annual pro forma operating budget in providing owners with financial information; the reserve study is also an important management information tool as the association strives to balance and optimize long-term property values and costs for the membership.

For buyers, understanding the reserve study is an important part of evaluating the value of a CID property. For association members, reserve planning helps assure property values by protecting against declining property values due to deferred maintenance and inability to keep up with the aging of components.

A good reserve study shows owners and potential buyers a more accurate and complete picture of the association's financial strength and market value. The reserve study should disclose to buyers, lenders, and others the manner in which management of the association (i.e., the board and outside management, if any) is making provisions for non-annual maintenance requirements. Preparing a reserve study calls for explicit association decisions on how to provide for long-term funding, and on the extent to which the association will set aside funds on a regular basis for non-annual maintenance requirements. A good reserve study may also function as a maintenance planning tool for the association.

California's Common Interest Development Act sets forth California's legal requirements for reserve study information to be included in the annual association budget. California Civil Code Section 1365 requires that homeowner associations prepare and distribute certain financial information, including a pro ,forma operating budget, 45-60 days prior to the start of the association's next fiscal year.

Thus, the pro forma operating budget must contain, at a minimum, the following items:

? estimated revenue and expenses on the accrual basis of accounting;
? identification of total cash reserves currently set aside;
? estimated remaining life of major components;
? estimated current replacement cost of major components;
? identification of methods :ending for future repair, replacement or additions to major components: and
? statement of methods used to develop estimates and funding plan.

Since the time when these requirements were established, a number of California CID have assembled data and produced reports in response to the law. Many CID, however, still have not developed required component information or funding plains. This is particularly true in smaller, self-managed associations. Even in la=ger associations with extensive professional support, there is often conflicting advice on what is required.

The law calls for disclosure of specific information from the "reserve study." The law does not specify the funding goal to be achieved by an association, nor does it dictate the exact form of the reserve study. While a study alone, containing the elements prescribed by Civil Code Section 1365.5, is sufficient to constitute legal compliance, an association will be stronger financially if regular assessments are collected to help assure funding of replacement requirements as they occur.

This report is the result of a project that gathered information on current reserve study practices in California, including interviews with board members and industry professionals concerning their experiences with, opinions on, and appropriate responses to the reserve study provisions of Section 1365.5. This document sets forth several decision points necessary for the board to respond to the reserve study requirements. By following the procedures set forth in this document, it should be possible for reserve studies to be produced that include the information called for in Section 1365.5 and that comply with good business practice in the management of association property.

The texts of Civil Code Sections 1365 and 1365.5 are included next as Exhibit 1.1.

1365. Unless the governing documents impose more stringent standards, the association shall prepare and distribute to all its members the following documents:

(1) The estimated revenue and expenses on an accrual basis.
(2) A summary of the association's reserves based upon the most recent review or study conducted pursuant to Section 1365.5, which shall be printed in bold type and include all of the following:

(A) The current estimated replacement cost, estimated remaining life, and estimated useful life of each major component.
(B) As of the end of the fiscal year for which the study is prepared:

(i) The current estimate of the amount of cash reserves necessary to repair, replace, restore, or maintain the major components.
(ii) The current amount of accumulated cash reserves actually set aside to repair, replace, restore, or maintain major components.

(C) The percentage that the amount determined for purposes of clause (ii) of subparagraph (B) is of the amount determined for purposes of clause (i) of subparagraph (B).

(3) A statement as to whether the board of directors of the association has determined or anticipates that the levy of one or more special assessments will be required to repair, replace, or restore any major component or to provide adequate reserves therefor.

(4) A gener : statement addressing the procedures used for the calculation and establishment of those reserves to defray the future repair, replacement, or additions to those major components that the association is obligated to maintain.

The summary of the association's reserves disclosed pursuant to paragraph (2) shall not be admissible in evidence to show improper financial management of an association, provided that other relevant and competent evidence of the financial condition of the association is not made inadmissible by this provision.

A copy of the operating budget shall be annually distributed not less than 45 days nor more than 60 days prior to the beginning of the association's fiscal year.

(b) A review of the financial statement of the association shall be prepared in accordance with generally accepted accounting principles by a licensee of the California State Board of Accountancy for any fiscal year in which the gross income to the association exceeds seventy-five thousand dollars ($75,000). A copy of the review of the financial statement shall be distributed within 120 days after the close of each fiscal year.

(c) In lieu of the distribution of the pro forma operating budget required by subdivision (a), the board of directors may elect to distribute a summary of the pro forma operating budget to all its members with a written notice that the pro forma operating budget is available at the business office of the association or at another suitable location within the boundaries of the development and that copies will be provided upon request and at the expense of the association. If any member requests that a copy of the pro forma operating budget required by subdivision (a) be mailed to the member, the association shall provide the copy to the member by first-class United States mail at the expense of the association and delivered within five days. The written notice that is distributed to each of the association members shall be in at least 10-point boldface type on the front page of the summary of the budget.

(d) A statement describing the association's policies and practices in enforcing lien rights or other legal remedies for default in payment of its assessments against its members shall be annually delivered to the members during the 60day period immediately preceding the beginning of the association's fiscal year.

(e) (1) A summary of the association's property, general liability, and earthquake and flood insurance policies, which shall be distributed within 60 days preceding the beginning of the association's fiscal year, that includes all of the following information about each policy:

(A) The name of the insurer.
(B) The type of insurance.
(C) The policy limits of the insurance.
(D) The amount of deductibles, if any.

(2) The association shall, as soon as reasonably practical, notify its members by first-class mail if any of the policies described in paragraph (1) have lapsed, been canceled, and are not immediately renewed, restored, or replaced, or if there is a significant change, such as a reduction in coverage or limits or an increase in the deductible, for any of those policies. If the association receives any notice of nonrenewal of a policy described in

paragraph (1), the association shall immediately notify its members if replacement coverage will not be in effect by the date the existing coverage will lapse.

(3) To the extent that any of the information required to be disclosed pursuant to paragraph (1) is specified in the insurance policy declaration page, the association may meet its obligation to disclose that information by making copies of that page and distributing it to all of its members.

(4) The summary distributed pursuant to paragraph (1) shall contain, in at least 10-point boldface type, the following statement: "This summary of the association's policies of insurance provides only certain information, as required by subdivision (e) of Section 1365 of the Civil Code, and should not be considered a substitute for the complete policy terms and conditions contained in the actual policies of insurance. Any association member may, upon request and provision of reasonable notice, review the association's insurance policies and, upon request and payment of reasonable duplication charges, obtain copies of those policies. Although the association maintains the policies of insurance specified in this summary, the association's policies of insurance may not cover your property, including personal property or, real property improvements to or around your dwelling, or personal injuries or other losses that occur within or around your dwelling. Even if a loss is covered, you may nevertheless be responsible for paying all or a portion of any deductible that applies. Association members should consult with their individual insurance broker or agent for appropriate additional coverage."

1365.5. (a) Unless the governing documents impose more stringent standards, the board of directors of the association shall do all of the following:

(1) Review a current reconciliation of the association's operating accounts on at least a quarterly basis.
(2) Review a current reconciliation of the association's reserve accounts on at least a quarterly basis.
(3) Review, on at least a quarterly basis, the current year's actual reserve revenues and expenses compared to the current year's budget.
(4) Review the latest account statements prepared by the financial institutions where the association has its operating and reserve accounts.
(5) Review an income and expense statement for the association's operating and reserve accounts on at least a quarterly basis.

(b) The signatures of at least two persons, who shall be members of the association's board of directors, or one officer who is not a member of the board of directors and a member of the board of directors, shall be required for the withdrawal of moneys from the association's reserve accounts.

(c) (1) The board of directors shall not expend funds designated as reserve funds for any purpose other than the repair, restoration, replacement, or maintenance of, or litigation involving the repair, restoration, replacement, or maintenance of, major components which the association is obligated to repair, restore, replace, or maintain and for which the reserve fund was established.

(2) However, the board may authorize the temporary transfer of money from a reserve fund to the association's general operating fund to meet short-term cash-flow requirements or other expenses, provided the board has made a written finding, recorded in the board's minutes, explaining the reasons that the transfer is needed, and describing when and how the money will be repaid to the reserve fund. The transferred funds shall be restored to the reserve fund within one year of the date of the initial transfer, except that the board may, upon making a finding supported by documentation that a temporary delay would be in the best interests of the common interest development, temporarily delay the restoration. The board shall exercise prudent fiscal management in maintaining the integrity of the reserve account, and shall, if necessary, levy a special assessment to recover the full amount of the expended funds within the time limits required by this section. This special assessment is subject to the limitation imposed by Section 1366. The board may, at its discretion, extend the date the payment on the special assessment is due. Any extension shall not prevent the board from pursuing any legal remedy to enforce the collection of an unpaid special assessment.

(d) When the decision is made to use reserve funds or to temporarily transfer money from the reserve fund to pay for litigation, the association shall notify the members of the association of that decision in the next available mailing to all members pursuant to Section 5016 of the Corporations Code, and of the availability of an accounting of those expenses. Unless the governing documents impose more stringent standards, the association shall make an accounting of expenses related to the litigation on at least a quarterly basis. The accounting shall be made available for inspection by members of the association at the association's office.

(e) At least once every three years the board of directors shall cause to be conducted a reasonably competent and diligent visual inspection of the accessible areas of the major components which the association is obligated to repair, replace, restore, or maintain as part of a study of the reserve account requirements of the common interest development if the current replacement

value of the major components is equal to or greater than one-half of the gross budget of the association which excludes the association's reserve account for that period. The board shall review this study annually and shall consider and implement necessary adjustments to the board's analysis of the reserve account requirements as a result of that review.

(1) Identification of the major components which the association is obligated to repair, replace, restore, or maintain which, as of the date of the study, have a remaining useful life of less than 30 years.
(2) Identification of the probable remaining useful life of the components identified in paragraph (1) as of the date of the study.
(3) An estimate of the cost of repair, replacement, restoration, or maintenance of the components identified in paragraph (1) during and at the end of their useful life.
(4) An estimate of the total annual contribution necessary to defray the cost to repair, replace, restore, or maintain the components identified in paragraph (1) during and at the end of their useful life, after subtracting total reserve funds as of the date of the study.

(f) As used in this section, "reserve accounts" means moneys that the association's board of directors has identified for use to defray the future repair or replacement of, or additions to, those major components which the association is obligated to maintain.

(g) As used in this section, "reserve account requirements" means the estimated funds which the association's board of directors has determined are required to be available at a specified point in time to repair, replace, or restore those major components which the association is obligated to maintain.

(h) This section does not apply to an association that does not have a "common area" as defined in Section 1351.

The reserves are an important part of the association's annual pro forma operating budget. The replacement reserves relate to association budgeting in two important ways:

? The pro forma operating budget will include planned replacement reserve funding and the accrual-basis expense for the year.
? The reserve estimates depend on assumptions about the association's maintenance program, and maintenance expense is a part of the operations budget.

It is important that association members understand the difference between operations and replacement reserve activities. Boards should establish policy to distinguish between reserve expenses (funded from the replacement reserve account) and operating expenses (funded through the non-reserve operating budget). In common interest developments, the following division of maintenance and replacement responsibility is typical, although actual items included in each category will vary according to each association's physical plan and governing documents:

? individual responsibility for maintenance;
? association responsibility for day-to-day maintenance of common area;
? association responsibility for non-annual maintenance and replacement of common area; and
? association responsibility for improvements.

Individual homeowners are responsible for maintenance of their own units. Certainly, this includes maintenance of interiors of the homes themselves. The carpeting, interior paint, kitchen counters, etc. are typically the separate responsibility of the unit owner. In addition, the owner may have explicit maintenance responsibility for exclusive use common area (such as private yards, decks, front doors, etc.), or for some exterior features of the unit (such as siding, roofs, etc.).

Individual and association maintenance and replacement responsibilities can interrelate. For instance, individuals in their private units are responsible for periodic replacement of the caulking around the bathtub. Failure to replace caulking may result in moisture intrusion into walls and subflooring, and could

eventually cause damage to the common area structure of the building, or another unit.

The association maintains the common area, which typically includes landscaping, recreation facilities, parking areas, drainage gutters, outdoor lighting, and other public or "common" property. Day-to-day maintenance for these items is the responsibility of the association, and provision for this maintenance is frequently the largest category of expense in the operating budget. Individual owners, while not directly responsible for day-to-day maintenance, do have responsibility for obeying rules and regulations pertaining to the use and protection of common area property. Unfortunately, some owners do not realize their community responsibilities or the fact that damage to common area property can result in direct costs to all homeowners through assessments.

The association is responsible for the long-term maintenance and replacement of common area components as they end their useful lives. Usually, this type of replacement can be planned well in advance, based on industry information about the expected life of the various components and periodic physical inspection of wear.

Association improvements can be considered a special category of expense. If there is an addition to the common area, not planned in the original development, the association may elect to fund and make the addition. Improvements are typically onetime additions; once a part of the common area, the improvements require both day-to-day maintenance and provision for repair and replacement.

Clear distinctions must be made between the private property of individual owners in CID projects and the common areas for which the association is responsible. Ideally, association governing documents are very explicit in distinguishing that which is private property from that which is common area property maintained by the association. However, sometimes the status of components is not identified, or is identified erroneously. We have seen association governing documents that specify responsibility for components that are not in the complex (e.g., interior hallways) or that fail to define the responsibility for other important components. If the governing instruments don't allocate these responsibilities clearly, the association may wish to consider amending the documents.

A Reserve Study is made up of two parts: the Physical Analysis, and the Financial Analysis.

The Physical Analysis provides information about the physical status and repair/replacement cost of the area components the association is obligated to maintain. The Physical Analysis is comprised of the Component Inventory, Condition Evaluation, Age Adjustment [based on useful life (total) and remaining life of the components] and the Costs to Replace. The Component Inventory should remain relatively "stable" from year to year, while the Condition Evaluation, Age Adjustment and Cost to Replace and Valuation will clearly change from year to year.

The Financial Analysis is the analysis of the association's Reserve income and expenses. The Financial Analysis is made up of a finding of the client's current Reserve Fund strength (measured in cash or as a Percent Funded) and a recommendation for an appropriate Reserve contribution rate (Funding Plan).

Many CID homeowners or home buyers assume that their reserve requirements have been adequately established because developers prepare a reserve budget worksheet as part of the project approval process. This worksheet is filed with the California Department of Real Estate (DRE) along with other information in order to obtain a Final Subdivision Public Report that allows the developer to begin selling homes in the project. The reserves worksheet is used to estimate the monthly reserve contribution in the association's first-year budget. Developer estimates may have been prepared one, two, or more years before the project is actually constructed. As a result, they may be dated by the time the first unit is sold, unless they have been subsequently adjusted for changes in replacement costs. More seriously, since the information was assembled at the planning stage, the reserve worksheet may not reflect the association's true liability for the project as actually constructed.

Another possible shortcoming is that the standard preprinted reserves worksheet contains only certain major components (e.g., roofing, painting, paving, etc.).

Consequently, some components may not be listed even though the association must repair and/or replace them. In addition, the estimated life shown for components may not reflect local conditions, and the costs shown may not be based on actual local prices. When associations compare the reserve worksheet to their reserve responsibilities, they may find that the worksheet needs modification.

Consequently, a new association should conduct its own reserve study before the project is more than a few years old. Exhibit 3.1 shows the major decisions an association board should make to produce reserve information.

Resolve to Have a Reserve Study
The board should pass a resolution that a reserve study shall be performed and that the association is committed to taking the necessary steps. Older associations

that have been operating without a reserve study, or funding plan, should initiate this process as soon as possible. New associations should have a Reserve Study done in a timely manner and certainly by the end of the first year of any significant construction, as initial budgets may not include a physical analysis of the new construction. The California Civil Code requires the Board of Directors of existing associations that have completed a study to review the study annually and consider and implement any necessary adjustments as a result of that review. For new associations it may not be possible to make that analysis without including a Physical Analysis and ensuring the Component Inventory is consistent with what was actually built. Additionally, the Civil Code requires that a Physical Analysis be conducted at least every three years. With ongoing construction, it may well be necessary to do such analysis annually in order to adjust for changes during construction. The Board of Directors should carefully consider these factors for new homeowners associations.

Identify the Work Products

The board should identify the reserve study products needed and who is to produce them. A Physical Analysis, a Financial Analysis, and the text and exhibits to be included in the reserve study portion of the annual pro forma operating budget will cover the statutory requirements and also provide sufficient detail for long-term association financial planning. As discussed in Chapter 5, the pro forma operating budget must also disclose to homeowners and potential homeowners other important information about reserve funding and obligations.

An association board may contract for the preparation of Physical Analysis, Funding Analysis, and operating budget by professionals, or it may decide to produce one or more of these products by itself. Another option is for the board to perform part of the work and hire a professional to do the rest. Chapter 6 will discuss the option of hiring professionals for some or all of the reserve study tasks.

Develop a Work Plan
Before conducting a reserve study, an association board should develop a work plan, specifying the nature of the tasks to be performed. The work plan should establish:

? the types of components to be included or excluded
? the time frame for funding common area components
? the budget available for conducting the study

Choosing which components to include. Components can be excluded from the reserve study only if individual homeowners, not the association, are responsible for their replacement. In any association, there may be "exclusive use common

areas" that individual homeowners must maintain. Defined by California statute as common area items used exclusively by individual units (e.g., decks and patios), these areas are usually identified in the association governing documents known as the Covenants, Conditions, and Restrictions (CC&Rsl. The CC&Rs should also make clear the maintenance responsibility of the association and homeowners for these items. With the guidance of their CC&Rs, the board should make a separate list of exclusive use common area components and decide who should bear the responsibility for maintaining these items. If the association has responsibility for maintaining these items, thev should be included in the list of major components and be given a line item in the reserve budget. Whatever the beard decides, the documentation of the reserves and the assumptions that are an integral part of the study should include appropriate disclosure of such specifications. Any information distributed to home e?-ners, or prospective homeowners, should disclose which of these items were included and which excluded. Timeframe. Professionals do not always agree on the appropriate timeframe for a reserve study. The California Civil Code requires, as a minimum, ail components with a useful remaining life of less than 30 years be included in the study. It Should be noted that a component with a long useful remaining life, that may have been excluded in earlier studies, could be included in a later study if its useful remaining life drops to within the time parameters of a later study. A good rule of thumb is to forecast for a time period that will include the replacement year of the component with the longest estimated useful life. Professionals y generally recommend that the study include all components that will fail before the building itself. "Life-of-the building" components (such as the building foundation and structure) are generally omitted from the reserve study budget. However, if there is reason to expect the item to wear out before the building does and if, due to the age of the units, the item may wear out within the time span of the reserve study, then that item (e.g., the electrical or plumbing system in a condominium) should be included as a reserve study component. Obviously, the ability to estimate accurately is best in the near term. Estimates of costs that are 20 to 40 years away are at best an educated guess. However, a reserve study is incomplete and may be misleading unless it covers the life of the longest-lived component. Since studies should be reviewed annually as a part of the association's regular budget cycle, estimates can be updated as necessary. Budget available for conducting the study. The third consideration will be the amount of money available to conduct the initial study. All associations required to perform a reserve study under the California Civil Code should, on an annual basis, adequately fund their budget to enable them to either conduct a study or

hire outside professionals to complete the study, if need be, and/or pay for study updates at least once every three years.

Conduct the Component and Funding Studies
The board should identify some documents, including the CC&Rs, the most accurate existing drawings of the development, and the maintenance history of major common area components. If "as-built" drawings exist, these are the best source of information about the nature of the major components. The maintenance history obtained should include the actual dollar cost figures of that maintenance. If the association does not already do so, it may wish to create a "permanent" maintenance history file for each major component. Chapters 4 and 5 describe the conduct of the component and funding studies in detail.

Accept, Disclose, and Implement the Results
The board reviews and accepts the reserve study and incorporates a summary of the long-term funding plan, and certain other information, in the pro forma operating budget, as provided in Civil Code Section 1365.

? estimate useful and remaining life of major components; and
? estimate current replacement cost of major components.

The Physical Analysis lists and estimates replacement costs and timing for replacement of the major components whose repair or replacement is to be funded through association reserves. The study determines when such repairs or replacements will be needed and what they will cost. The major steps in conducting a Physical Analysis are shown in Exhibit 4.1.

There are a number of firms that perform these studies for community associations. This explanation of how to perform a Physical Analysis will help associations to contract for this service and to interpret the study results. For associations who cannot, or do not wish to, hire a Reserve Study preparer, this explanation will provide guidelines for board members who decide to perform their own Physical Analysis. (See Chapter 6 for additional discussion on hiring professionals.) Boards of Directors should consider the fact that they could lose the personal indemnity that comes from relying on professional advice if they choose to undertake their own study. Because of this, you should consider seeking legal advice before proceeding.

Inspect components; define scope and methodology for inspection.
This should be performed by reasonably qualified individuals

For each association, the exact list of major common area components is unique. Although lists from other associations or industry publications (including this one) may serve as a general guide, they are rarely usable without modifications and additions. An inaccurate or incomplete list of components can materially distort the association's long-term funding plan.

Criteria for Components
The board should establish criteria for determining common area rnajor components. Many professionals suggest that items be placed on the list of components for the reserve budget if they meet all of the following criteria:

? the item is the responsibility of the association to maintain or replace, rather than the responsibility of the individual homeowners;
? the item costs over a certain amount to replace (amount to be determined by the board);
? the estimated useful life of the item is greater than one year; and
? the estimated useful life of the item is less than thirty years at the time of the study.

Developing a Component List
Unfortunately. there is often no one document with a comprehensive list of components for a development. As a result, it is not easy to identify components accurately, although it is essential that the association dev?eop an accurate lief of all items for whose repair or replacement it must budget. The exact list of components to include depends upon the physical characteristics of the project as well as open the legal division of responsibility among the homeowner, the association, arid the local government. .appendix A provides a list of items that might be lined as components for association reserves. This list is not exhaustive of all possible items, but does include many of those that would commonly be found.

' One possible guideline is to include items that cost 1 % or mere of the total annual association budget. Another possible guideline. is to include items that cost over 500 or over S1000 to replace, including groups of related items 'e.g., all gates in the development) that cost over $1000 to replace. The dollar amount or percentage to u?e as the guideline should be discussed and adopted by the board. Items costing less than this amount may be included in the annual operating budget rather than funded through the reserve budget

The association's "CC&Rs" and condominium plans generally describe the common areas of the development and so can help to provide a list of components. Most CC&Rs describe what is a part of each "unit" and what is outside the unit. In a true condominium, the unit owned by the individual homeowner consists only of the air space within the common walls, although owners are generally responsible far the paint and non-structural fixtures inside, and are generally also responsible for external doors, door hardware, windows, patios, balconies, and similar items (see Civil Code Sections 1351 and 1634). However, in planned developments (PDs), the owners are usually responsible for some portion of the maintenance on the exterior and structure of their individual units as well. The CC&Rs usually specify the division between individual and association responsibility, and will serve as a guide to the components to be included in the reserve study.

The developer reserve budget should list components that the builder identified while planning the project. Such items as streets, roofs, exterior paint, and recreation areas are usually included in the developer's original reserve budget.

Many an association has found that, despite its existence, an item such as a sidewalk or set of balconies has not been mentioned in either the CC&Rs or the developer budget. A site analysis by knowledgeable persons should result in a comprehensive list of reserve items for which the association is, or might be, responsible. (For a list of items that are often overlooked in the CC&Rs and the developer budget, see Appendix B.)

Local governments and utility companies can often help define common area components by stating where their responsibility ends and that of the association begins. For example, the developer budget and the CC&Rs may be unclear about whether the sidewalks along the edge of a development belong to the association or the city. If the former, these sidewalks are components which, at some point in time, should be included in the reserve budget; if the latter, the association need not budget for their repair or replacement.

Specifying the Quantity of Each Component
Although. existing maps and construction drawings of the development may serve as a guide to component quantities, a detailed site and building analysis is the best way to obtain an accurate count of these items. For some components (e.g., streets, roofs, fences) the square or linear footage must be measured in order to describe the quantity, while for other items (e.g., utility room doors) it may be sufficient to know the number required. "As-built" drawings are an excellent source of information for these quantities, but in their absence the items should be accurately measured.

2 The drawings filed when the development was begun represent builder plans rather than the development as actually built. As such, they are useful but should be verified by physical inspection.

For components that are actually made up of a number of items, the nature and quantity of the constituent parts should be stated (e.g., the metal flashing for a shake roof as well as the square footage of shingles). It is common to neglect the "extra" pieces that are in fact necessary to the construction of such essential items as roofs, siding, and irrigation systems.

Once the number and constituent parts of each component are detailed, it is necessa