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Summary of Current California Reserve Study Law

The state of California has adopted specific statutes related to reserve studies, which are set forth in Davis-Stirling Common Interest Development Act, Civil Code Section 5550 through 5580.

Those statutes generally state the requirements for conducting reserve studies, managing reserve funds and making disclosures to owners regarding said funding.  These requirements include a reserve study being conducted once every three years that involves those items which the association is obligated to repair, replace, restore or maintain,  This study must identify those items with less than a 30 year useful life, estimate the probable remaining useful life, and estimate the cost of repair, restore, replace or maintain.

While a reserve study is obligated to be performed, California law does not require funding to the reserve accounts.

Common industry practice is that homeowners associations should perform periodic reserve studies as a prudent business practice.  Directors of associations are generally held to a “prudent businessman” rule in determining whether or not they have met the fiduciary duty of their position for the association.  A prudent businessman would establish a capital replacement budget (reserve study) to make sure he is generating enough revenues (reserve assessments) to provide for major repairs and replacements.

Davis-Stirling Common Interest Development Act

California law is codified as the Davis-Stirling Common Interest Development Act.

Sections 5550 through 5580 establish the overall requirements for reserve planning.

Sections 5570 establishes the budgetary reserve disclosure requirements.

Section 5550 establishes performance standards.  These standards require a visual site inspection every three years.

California has established reserve study performance and disclosure requirements, but has not established any minimum funding requirements.  The law does require disclosure of the funding plan, and also whether or not any special assessments are planned as any part of the 30-year funding plan.

Reserve sections of Davis-Stirling Common Interest Development Act.

5550.

(a) At least once every three years, the board shall cause to be conducted a reasonably competent and diligent visual inspection of the accessible areas of the major components that 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, excluding the association’s reserve account for that period. The board shall review this study, or cause it to be reviewed, annually and shall consider and implement necessary adjustments to the board’s analysis of the reserve account requirements as a result of that review.

(b) The study required by this section shall at a minimum include:

 (1) Identification of the major components that the association is obligated to repair, replace, restore, or maintain that, 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).

 (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.

(5) A reserve funding plan that indicates how the association plans to fund the contribution identified in paragraph (4) to meet the association’s obligation for the repair and replacement of all major components with an expected remaining life of 30 years or less, not including those components that the board has determined will not be replaced or repaired.

 5560.

 (a) The reserve funding plan required by Section 5550 shall include a schedule of the date and amount of any change in regular or special assessments that would be needed to sufficiently fund the reserve funding plan.

 (b) The plan shall be adopted by the board at an open meeting before the membership of the association as described in Article 2 (commencing with Section 4900) of Chapter 6.

 (c) If the board determines that an assessment increase is necessary to fund the reserve funding plan, any increase shall be approved in a separate action of the board that is consistent with the procedure described in Section 5605.

 5565.

 The summary of the association’s reserves required by paragraph (2) of subdivision (b) of Section 5300 shall be based on the most recent review or study conducted pursuant to Section 5550, shall be based only on assets held in cash or cash equivalents, shall be printed in boldface type, and shall 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:

 (1) The current estimate of the amount of cash reserves necessary to repair, replace, restore, or maintain the major components.

 (2) The current amount of accumulated cash reserves actually set aside to repair, replace, restore, or maintain major components.

 (3) If applicable, the amount of funds received from either a compensatory damage award or settlement to an association from any person for injuries to property, real or personal, arising out of any construction or design defects, and the expenditure or disposition of funds, including the amounts expended for the direct and indirect costs of repair of construction or design defects. These amounts shall be reported at the end of the fiscal year for which the study is prepared as separate line items under cash reserves pursuant to paragraph (2). Instead of complying with the requirements set forth in this paragraph, an association that is obligated to issue a review of its financial statement pursuant to Section 5305 may include in the review a statement containing all of the information required by this paragraph.

 (c) The percentage that the amount determined for purposes of paragraph (2) of subdivision (b) equals the amount determined for purposes of paragraph (1) of subdivision (b).

 (d) The current deficiency in reserve funding expressed on a per unit basis. The figure shall be calculated by subtracting the amount determined for purposes of paragraph (2) of subdivision (b) from the amount determined for purposes of paragraph (1) of subdivision (b) and then dividing the result by the number of separate interests within the association, except that if assessments vary by the size or type of ownership interest, then the association shall calculate the current deficiency in a manner that reflects the variation.

 5570.

 (a) The disclosures required by this article with regard to an association or a property shall be summarized on the following form:

 (5)   All major components are included in the reserve study and are included in its calculations.

 (6)  Based on the method of calculation in paragraph (4) of subdivision (b) of Section 5570, the estimated amount required in the reserve fund at the end of the current fiscal year is $____, based in whole or in part on the last reserve study or update prepared by ____ as of ____ (month), ____ (year). The projected reserve fund cash balance at the end of the current fiscal year is $____, resulting in reserves being ____ percent funded at this date.

 If an alternate, but generally accepted, method of calculation is also used, the required reserve amount is $____. (See attached explanation)

 (7) Based on the method of calculation in paragraph (4) of subdivision (b) of Section 5570 of the Civil Code, the estimated amount required in the reserve fund at the end of each of the next five budget years is $______, and the projected reserve fund cash balance in each of those years, taking into account only assessments already approved and other known revenues, is $______, leaving the reserve at ______ percent funding. If the reserve funding plan approved by the association is implemented, the projected reserve fund cash balance in each of those years will be $______, leaving the reserve at ______ percent funding.

 Note: The financial representations set forth in this summary are based on the best estimates of the preparer at that time. The estimates are subject to change. At the time this summary was prepared, the assumed long-term before-tax interest rate earned on reserve funds was ____ percent per year, and the assumed long-term inflation rate to be applied to major component repair and replacement costs was ____ percent per year.

 (b) For the purposes of preparing a summary pursuant to this section:

 (1) “Estimated remaining useful life” means the time reasonably calculated to remain before a major component will require replacement.

 (2) “Major component” has the meaning used in Section 55530. Components with an estimated remaining useful life of more than 30 years may be included in a study as a capital asset or disregarded from the reserve calculation, so long as the decision is revealed in the reserve study report and reported in the Assessment and Reserve Funding Disclosure Summary.

 (3) The form set out in subdivision (a) shall accompany each annual budget report or summary thereof that is delivered pursuant to Section 5300. The form may be supplemented or modified to clarify the information delivered, so long as the minimum information set out in subdivision (a) is provided.

 (4) For the purpose of the report and summary, the amount of reserves needed to be accumulated for a component at a given time shall be computed as the current cost of replacement or repair multiplied by the number of years the component has been in service divided by the useful life of the component. This shall not be construed to require the board to fund reserves in accordance with this calculation.

 5580.

 (a) Unless the governing documents impose more stringent standards, any community service organization whose funding from the association or its members exceeds 10 percent of the organization’s annual budget shall prepare and distribute to the association a report that meets the requirements of Section 5012 of the Corporations Code, and that describes in detail administrative costs and identifies the payees of those costs in a manner consistent with the provisions of Article 5 (commencing with Section 5200) of Chapter 6.

 (b) If the community service organization does not comply with the standards, the report shall disclose the noncompliance in detail. If a community service organization is responsible for the maintenance of major components for which an association would otherwise be responsible, the community service organization shall supply to the association the information regarding those components that the association would use to complete disclosures and reserve reports required under this article and Section 5300. An association may rely upon information received from a community service organization, and shall provide access to the information pursuant to the provisions of Article 5 (commencing with Section 5200) of Chapter 6. 

Contact the experts at Facilities Advisors, Inc. for your reserve study needs.  Serving California associations since 1982.

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Additional State Reserve Study Laws