Inflation factor and annual contribution increase in the reserve analysis
Dennis,
I was wondering why our reserve analysis has both and inflation factor as well as a contribution increase factor. Why wouldn’t the inflation factor alone be adequate if you are well over 80% funded. It seems to me that when these two parameters are used together, it’s like wearing a belt and suspenders to keep your pants up. Ultimately, the residents are being charged more than necessary to fund the reserve.
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DPK,
Inflation assumption are vital to any reserve analysis. To ignore that would be hiding your head in the sand. You can get a detailed cost estimate today for any project but if you only need to do that work in 5 years the cost in five years will be higher than it is today and if not addressed in your analysis you will end up in a shortage of funds to do the work. The annual contribution increase is simply a ploy used to raise more money by most reserve companies. You can address your funding needs in many ways including fixed contribution to the reserves every year. These are choices that can be made, but the cost of future products or services will always increase. We have never experienced negative inflation in our economy.
Dennis
Thank you for your reply. Yes, I completely understand the need for the inflation parameter. I didn’t understand the need toalso include a “planned contribution increase” parameter. Why would you want to plan to increase your required contribution after you had already included an inflation factor? It just seemed like you were padding an assessement and not acting with the fiscal responsibity required to be an elected member of the HOA. Thank you for noting that it’s a ploy to raise more money. That was my hunch.
DPK,
The issue is how do you raise the money that you need for the end projects. You can raise the money with an annual contribution model that is consistent but considerably greater than your current contribution level or you can raise the money by a contribution level that is increased over time to limit the pain. There are two different aspects of a reserve plan one deals with the nature and cost of future projects and the other deals with how you get the money for the first part. To get accurate projections for future cost you need an inflation factor, to get the money you need for a future project you can go at it with a fixed contribution rate, or an annual contribution rate that varies every year or any combination of the two extremes. If you apply discipline to the process there is nothing wrong with annual increases to the reserve contribution, as long as the target is to have the money you need when you need it. That is simply responsible planning. The issue is has the association used appropriate compounding calculations or di they take the easy way out and simply applied a compounding factor that is totally unassociated with the desired end point for money raised. If after accounting for an inflation factor you have a project that will cost $1,000,000 in 10 years you can calculate an annual contribution increase factor that results in the total contributions raised in 10 years to be $1,000,000 and that would be perfectly acceptable. But if you applied an annual contribution increase factor that was not calculated out you could end up with $1.5 million and that is exactly what you are concerned about. So the real question is has the association done the math correctly in calculating the annual contribution increase factor. This is where a spreadsheet helps to demonstrate the overall plan. You can look out 40 or more years and include all expected projects in that time frame and the expenditures for that time frame and confirm that you have enough money when you need it for each project. If you don’t you have to adjust your annual contributions to meet the demand or eliminate or alter the projected project cost. it is not an exact science but rather a balancing act. that has to be reviewed every 3-5 years to check and adjust.
Dennis
Thank you for your reply. I thought the annual contribution increase might be unwarranted and unnescessary.