Reserve Study Components vs. Capital Improvements

The Basics

● Reserves are intended to only fund major repairs and/or replacements of existing assets. They are not intended for additions of new assets.

● Capital improvements are typically funded through a separate means of funding, whether that be a loan, a specific assessment for the project, an Operating fund surplus, or a capital improvement fund established for such additions.

● Understanding the difference helps communities make smarter financial decisions

Community associations constantly make decisions related to ongoing maintenance, repairs, and replacements. Reserves are often the source of funding for those projects.

However, the line between what classifies as a reserve expense versus a capital improvement (or capital addition) can become blurred by specific nuances.

Reserve Components

Reserve funds are collected over many years with a specific purpose: To repair or replace

existing common area components when they reach the end of their useful life. In addition, the funding collected should be seen as the unit owners’ current “fair share” of use now. It isn’t a “slush fund” for future additions.

Common reserve components encompass existing assets on property, which can include but aren’t limited to:

• Pavement Repairs, Sealing, & Resurfacing

• Concrete Flatwork Repairs

• Building Exteriors (Doors, Painting, Railings, Roofing, Siding, Windows, Etc.)

• Major Mechanical Pieces (Elevators, Fire Alarm Systems, HVAC, Etc.)

• Amenities (Playgrounds, Pools, Sport Courts, Etc.)

A Reserve Study is a long-term financial planning tool, often created by a qualified professional, that identifies the predictable repair and replacement projects for major common area components. It includes each component's total life expectancy, remaining useful life, estimated project cost, and financial recommendations for funding that project over a long-term projection (typically 30 years). Its goal isn’t only to predict future expenses. It's to ensure the community collects reserve funds sustainably so large replacement projects don't become unexpected financial emergencies.

Capital Improvements

Capital improvements most often encompass the addition of a new asset or area for the

community.

More common examples today include but aren’t limited to:

• Adding a Dog Park.

• EV Station Additions

• Constructing a New Clubhouse

• New Playgrounds

• Sport Court (i.e. Pickleball) Additions.

These are valuable investments and may be a strong consideration to remain competitive with neighboring communities. In fact, these items should be considered if they benefit your community association. However, because these projects represent entirely new assets, they are generally funded separately from reserves.

Once new assets are installed, they are then become reserve components that are included in future reserve studies for their eventual replacement.

Why The Difference Matters

Using funds incorrectly can cause a shortfall in the association’s reserve position, leading to a higher risk of special assessment (and/or loan) needs when major reserve projects occur.

Understanding which category each project belongs within will help communities ensure reserve funds remain available for the assets they were intended to support.

The “Grey Area”

What if there is a situation where existing assets are being replaced with something different?

Or maybe there’s a project that technically expands an existing area or asset?

This is where the Community Associations Institute (CAI) introduces a significant topic within the Reserve Study Standards: consideration of “logical upgrades” related to existing reserve components.

Communities change over time:

• Technology advancement can render existing equipment obsolete.

• Building codes and safety standards evolve.

• Past amenities don’t adequately serve the community’s needs.

• Resident expectations shift.

As a result, replacing an existing asset doesn't always mean installing an identical replacement.

Logical upgrades through reserves are appropriate when an existing asset has become

obsolete, inefficient, or no longer effectively serves the community. Yet, this argument in itself presents a grey area. Depending on a community’s financial position, the question should be asked as to whether reserve funds (in part or total) “should” be used. We recommend answering at a few factors for each project decision:

1) Does this qualify as a logical upgrade?

2) How related is the new product related to the original reserve component?

3) What are the financial (i.e. reserve fund) implications related to this project?

Let’s look at a few examples!

A Few “Easy” Examples

In some cases, the above three questions are easy to answer without too much context.

Mechanical equipment is often the easiest to understand, because specific equipment designs will become outdated and like-for-like replacement becomes difficult (if not impossible). For example:

● A manual keypad entry system is no longer available on the market (discontinued) and

ownership would prefer upgraded technology, so the association decides to complete

replacement with a touch-screen entry system.

● HVAC systems are to be replaced with newer models/types due to new coolant

restrictions and higher efficiency standards.

● A 5-camera surveillance system being replaced with a 9-camera surveillance system

because the prior system missed critical visibility zones within the property.

● Traditional light fixtures are being replaced with LED versions due to energy efficiency

and savings.

● Aged irrigation controls are being replaced with smart models for enhanced capabilities, reduced water consumption, and better ease of use.

These projects represent the replacement of existing components directly with newer

designs/types, of which the reasoning can be easily justified. Reserves typically should be used in these cases, as the expenses are likely higher but still comparable to what like-for-like replacement costs would have been.

Examples With Added Complexity

In other cases, the complexity adds potential for the “grey area” mentioned above. New

questions arise as to whether the entire project should be funded by reserves or not.

Example #1A: Conversion of Existing Tennis Courts Into Pickleball

This type of sport court expansion is common. Many associations have tennis courts that are no longer used as frequently, and they can be converted into pickleball courts for less than what a new pickleball court installation project would cost. In many cases, this makes sense as a logical upgrade (that answers question #1 above). The outcome is fairly similar to the original reserve component, as both are sport courts. Your association should have accumulated reserve funds for refurbishment and reconstruction of the existing court assets (court surface, fencing, lighting, etc.), so other than some additional fencing needed to separate pickleball courts, the cost should be fairly comparable.

Example #1B: Expansion of Sport Courts During Conversion

This is where the above example can get tricky. An association could argue that an additional (1) or (2) courts would be needed to adequately serve the needs of the community. However, those two courts didn’t previously exist and the additional cost may strain the association’s reserve funding position. As such, the right answer may partially fund the project through reserves with the remainder funded through an additional assessment, loan, Operating surplus, or other capital improvement funding (if available). In this case, directly discussing with your Reserve Study provider and attorney would be recommended as best practice.

Example #2: Replacement of an Existing Clubhouse With a New Clubhouse

Your association likely has been collecting reserve funding for repairs and/or replacements of the existing clubhouse’s assets, so there should be reserve funds to use. However, reserve funds aren’t intended for comprehensive demolition and replacement, so the cost of the project would likely far exceed the collected funds. In this case, the most likely scenario would be to use a portion of reserve funds paired with a loan and/or additional assessment. Specifics of the “how much” would be best discussed with your association’s attorney and Reserve Study provider.

A Common Mistake Associations Make

Communities often make the most mistakes due to lack of information and/or understanding rather than a lack of effort.

Just assuming reserve funds can be used because they simply exist is one fallacy. Reserves aren’t intended as a “slush fund” with fully discretionary use. They have a specific purpose, as noted earlier in this blog post.

Likewise, it would be unreasonable to assume that any upgrade automatically becomes a

capital addition separate from reserves. Reasonable upgrades should be incorporated as a reserve expense.

If you or your Board is unsure, the best thing to do is research with those who can offer expert guidance and support. Those who should be able to assist with the responses often include your association’s accountant, attorney, and Reserve Study provider.

How We, As Reserve Study Professionals, Can Help

As you’ve seen throughout this article, determining whether a project qualifies as a reserve expense or as a separate capital improvement isn't always straightforward.

Reserve Specialists can provide added guidance because they’d evaluate the purpose of the project, the history of the component, its replacement needs, current industry standards, and the association's financial position and responsibilities during the creation of a Reserve Study. This knowledge allows a tailored recommendation on potential funding approaches for all situations and scenarios.

Rather than relying on assumptions, Boards receive documented recommendations supported by industry standards and a plethora of reserve planning experience. With proper knowledge, the professional should also be able to communicate with Boards when it’s appropriate to research with legal counsel further before proceeding with use of reserve funds.

If You Have Questions, Feel Free To Ask Us!

At Prime Reserve Planning, we help associations understand not only what needs to be

replaced, but how those replacements fit into the community's long-term financial strategy.

Our reserve studies reflect current industry standards while recognizing that community assets naturally evolve over time. We help associations distinguish between standard replacements, logical upgrades, and true capital improvements so funding decisions remain accurate,

defensible, and financially responsible.

With professional guidance and regularly updated Reserve Studies, communities gain the clarity they need to plan confidently for the future.

If you have questions, feel free to contact us!