Deficit Spending

Started by JoyceS1 • 27 replies • 2673 views

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JoyceS1 (Indiana)
Posts: 140

Posted:

When reserves are used to supplement the budget when the budget has been underfunded, "should" the funds be put back out of the following year's budget?

None of our documents speak to this. Should they?

RogerB (Colorado)
Posts: 5,067

Posted:

Joyce, you may wish to read some of the posts on reserve funds. Each annual budget should include funds to be placed in a capital investment or reserve fund. The amount should be established after doing a reserve study and creating a long range (20 year) reserve plan. These funds can be deposited in the operating fund (checking account) but should be transferred to reserve fund(s) account as per IRS guidelines. Reserve funds can be invested to generate a yield on investment. Guidelines on this have also been posted.

BradP (Kansas)
Posts: 2,640

Posted:

Joyce:

To answer your question, yes the money should be put back in the following year. You need to examine why you had to dip into reserves because a good budget should give you enough wiggle room to finance almost any situation unless it is a capital expense, but that is what reserves are for.

As Roger said there are some great topics on reserves on here.

JM2 (Oregon)
Posts: 439

Posted:

Hi Joyce:

Oregon law requirement is that in order for the Board to borrow from reserves, they must pass a resolution to repay the reserves within a period of time (18 months, I believe) and state how much they are borrowing and how they will repay.

The reasons may vary on why a board would borrow from reserves; here are some possibilities:
1) not enough operating cash at some point in the year, repay when there is;
2) inadequate budgeting;
3) board doesn't pass budget, can't assess, borrows from reserves until budget is passed and assessments are sent out (I actually had one commmunity that did that).

If reserve money is borrowed, it's best to pay it back along with the interest that would have been earned, particularly if the amount is large, or the borrowing period is long.

J. Patrick Moore, CMCA
Compliance Coordinator
Forest Heights Homeowners Association
Portland, Oregon

SidneyP (Florida)
Posts: 302

Posted:

JM2..." If reserve money is borrowed, it's best to pay it back along with the interest"

I have read many of the articles on Reserves but have never seen anything that says "WE MUST HAVE A RESERVE", that it is a law. If it is a State or Federal law that states this, please point me in that direction. Our Board has skipped paying into our reserves 4/5 months. I guess the reasion was we were running out of money to pay our bills. Jan 30, they had a BOD's meeting on the Budget Review. There was nothing in the budget to repay this money, infact they lowered our reserve by $150. a month. The $902. we were paying wasn't enough as it was, especially since they weren't even putting it in....If there is no law to force the BOD's to maintain a proper reserve, than what protection do the HO's have against a large"SPECIAL ASSESSMENT" down the road. And what is so unfair, the HO's that would be paying would probably be new owners that did not benefit the past 20 years from the reserve ammendities. So someone PLEASE tell me how I can force the Board to do what is their duty to protect present and future HO's. They refuse to get a Reserve study and are afraid to raise the association fees enough to cover the capital expendatures and the reserves. The developer had everything lowballed and we have no choice but to correct the short falls. I would love to keep my TH but I will not be able to afford a large SPECIAL assessment down the road.

JoyceS1 (Indiana)
Posts: 140

Posted:

Roger and Brian....

Perhaps I need to expand on my question a bit....we only recently conducted the reserve study; we upped our contribution to the reserves....but only by half of what is actually needed.

A current board member and past president has floated the idea that we can operate on deficit spending since the Federal Government operates that way! His proposal defeats our attempt to better fundreserves when we increased the contribution.

He wields a great deal of influence within the community, so people will think this is the greatest idea since orange juice was invented. It puts me as the current president at a disadvantage.

I and another board member are in the process of revising the bylaws. I wondered if we should insert language in the bylaws that money taken out of reserves to supplement the budget, must be paid back within a specified period of time. I don't know if that is appropriate to do so, but thought it might carry more weight if we address it in the bylaws, if appropriate to do so there.

I'm pretty sure there are no state for federal laws in our state mandating the handling of reserves, so it is pretty much left at the HOA level for us.

RogerB (Colorado)
Posts: 5,067

Posted:

Joyce, I would not put the reserve fund requirement in the By-laws. Rather you could try to get the Board (or association) to pass a Rule and Regulation on Reserve funds. The requirements desired can be place there.

And regarding new owners that did not pay toward past money placed is reserve, they purchase the property which includes the owner's equity in the reserve fund. Current owners should be paying the yearly depreciation plus an inflation factor towards future replacement of amenities. While there is no law requiring an HOA to have a reserve fund, the Board has a fiduciary responsibility.

SidneyP (Florida)
Posts: 302

Posted:

RogerB..."While there is no law requiring an HOA to have a reserve fund, the Board has a fiduciary responsibility."

And please tell me how you make them honor that responsibility?. If I've read once, I've read a hundred times on this forum that if you sue, you are sueing yourself and your neighbors. So that's out. And if you can't get HO's to come to a meeting or show any interest how can this change? And even if I could get their attention, how many do you think would understand and agree to a assessment increase. Like one HO told me, don't worry about it, you won't be around in 20 years. If theres not a State Statue that requires a Reserve study and fund than there should be. I'll ask again, how do I get the BOD's to get a reserve study, repay the money not put into the fund and raise the fund to the correct amount it should be instead of decreasing it to make the budget balance.

JoeW1 (New York)
Posts: 728

Posted:

SidneyP - there has to be something, somewhere in your by-laws that states something to the effect that the board must provide for the maintenance, repair, and replacement of the common elements. regarding the replacements - that is what the reserves will cover. how can a board fund for the replacement of something if it doesn't know the life-span, and cost of replacement. that is what a reserve study will show. common sense has to prevail. if the board in your community is as foolish as they sound, and the community is foolish to let them get away with it, there's little you can do but speak up at an open meeting with a solution and a compelling reason to fund for reserves, write a letter to the board and or community, or sue the board to force them to uphold their FIDUCIARY responsibility. suing would be a last resort. or you can move because it’s your investment at stake. i'm in a somewhat similar situation because my calculations, which are very well grounded in a reserve study, show our reserve balances will be in the negative at future year marks unless projects are staggered in phases and transfers to reserves increase. i am in the process of compiling my calculations and providing them to our boards in an excel spreadsheet showing reserve balances minus reserve expenditures over the next 46 years. while i won't be living in the community forever, it's conceivable the elements will deteriorate sooner than i move. so it's important for me to state my peace and move on.

GlenL (Ohio)
Posts: 5,491

Posted:

Posted By RogerB on 02/12/2007 12:41 PM

While there is no law requiring an HOA to have a reserve fund, the Board has a fiduciary responsibility.

In Ohio the law requires:
The Board of Directors shall adopt and amend a budget for revenues, expenditures, and reserves in an amount adequate to repair and replace major capital items in the normal course of operations without the necessity of special assessments, provided that the amount set aside annually for reserves shall not be less than ten percent (10%) of the budget for that year unless the reserve requirement is waived annually by the Unit Owners exercising not less than a majority of the voting power of the Association.

In plain language the HOA must fund reserves or the majority of the Association must vote EACH year to allow special assessments. This was designed to prevent people from moving into HOA's and being hit with large special assessments. I believe there is also a form the seller must now provide indicating the state of the reserves.

Studies show that 5 out of 4 people have problems with fractions

RogerB (Colorado)
Posts: 5,067

Posted:

Thanks for the info Glen. I wish every state would adopt such a law. We do provide the balance in the Reserve account when providing a status letter to the title companies (and Buyer) when property is purchased.

BobM5 (California)
Posts: 34

Posted:

In California, state law requires that all HOA's maintain and fund a reserve. The law is being tightened further to require the board to explain annually to all HO's the methods by which the board will achieve 100% funding to the reserves if the reserves are underfunded per the reserve study.

BonnieE (Illinois)
Posts: 338

Posted:

The IL Condominium Property Act requires that budgets adopted by a BOD on/after July 1, 1990 provide for reasonable reserves for capital expenditures for repair/replacement of common elements. It also specifies what a “reasonable reserve” would be – which is based on a reserve study. It also states that a 2/3 vote of the association may waive the requirement (in whole or in part) for a reserve fund. -Bonnie

LanceT (Alabama)
Posts: 121

Posted:

I question if the money needs to be "repaid". Example: Let's say that you have $10K in reserves. The pool springs a leak and needs $5k in repairs. The board takes the money from the reserves instead of creating a special assessment. That's because a special assessment would require a 2/3rds vote of the entire membership versus the board agreeing to take it out of reserves. (The reserve fund is setup to cover such capital expenses.)
Now the crisis is over with but the HOA is left with only $5K in reserves. Correct? The question is that your asking is now does the board make the members pay back the $5k?
The answer really depends on if the current budget is adequate enough to keep handling the monthly bills/maintenance. If your HOA is facing other repairs due to age or increase in bills (electric/water etc), then your HOA may consider raising dues or having a special assessment to replace the money. However, if this was a one time expense incurred by the HOA, then repaying the money may not be as important. Your reserves/savings fund amount balance is whatever your HOA wants it to be. (considering taxes of course in some states). Your HOA may be fine to run on a $5k reserve fund.
What I bet has happened is the board took the "easy" way out and spent from the reserve fund to avoid a special assessment process. The special assessment process is long, not guaranteed, and isn't easy. So your board essentially, "borrowed from Peter to pay Paul". That may be perfectly okay as long as your HOA doesn't incur another large capital expense and is able to put money toward the reserve funds with extra funds each month or so.

Recovering Ex-President of a HOA

GlenL (Ohio)
Posts: 5,491

Posted:

Lance with all due respect please put a space between your paragraphs to make your posts easier to read.

Second as they say in Law & Order you're assuming facts not in evidence. Joyce's original post asked the question:

Posted By JoyceS1 on 02/12/2007 5:42 AM

When reserves are used to supplement the budget when the budget has been underfunded, "should" the funds be put back out of the following year's budget?

None of our documents speak to this. Should they?

If you "borrow" from reserves to fund your day to day operations, then the money needs to be repaid to prevent a shortfall in the reserve account. From her second post I would assume that her Board is trying to under-fund the budget to keep assessments low in order stay in power.

Joyce I would point out to the other Board members that THEY PERSONALLY can be held accountable if they deliberately violate their fiduciary duty and that the D&O insurance doesn't cover deliberate misconduct.

Studies show that 5 out of 4 people have problems with fractions

LanceT (Alabama)
Posts: 121

Posted:

How is it that the board would be PERSONALLY responsible? They didn't receive any personal gain and the decision made was done in a group in the function of the board. Bad group decision doesn't make a board person personally responsible in a HOA.

I don't even see a bad decision here in this situation. It just seems that the HOA spent money out of their underfunded reserves without a solid plan on replenishing it. This isn't unusual. Once the dust settles, I am sure things will sort out. Worst case, the HOA raises dues or has a special assessment.

Recovering Ex-President of a HOA

RogerB (Colorado)
Posts: 5,067

Posted:

Posted By GlenL on 02/19/2007 9:35 PM
Joyce I would point out to the other Board members that THEY PERSONALLY can be held accountable if they deliberately violate their fiduciary duty and that the D&O insurance doesn't cover deliberate misconduct.

I agree Glen, this can be effective. It can either educate Board members or place them in a situation where they are liable. Board members are not liable for bad decisions but they are liable for making decision which are known to be detrimental. That's why negative votes should be recorded in the minutes and include the name(s) of those opposed. It will protect them in case there is a legal action against the Board members.

GlenL (Ohio)
Posts: 5,491

Posted:

Posted By LanceT on 02/20/2007 4:31 AM

How is it that the board would be PERSONALLY responsible? They didn't receive any personal gain and the decision made was done in a group in the function of the board. Bad group decision doesn't make a board person personally responsible in a HOA.

I don't even see a bad decision here in this situation. It just seems that the HOA spent money out of their underfunded reserves without a solid plan on replenishing it. This isn't unusual. Once the dust settles, I am sure things will sort out. Worst case, the HOA raises dues or has a special assessment.

Lance they can be held responsible for deliberately violating the business rule, just like the executives at ENRON. Not for making a bad decision but for deliberately making a bad decision for personal gain; whether it is an attempt to keep assessments low to remain in power or to keep them low because they themselves don't want to pay towards the eventual replacement of capital items.

I disagree, worst case the errant trustee's sell & move out leaving the remaining people holding the bag. Nobody likes to raise assessments or to have them raised on you but if you don't fund your association you have things happening like you yourself have complained about in your other posts.
The way you toss of the comment about having a special assessment to settle things out is scary. That's why the State of Ohio made them hard to have, to protect homeowners from such a cavalier attitude.

Studies show that 5 out of 4 people have problems with fractions

DavidS3 (Maryland)
Posts: 37

Posted:

GlenL

Does the 10% referred to in the law pertain to the required reserve funding amount as defined by an independent reserve study? Hopefully, it doesn't mean 10% of the total annual operating budget.

LanceT (Alabama)
Posts: 121

Posted:

Hold everyone's horses. Personal gain as a board member? I would LOVE to know how that could actually happen. Please tell! The last time I remember being a board member, I was still obligated if not MORE to pay my dues and any special assessment that was voted in. If I didn't pay up, then I wasn't qualified to be a board member because I wouldn't be in "good standing".
Honestly, look at any HOA. You won't see professionals running the place who went to school for HOA management. What you see is the retired school teachers, soccer moms, or stay at home parent. Yes, there could be professionals such as lawyers or other business people in your HOA, but they are still human and homeowners like the rest of us.
I wasn't a professional person when I ran my HOA and neither were my board members. I did have one that was a retired accountant. (she could be difficult to deal with.) However, I can tell you firsthand NONE of these people were on the board because of the chance of "personal gain". They joined the board because they had a geniune interest in the community. Other members elected them because of their interest.
Holding a board member "Personally" responsible for a group decision is ridicolous in my book. They aren't the most educated nor up to date people on rules and regulations. They are humans who make mistakes. They are YOU and ME. How would you feel if someone decided to sue you and hold you personally responsible if you had voted that no trash cans are allowed on the street after 6 pm. Their trash can was out at 7Pm. They argue if you hadn't passed the rule of 6 P.M. they wouldn't be in violation. Same difference on any board vote.
Raising dues or having special assessments don't make a board member any richer. That's because board members are also regular members and subject to the SAME rules.

Recovering Ex-President of a HOA

GlenL (Ohio)
Posts: 5,491

Posted:

Posted By DavidS3 on 02/20/2007 12:07 PM

GlenL

Does the 10% referred to in the law pertain to the required reserve funding amount as defined by an independent reserve study? Hopefully, it doesn't mean 10% of the total annual operating budget.

Yes 10% of the operating budget, that is the minimum allowed.

Studies show that 5 out of 4 people have problems with fractions

GlenL (Ohio)
Posts: 5,491

Posted:

Posted By LanceT on 02/20/2007 2:54 PM

Hold everyone's horses. Personal gain as a board member? I would LOVE to know how that could actually happen. Please tell! The last time I remember being a board member, I was still obligated if not MORE to pay my dues and any special assessment that was voted in. If I didn't pay up, then I wasn't qualified to be a board member because I wouldn't be in "good standing".
Honestly, look at any HOA. You won't see professionals running the place who went to school for HOA management. What you see is the retired school teachers, soccer moms, or stay at home parent. Yes, there could be professionals such as lawyers or other business people in your HOA, but they are still human and homeowners like the rest of us.
I wasn't a professional person when I ran my HOA and neither were my board members. I did have one that was a retired accountant. (she could be difficult to deal with.) However, I can tell you firsthand NONE of these people were on the board because of the chance of "personal gain". They joined the board because they had a geniune interest in the community. Other members elected them because of their interest.
Holding a board member "Personally" responsible for a group decision is ridicolous in my book. They aren't the most educated nor up to date people on rules and regulations. They are humans who make mistakes. They are YOU and ME. How would you feel if someone decided to sue you and hold you personally responsible if you had voted that no trash cans are allowed on the street after 6 pm. Their trash can was out at 7Pm. They argue if you hadn't passed the rule of 6 P.M. they wouldn't be in violation. Same difference on any board vote.
Raising dues or having special assessments don't make a board member any richer. That's because board members are also regular members and subject to the SAME rules.

Lance nobody is talking about holding Board members responsible for decisions made in good faith. Nor holding them responsible for group decisions that they voted against, see Roger's post on making sure negative votes be recorded in the minutes and include the name(s) of those opposed. There are lots of ways for unscrupulous people to profit from their position on the Board, just read through the posts here.

If you would read the question posed by Joyce it was should money borrowed from the reserves to cover a under funded budget be paid back. In the next post we learn that the reserves themselves are also under funded and a Board member wants to continue this deficit behavior. This is no different from a developer low balling assessments in order to sell homes then leaving before the HOA realizes the predicament that they are in.

This is not the same as the post from the new Board that accidentally under funded their budget because there were things that they didn't realize they needed to budget for, that was an accident.
What Joyce is talking about is deliberate misconduct and as a trustee if you deliberately do something you know is wrong; you can and should be held personally responsible.

Studies show that 5 out of 4 people have problems with fractions

DavidS3 (Maryland)
Posts: 37

Posted:

GlenL

I'm obviously missing something. In our HOA at least there just isn't any correlation between the operating budget and the reserves other than the fact that the former contributes something to the latter.

Our reserve contribution and balance was determined by a professional consulting firm with a great deal of expertise in that area. We now are on track with their recommendations with a balance of about $130,000 and an annual donation of about $35,000. We update the study every other year.

Our annual operating budget is about $1,000,000 and over 50% of that goes to residential services (lawn mowing, snow removal) and common grounds maintenance. Other large expenses are management, utilities, facilities maintenance, etc. What possible relation does the amount of these expense have to how much it will cost us to replace the clubhouse roof or repave the parking lot 20 years from now? Yet I believe you are saying that if we lived in Ohio we would have to contribute a minimum of $100,000 (10%) per year - three times as much as we can possibly use.

As I said I must be missing something.

DaveS3

GlenL (Ohio)
Posts: 5,491

Posted:

Posted By DavidS3 on 02/20/2007 6:34 PM

GlenL

Yet I believe you are saying that if we lived in Ohio we would have to contribute a minimum of $100,000 (10%) per year - three times as much as we can possibly use.

As I said I must be missing something.

DaveS3

Dave if the majority of the Association votes each year to allow the possibility of special assessments they can put less than 10% into reserves. The law came about because there were a rash of first time home buyers who moved into under funded HOA's and then were hit with massive special assessments and lost everything because they couldn't afford to come up with the money in the time required.

Like any law it has its good and bad points but for the most part I think this one has more good than bad. Your Association sounds like it's in good shape, as is ours. But unfortunately this forum is littered with posts from people who found out the hard way that their reserves were non existent. Developers traditionally have under funded reserves in order to keep assessments low as a selling point and many Boards do it for the same reason.

Studies show that 5 out of 4 people have problems with fractions

JoeW1 (New York)
Posts: 728

Posted:

DaveS3 and all HOA members:

I encourage all of you to perform your own reserve adequacy test using info from your professional consulting firm. 1)Determine all of your reserve expenditures (elements to be replaced). The consulting firm should provide a replacement cost of each and the expected useful life-cycle. 2)Determine the date each element was constructed, critical factor. Some developments were built in phases spanning years. Therefore not all elements need to be replaced at the same time, even though the professional study a total replacement cost of say $330,000.00 for 2 miles of roadway asphalt. 3)Forecast when each element will need to be replaced. For example, if your sidewalks were installed in 2005 and the expected useful life-cycle is 30 years, the sidewalks will need to be replaced in 2035 and you have 28 years left of reserve funding to cover the sidewalks. 4) Take your current annual reserve contribution plus your existing reserve balance, and add to this figure the amount of 28 years of reserve funding (as an example). 5) Subtract all of the expenditures that will occur in the 28 years. For example, roadway asphalt may need to be replaced at each 15 year mark, or aspahlt needs to be sealed at every 5 year mark. 6) Now do this for each element/expenditure line item. Are any of the reserve balances at the time of replacement at a negative balance, or dangerously low?

If you are part of a Board, or live in a community where this test was not done by a professional consulting firm's study, then a claim that reserves are adequately funded has no basis. You might as well be shooting in the dark.

Reserve studies are designed to steer boards and associations away from lawsuits, not towards them.

JoeW1 (New York)
Posts: 728

Posted:

LanceT - it is incorrect to say the reserves do not need to be re-funded if the amount remaining is adequate enough to keep handling the monthly bills/maintenance. First, reserve accounts don't fund monthly bills/maintenance. Second, if the dues are not adequate to cover costs, the dues should be raised to fund the cost, not raised to replenish the reserves that were borrowed from. the reserves should be considered sacred money, not to be tampered with. if the reserves are not replenished it is not "borrowing from Peter to pay Paul", it is "stealing from Peter to pay Paul. end of story.

DavidS3 (Maryland)
Posts: 37

Posted:

JoeW1

Thank you for your post. The thing I like best about this forum is that it encourages me to go back and challenge my own assumptions. Reviewing our Level 1 (on-site inventory of all items)study report it was comforting to see that it addressed the "test" that you described above. It provides an itemized (83 items)replacement reserve inventory that lists the number of units associated with each item, unit replacement costs, normal and remaining economic life, and computes total replacement costs for each item. This is followed by a replacement calender fot the next 30 years. This data along with the Reserve balance at the time of the study is entered into two different models that reflect different methodologies for arriving at the minimum annual contribution. The "Cash Flow Method" which we use, establishes a reserve threshold and determines the contribution required to make sure we always stay above it. Ours is 5% of total replacement costs. Nominally, the study should be updated every three years though our experience is somewhat different. The initial (Level 1) study cost us around $4,500. I cannot even imagine doing it on our own.

That does not mean that a Board can sign the check, set the reserve contribution to the amount recommended and forget about it. Two years after the initial study we are commissioning a Level 2 update to add or delete items and update some bad relpacement estimates. For example, we were advised by our auditor, that significant replacement/addition of landscaping was a valid reserve item. we learned that the developer had listed two private drives as HOA responsibity and have to add them. A small sub-committee headed by a Board member went over every item and has a list ready when the consultant arrives. We hope that this work will put us back on a three year update schedule again.

DaveS

JoeW1 (New York)
Posts: 728

Posted:

DavidS3 - bravo!!! every hoa/coa should raise the bar to the level of your association. i would recommend that everyone perform a test of their existing reserves by adopting a method similar to what i've described. not to override their professional study, but to test the adequacy of their current reserve funding and to grasp the concept of a reserve account as it fluctuates over time. it's important to remember the replacement costs must also account for inflation, rising construction costs, etc. over time.

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