Why Should Current Owners Contribute to Reserve Fund

I am on the board of a small HOA in Washington state. We recently had a reserve study done and discovered that due to very low dues for many years, our reserve fund is about half of what it should be. To rectify the situation, we would need about $5K from each of 50 homeowners. We have not yet had a formal meeting to decide what to do.

In talking to a few homeowners, a popular opinion seems to be that we should not do a special assessment, and instead just spread that missing cost out over the next 10-30 years. Our most major expenses won't be for a decade, so there's no imminent risk of not being able to pay our bills.

Of course, the mentality that we should keep costs low for current owners is exactly what got us into this situation in the first place. However, I'm having a hard time trying to justify to owners why it's important for us to adequately fund our reserve account now as recommended in our reserve study.

As board members, we are charged with the long-term financial stability of the association, which means planning to properly fund our upcoming expenses evenly over time. As owners, however, many know that they will not be living here 5-10 years from now, so they are financially motivated to postpone expenses as much as possible. Because our expenses will eventually arrive no matter what, postponing expenses now only means special assessments in the future.

According to our CC&R's, a supermajority of the owners must approve any special assessment or dues increase over 10%, so the only way we'll be able to collect the funds needed now will be for the current owners to agree.

How do we as board members help convince the current homeowners that it's better to pay now? What arguments do we have that a rational homeowner would pay attention to, particularly one who is planning on moving out before major expenses arrive?

Spreading it out over time is likely the best route. It will probably have the most support from the members. One way to help sell such an increase in assessments is to have a Reserve Study done (either professionally or on your own). If your in a condominium, I'd suggest having one done professionally vs. doing it on your own because the professional one may find items that should be in the study that you may overlook.

I'm in a 120 lot town home development HOA (not a condominium). We are having our first professional study done this year (after 30 years of being a development and 5 years after we did our very first study internally). The cost is under $3,000

For more information on Reserve Studies, see the following thread in this forum:

http://www.hoatalk.com/Forum/tabid/55/forumid/1/postid/103517/view/topic/Default.aspx

Gordon

I agree with Fred.

You said you could increase dues 10% a year so just ramp up 10% a year. This means dues would be 50% more in 3 1/2 years and would be double in 7 years. Ramp up 7% and dues would double in 10 years. It is called compounding.

GordonS1 (Washington) :

$250,000 is the shortfall shown in your new reserve fund. If that is the current date under-funding, reluctant owners need to also consider the amount down the road and the worse hit to be taken if not addressed then or if unscheduled. System replacement projections are judgment estimates vulnerable to premature breakdowns.

Current owners run risks - maybe illegally in your jurisdiction - by slope-shouldering current obligations onto future owners.

Consumers are already smart enough to punish the market value of reserve-underfunding. Resale buyers have been doing so for decades in our jurisdiction with the Legislature & accountants under pressure to enforce. Owners may want to duck funding, but the marketplace may have a cruel punishment.

Thanks everyone for your perspectives so far. They've been enlightening!

We have been considering a special assessment as it's the only way to get the property immediately to 100% fully funded. Any other alternative (keeping dues low, ramping up over time, even paying over just 5 years) leaves us underfunded in the interim - proposals range from 10-30 years. Most homeowners seem to be of the "don't go bankrupt" school of finance, where any level of funding above zero is acceptable. Obviously our reserve study recommends a much healthier funding position.

JohnC46: Increasing 10% per year doesn't effectively pay off the past nor does it adequately prepare us for the future. Since our dues were so low, we were already planning on increasing rates nearly 10% a year anyway, just to keep up with rising operating costs. This plan still leaves very little being devoted to the reserve fund. All of the plans being considered start with a jump of around 50% immediately just to start properly funding the reserve fund from this point. There's still the problem of what to do with this $5K per owner gap.

BobD4: This is a good point. It is risky for us to be so severely underfunded. However, if the alternatives are:

1) Definitely pay now, OR
2) Maybe pay in the future,

Most homeowners are apt to choose option 2. Anything that pushes current costs into the future is a tempting proposition, because it means that those costs will be borne by future owners. That means it's highly desirable by current owners, whether they plan to move or not.

FredB4: Yours might be the most helpful insight. Qualifying for a mortgage is a strong motivator. Unfortunately, our understanding is that even programs like FHA require a minimum of only 30% funding in the reserve fund. We're at about 50% now. I wonder if you have any pointers on strict lenders or rejections based on a certain percentage?

I just have to wonder what are your dues levels currently?

How many units? And your total operating budget is ___________________.

Sounds like the plan many properties have used for decades. Cover the bare minimum and hope you don't ever need more.

Just how old is your property?

We were underfunded for years. The former President made that his claim to fame.

Common sense tells you as the property gets older your costs will rise and the money will come from somewhere.

1) issues with qualifying for lending from banks for new buyers

2) issues for those who might be refinancing

3) avoiding a large assessment in case of a major unforeseen expense

4) protecting the value of your investment by being financially healthy in the event you decide to sell

5) postponing necessary repairs which in the end increase your final costs

Our property is 30+ years old. When I took over as board president we held less than $30,000 in total assets.

Covering more than 130 condominium units on 16+ acres hardly enough to fund the necessary long term maintainable.

We now have nearly $500,000 in assets and have performed over $600,000 in none budgeted improvements. Above and beyond normal operating costs.

We have increased CCs one time in 6 years. This to fund an automatic transfer of 10% of our operating budget directly into a reserve account to satisfy the requirements of some local banks. That increase goes directly into our reserves.

Now most of our savings were not through increased CCs. We reviewed each and every cost eliminated or reduced them whenever possible and relied on savings rather than increased income.
Tough to judge without any actual numbers for comparison in your case.

As suggested, I would plan to implement the 10% increase in any event. Unless, someone is prepared to go door to door and solicite support that is your only option. Sometimes the board members need to act as the adults in the room. And whether it is popular or not act in the interest of the entire property and all the property owners. IF you and the board feel this strongly about a necessary increase than you sure have some work to do.

One last thought, the amount given in the RS is under optimum conditions with a tail wind. Many properties are not 100% funded in the amount of the called for reserves. We certainly were not. The process to catch up takes time. YEARS we are talking. You have taken the first steps in a good direction you had the study done, you know the ballpark needed, and now you plan to act to increase your reserves.

My most important suggestion don't only search for increased revenue but search high and low for savings and reducing costs. We were able to find quite a few that did not affect the operate of the property but rather made it more efficient.

One of our benefits to having increased reserves was income from investing those funds. When interest rates were 6% we were making several thousand per year from our reserves. Now recently we found a CD at 2% one reason I would hope interest rates rise at some point. = more income for the property.
Good luck sounds like you are heading in the right direction. Low cost in the long run will cost you more. Time and time again that proves to be true.

SheliaH: Yup, we are investigating whether our reserve specialist can attend our member meeting. He's an experienced voice of reason that can help homeowners understand that this is not just the board trying empty the pockets of the homeowners. Great idea about a banker/lender - I wonder how we might find someone who would be willing to come talk to a bunch of homeowners at an evening meeting.

FredS7: Yes, the problem with the gradual increase is that it persists the underfunded state longer. The goal is not just to avoid bankruptcy, the goal is to evenly spread costs over time. Paying less now just means paying more later.

JonD1: Great perspective, sounds like you were in a very similar position. Our current dues are $135 per month, which seem to be less than half of what comparable properties in the area charge. We have 50 units and the property is now over 30 years old. Operating budget is about $60K a year, which is primarily insurance, landscaping, and maintenance. We don't have any amenities (pool/clubhouse/etc.), we do maintain siding, roof, streets & sidewalks, and common green areas.

The list of reasons you outline is good fodder for our presentation to the members as well. I hadn't considered that banks will investigate the association finances during a homeowner refinance as well. Thanks for the helpful thoughts!

The 10% increase is a foregone conclusion. We were already anticipating a 10% increase each year for the next several years, just to be able to have a shot at covering the large upcoming expenses. But we didn't have a real plan - the board's methodology has been: 1) Focus on keeping dues low 2) Keep CURRENT costs low (even if that leads to higher expenses later) and 3) Try not to go bankrupt. For us to get on track will require an immediate injection of capital PLUS dues increases of about 50%.

We're also searching for ways to cut costs, although it's tough since the board has actually done a pretty good job keeping operating costs low. Some of our current/anticipated changes:
- re-bid our insurance policy. Our vendor hasn't changed in many years, and we don't actually know if we're getting a competitive rate or coverage.
- change from an hourly general accounting firm to a flat-rate accounting-only management firm who specializes in community associations.
- delay big expenses where feasible. We might not need to paint as imminently or as often as our reserve specialist suggests.
- take on some minor maintenance items (like touch up painting) ourselves, rather than punting everything to a handyman service.

But for the most part, these are savings on the order of a few thousand dollars a year. It's the looming costs that approach $1M within ten years that make me concerned about our future.

Gordon,

HOA homeowners should absolutely "pay as you go" for neighborhood amenities so that when the amenity needs replacing, it gets replaced without special assessment.

EXAMPLE: I live in your neighborhood and you install a pool with a 10-year life expectancy on the pool surface. The entire neighborhood HOA budget should set aside 1/10th of the cost of replacing that pool surface during the first year. In Year Six, I sell my home and move out but my responsible HOA has made sure my monthly payments have helped save 60% of the pool surface replacement. The new homeowner can then begin paying for remaining four years. There is no assessment, I've paid my share of pool usage, percentage-wise, as has the so-called "new resident."

REAL WORLD: HOA budget writers underfund Reserves to "keep dues low" but the next amenity replacement comes in ten years, at least.

In this case, the newish HOA board needs to ensure that they will have enough Reserve Funds to fully replace the amenity that "dies" in ten years....but you can watch that amenity and delay it a year IF the amenity can handle it without compromising the dues payers' use or enjoyment of the amenity.

With that baseline met, make sure you have enough funding the NEXT project that needs replacing, say in 11 to 13 years, in all cash with no assessment WHILE STILL POSSESSING AT LEAST enough cash equivalent to 10-20% of your normal operations budget.

If expenses are in check, then use dues increases - beginning with your 2016 budget - to fuel Reserves above those minimum standards on a slow but continuous basis with no deadline for necessarily reaching 100%.

The only way the HOA truly fails is to need a special assessment to cover an amenity that HOA leaders KNOW they'll be replacing on a schedule. The reason you want to save beyond the baseline amount is that the HOA will never be sure its amenities will last as long as the Reserve Study anticipates. Minimum savings can keep you on your Reserve schedule but unexpected, back-to-back Reserve projects will break you and require a special assessment.

My HOA is 36% funded by the most recent calculation but is in no danger of needed special assessment unless three or more major emergencies arise at the same time. My HOA had to raise dues on current members - and hold expenses - to run the operation and save for Reserve Funds due to incompetence (but not negligence). By the way, I don't foresee us reaching 100% funding before 2019 or 2020 and am fairly certainly we'll incur an expense that will prevent that from happening....but we will remain at minimal financial risk.

You will not avoid a special assessment from the HOA in your present state so you'll whistle by the graveyard for a years. Turn the ship slowly.

I've been there. And whistled as we paid down debt and prayed nothing broke down.

Gordon,

If I was in your situation I think I would make an offer to any and all owners who object to increasing reserves: "Please take my place on the board so that whenever the board members get sued for breach of their legally-required fiduciary duties you will be the defendant instead of me."

I was not suggesting that at all. The issue I saw was not whether to follow the recommendations of an expert but whether to fund reserves at all. From what Gordon wrote it appeared that his board has a history of failing to fund reserves at anything approaching a reasonable level.

I was, however, pointing out that as a board member Gordon has a legal obligation to the association that the couch-potatoes do not. If and when the lawsuits start to fly, board members may find that they have a personal liability for failing to fund the reserves.

Regardless how "minimal" it is possible to get away with deferring to legislated reserve "minimums", Directors are not doing any favours by postponing full adequacy or full sufficiency.

Once such is reached & maintained, there would be no need for anyone to moan about buying into past owners' underfunding. Until then as consumers get smarter, the market tends to quietly punish the sale prices of units lacking credibly adequate reserve funding. ( Below wasn't so quiet. * )

Maybe some Washington posters can jump in here. I notice that both Washington State's HOA law and Condo law respectively provide a matching immunity for Directors,officers and advisors for failures to ": Establish a reserve account; have a current reserve study prepared or updated in accordance with the requirements of this chapter; or make the reserve disclosures in accordance with this chapter." but NOT for failed adequate funding itself. ( HOA- RCW 64.38.085 condominiums - RCW 64.34.390 ).

No one in 40 years of condo law in our jurisdiction has been held liable for underfunding, much less even sued if unit sale prices are quietly being punished all the time.

What if the real punishment is a crisis with a large underfunded system or building envelop failure.

* A $15 M shocker hit a 275 unit multi-storey, 40 year old condo community here in Jan 2014 with only $200 K in the reserve fund. Imagine trying to sell . .

We have never had an outside reserve study done, but after looking at some good examples I put together a fairly involved spreadsheet last year modelled on them. Our official reserve numbers do not include a "percent fully funded" calculation, but my own unofficial spreadsheet says we are, this year, 145% fully funded. While that sounds really good there's a major flaw in it.

We probably have 3 or 4 common elements that we SHOULD be reserving for, but we're not. If we put those things in there then our FF numbers go pretty much straight into the toilet. Fencing around the pool and tennis courts, street lights, sidewalk and driveway replacement, and clubhouse HVAC are all potentially big reserve components and I haven't even considered those yet. Not to mention we spoke the other day about a bid the board got a few years ago to re-do our entire 22-year-old sprinkler system. Half a million so there's not any serious consideration being given to that except to deal with it piecemeal as it breaks down (and punches holes in the budget).

I'm re-doing last year's spreadsheet, but it's still a low-priority item for the moment. I will do two alternatives, one just like last year with updated figures and another with some of the necessary, to me at least, additional components. Fun times. Nobody is going to want to deal with it.

Like many other places, my feeling is that assessments here have been kept artificailly low for many years and eventually those chickens come home to roost.

Actually Kerry, there is case law that supports the notice that Board have a fiduciary duty to fund their reserves. Six months or so ago, I sat in on a webinar hosted by an attorney (guess who?) and a Reserve Specialist. The attorney, AA, stated that the Board could have an issue with not following the advice of the analyst who prepared the study and which the association contracted and paid for, BUT did not follow their recommendation.

My opinion, as the reserve summary is required in the Annual Disclosures, if the association does not follow the recommendation it should be explained, not only for the homeowners, but the lenders who get the documents via an escrow package.

If your community already has a corporate bank account, I'd start with that banker (this could be a good way to gauge how helpful they will be if they want to keep the association's business!) I've attended some CAI events which have had reps from banks who have departments who specialize in HOAs, so if you have a local chapter, that might be another source.

Since this would be an evening meeting, you may need to have the banker one night and the reserve specialist another evening if necessary. In addition to talking about reserves and how banks look at them, the banker could take it a step further and discuss HOA finances in general, talking about the nuts and bolts of HOA loans - and why it's better in the long run to reserve for future repairs.

Kerry,

I don't think realistically you can put a % number to where an association should be. Circumstances are all difference. High Rise condos, low rise condos, condo conversions, PUDs, townhomes. Small of association makes a big difference, the larger the association, generally, the better off financially they are. Small association have less bodies to spread the pain. Many directors don't want the responsibility of being the bearer of bad news. Earthquake insurance plays a big factor in this.

As far as the webinar, I need to find the presentation. In short A.A. stated that Boards were not fulfilling their fiduciary duties, IF they didn't heed the recommendations of the RS. As A.A. only represents HOA's and their Boards, he wouldn't be the one bringing charges against his bread and butter client.

As far as properties I was involved with were woefully underfunded, had to do special assessments, illegal mine you, and even though the reserve allocations were in their budgets, never contributed because the manager was too lazy to follow through. Hence, we parted company.

As far as the association I own a home in, well the RS from the same company has two different percentage year after year. Year ending 2013, 158% funded, 2014, 135%, but in looking at the actual study, a lot of inconsistencies.