Reserve Funding: Condo and HOA Unknowns

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Reserve Funding: Condo and HOA Unknowns

The benefits of a reserve study have been well documented and universally accepted. Reserve studies highlight the scope of predictable repair and replacement an association will face over a predefined period, providing not only a roadmap of anticipated costs but a clear plan as to how to navigate and prepare for them. However in spite of its acceptance as a good means of management and financial planning, a reserve study must also be understood for its inherent limitations.

Reserve Components

By definition, reserve components are items “whose infrequent and significant nature make them impractical to be included in the annual budget” (RCW 64.34.382).  Determination of what constitutes a reserve component is dependent on a number of factors.  Unless explicitly determined otherwise, a four-part test is generally used to distinguish a reserve expense from that of an operational or maintenance expense.

A reserve component will generally satisfy the following criteria:

  • The component is part of the Association’s common or limited common area responsibilities.
  • The component has a predictable useful service life.
  • The component’s useful life fits within the projection period (30 years).
  • The component’s cost for repair and replacement is too high to be included as part of the operating or maintenance budgets.

The above four part test should serve as a reminder to associations that not every aspect of a development is necessarily accounted for in a reserve study. Many reserve components, such as roofs, sidings and windows fit well within the framework above. However there are components of a property, some very long-lasting others not readily visible, that are generally not included in a reserve study. It is important that associations do not lose sight of these latter items, such as electrical or drainage systems. These “known unknowns” are items which still constitute part of the association’s common area responsibility, but are often omitted from the reserve study because of the difficulty in establishing their useful or remaining useful life.

Impact On Associations

This means of categorization of reserve and non-reserve components is both beneficial and prudent, as it does not unfairly burden an association with repair and replacement costs that may not eventuate. Many would agree that it makes little sense to reserve for a building component that has an unpredictable service life and cannot be accurately quantified.

Of course, such “life of the property” items sometimes begin to fail prematurely. In these instances, the reserve study framework can be a convenient tool that will allow for the inclusion of a schedule for replacement of such an item. This is especially helpful if the unexpected replacements must be phased in over time.  So in certain instances “known unknowns” can be quantified and, based upon competent investigation of conditions, a manageable replacement and repair schedule can be developed and incorporated into the regular reserve study framework.

Every Community is Unique

Every community is different by design. Each community has to deal with its own unique challenges and conditions. A reserve study has the flexibility to incorporate these unique needs and address the individual challenges faced by each community. In this context awareness of these “known unknowns” can be viewed simply as good governance.

Good governance requires associations to prepare for the future and in doing so they should be aware of the scope of a reserve study. They need to be aware of what elements of their common areas are addressed within the report. Understanding why certain items are included, and why others are not, is important. Associations need to recognize that in some circumstances the task of selecting reserve components needs, on occasion, to extend beyond the accepted framework. However this is more the exception than the rule.

Stuart Wilkinson, RS

Reserve Study Group – Seattle

Stuart Wilkinson can be reached at (888) 315-2843.
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The Team Approach to Community Association Management

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The Team Approach to Community Association Management

Before reading this article, I want you to grab a pen and paper and write down the top five to ten things that make you a successful manager.  What skills do you bring to the table that make you unique in your job?  I know, I know, it’s more paperwork, just trust me.

Now write down the top three things you want to work on. Maybe it’s time management, maybe it’s your organizational skills.

Now think of your colleagues, work partners, and staff. How many of them seem to possess the skills you seek to improve?  How often do you seek advice from them?

The point I am trying to convey is that we are not perfect. Where we come up short in one area, others may gracefully succeed.  In these times where managers are expected to be lawyers, architects, engineers, CPAs, and sometimes miracle workers, it is not always the wisest thing to go it alone, guns blazing.  Sometimes we need to pause and take into account the pure talent that you as a manager have at your fingertips.  You have your colleagues, your staff, your boss, and, if you trust it, maybe even your magic eight ball.

When a complex situation comes up, I know I can go to one of my colleagues for their thoughts.  Different personalities and experiences often dictate the answers I receive.  Are you an A-type personality?  Get the opinion of a B-type.  Are you a good cop?  Ask the bad cop for what they would do.  Oftentimes you will get an idea you would not have thought of on your own.  From there you can give your community an answer or a plan that suits (and hopefully benefits) them.

The Recipe for a Successful Team

A hint of humility, a dash of insight, and a cup of faith…

“A group in itself does not necessarily constitute a team. Teams normally have members with complementary skills and generate synergy through a coordinated effort which allows each member to maximize his/her strengths and minimize his/her weaknesses. Team members need to learn how to help one another, help other team members realize their true potential, and create an environment that allows everyone to go beyond their limitations.” (Davis, 2009)

Let’s dissect this description.

As stated earlier, the team needs to have complementary skills and synergy.  Where I may be good at handling and scheduling the aspects of a building-wide maintenance project, my team members may have ample communication skills available to assist with notifying the residents and coordinating with the vendors.  In utilizing their skills, I am able to provide the level of service expected by my communities.

In order to have a successful team, you need to also have open communication.  Everyone involved needs to be on the same page.  There is nothing worse than being partially responsible for a project and being left in the dark.  As stated in this description, team members need to help one another.  Open lines of communication are an integral part of that.  The best way to do this is to hold regular meetings with your team members to bring everyone up to speed.

Another integral part is a) being able to admit when you need help; and b) knowing when someone else needs help.  As Community Association Managers, we are often expected to have a dense backbone, backed up by thick skin and an uber-A-type personality.  This presents a huge obstacle when it comes time to ask for help.  Pride can easily become a factor, and that pill can be hard to swallow.  If you do manage to keep it down and seek help, you will find that it can take a huge weight off of your shoulders.  Delegating tasks to a willing and capable team member can be a beautiful thing.  Just make sure to return the favor.  Be sure to say thank you.  And smile.

Finally, you need to be able to tell when someone needs help.  Sometimes all it takes is the gesture of asking to get them back on their feet.  If someone knows they can rely on you in their time of need, that refreshing energy gives them the strength to press on and ultimately succeed.

Avoiding Dysfunction

As stated earlier, human beings are not perfect.  Not all of us are meant to work together in peace and harmony.  However, that does not mean we cannot avoid conflict.  There are signs to look out for when choosing your team members.  One of the questions I ask is “would I get along with this person outside of the office?”  The answer, for the most part, is “yes.”

If you are of a more detail-oriented mind, there are five things to really look out for.

According to Patrick Lencioni’s book, The Five Dysfunctions of a Team, these are:

  • The Absence of Trust
  • Fear of Conflict
  • Lack of Commitment
  • Avoidance of Accountability
  • Inattention to Results

Some of these speak for themselves.  If you don’t trust the person, don’t work with them.  If they are not committed to the team effort, then there is a lesser likelihood of success.  Some of these are fairly ambiguous.  Fear of conflict pertains to going along with the team’s flow, even if you disagree with the team’s path.  If you feel things should be done differently, speak up.  Make your voice heard.  Even if your ideas are shot down, you may gain a better understanding as to why the rest of your team is heading down that particular path.  Avoidance of accountability also sets the stage for failure.  If the plan goes awry, don’t point fingers.  Remember, it is a team effort.  Instead, focus on how to make things right.  The idea of inattention to results brings to mind the famous business fable, The Stag Hunt.  In this fable, a group of hunters are tracking a stag and must work together to capture the beast.  If they are able to work together, they will conquer the animal and all will eat.  However, the hunt is not guaranteed to succeed and could take days.  The hunters also have the option of individually hunting a hare, which makes itself present and available for the taking.  The chance for success is greater, but also not guaranteed.  The hare can also only feed one as opposed to the group.  If one of them breaks off and hunts the hare, the stag will scare and the rest of the hunters will go hungry.  In summation, this idea is about the problem of going for personal success before team success.

These can all be huge detriments to the team dynamic, so be on the lookout.

In Summary

With everything taken into account, having a strong team of willing and experienced individuals backing you up can help you and your communities succeed. Their combined experiences and personalities offer a unique perspective into almost any problem that may arise.  Just be sure to avoid the potential dysfunctions that may come up.

The most important take away from this: You are not alone.

Citations:

Davis, Barbee. 97 Things Every Project Manager Should Know: Collective Wisdom from the Experts. Beijing: O’Reilly, 2009. Print.

By Mike Hilfer CMCA, AMS

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Bad Debt – Planning for Uncollected Assessments

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Bad Debt – Planning for Uncollected Assessments

Introduction:

For the past 35 years, Lake Superior State University publishes a list of “banished” words and phrases.  The annual list includes words and phrases that are misused, over-used, and generally useless.  The 2010 list includes such gems as “sexting”, “tweet”, “app”, and “too big to fail”.  Also included on the 2010 list is probably the most overused phrase in recent memory:  “In these economic times”.  It’s everywhere.  So in writing this article about budgeting for bad debt, I decided to see I could write it without using the banished phrase.  Why, you ask?  Because budgeting for bad debt is something that associations should consider doing even in the best of times, and saying that associations need only budget for bad debt in a down economy would be as shortsighted as… well, not budgeting for bad debt.

One of the things I let collection clients know right off the bat is that they are not alone.  According to RealtyTrac, 20,960, or 1/33 of all homes in Washington have received a foreclosure notice during the first six months of 2010 (this does not include properties that are already bank-owned).  Considering that associations make up approximately 25% of the total housing market, this means that over 5,200 association lots/units in Washington are subject to bank foreclosure.  If homeowners are having that much difficulty paying their mortgage, it follows that association assessments are going unpaid.  If your association does not have any delinquencies, consider yourself fortunate, but don’t stop reading.  Budgeting for bad debt may increase the amount owners pay each month in the short term, but in the long term helps alleviate the need for special assessments, which can cripple or destroy the finances of the owners and families that make up our communities.

Why Budget for Bad Debt

Except for a few common denominators like insurance, taxes, and utilities, different associations spend their money on different items for maintenance, services, and the like.  Unless an association has an external revenue stream such as rental income, all of the money that an association uses to pay its expenses comes from the assessment payments from the members that make up the association.  If even one association member’s assessments go unpaid or short-paid, anticipated projects cannot be carried out, the association may have to withdraw from its reserves to pay for operating expenses, and eventually the membership is required to pay special assessments to make up for the loss in revenue.  Condominiums in Washington are “encouraged” to establish a reserve account to fund major maintenance, repair, and replacement of the common elements.  Associations that are not meeting their operating budgets are likely not funding their reserve accounts.  Further, if a condominium association withdraws from its established reserve fund, the Washington Condominium Act requires that the association notify its members in writing and replace the money in the reserve fund within twenty-four months unless replacing the funds would be an unreasonable burden on the owners.  How will an association raise the money to pay back the reserve fund?  By levying a special assessment.

Let’s assume a ten-unit condominium association assesses its units an average of $400.00 per month and has an annual budget of $48,000.00.  In Month 1 the owners of one unit run into financial difficulty and stop paying their assessments and mortgage.  At around Month 6, the bank will start foreclosure, and the trustee’s sale will take place sometime between Month 10 and Month 14.  After the trustee’s sale, the unit could sit vacant and on the market for another six months or more.  If the association was formed under the Washington Condominium Act, or if formed under the Horizontal Property Regimes Act and has amended its declaration to provide for lien priority over foreclosing deeds of trust, the association can recover the assessments that became due in the six months before the trustee’s sale from the purchaser.  Assuming someone buys the unit from the bank in Month 20, the bank will pay the association the assessments during the six months before the foreclosure and the assessments through the date the new owner takes title (Months 9-14 plus Months 15-20).  In this scenario, the association suffered a ten percent reduction in revenue for twenty months, only to recover 55% of the total amount owed by that unit.  If the association decides against suing the former unit owners and collecting on a judgment, or if the former unit owners file bankruptcy after the foreclosure, that is all the association will ever get.  The remaining 45% of the unit’s share of the common expenses spread out among the remaining nine units is $400.00 per unit.  Had the association a bad debt contingency of 7.5% of the total budget, the monthly assessments for the units would average $430.00 per month, but the members would not have had to come up with an additional $400.00 per unit on short notice so that the association can pay its electricity bill.

Another important situation where budgeting for bad debt comes up is when there are insufficient funds in reserves and an association takes out a loan from a lender to fund a maintenance project or capital improvement.  An association needs to levy a special assessment to pay back the lender, and will typically allow the owners to either make a lump sum payment of the full special assessment, or pay over the period where the association repays the lender the balance of the loan plus interest.  A bad debt contingency should be included when the association determines the amount of the special assessment.  In these cases, an association should get input from its owners to determine who can afford the special assessment and remain in the property.  If owners are already underwater on their property they may decide to walk away, so the Association will need to make sure that it generates enough income during the life of the bank loan in order to maintain the monthly payments to the lender during the time where one or more unit’s assessments are going unpaid.

How to Budget for Bad Debt

Because all communities are different, there is no set amount or percentage that an association should budget for bad debt.  Instead, an association should consider the following factors when deciding on what amount to budget for bad debt:

  1.  The total amount needed to pay for the operating expenses and fund the reserve the account.  In adopting a budget, associations need to consider how much it will cost to pay the operating expenses and fund a reserve account, plus account for bad debt, and then work backwards to determine each unit’s assessment liability, rather than starting with an “acceptable” amount per unit.
  2. The percentage of delinquent units.  Communities with a high percentage of delinquent units should budget a greater amount for bad debt.
  3. The delinquent amount per unit.  The higher the delinquent amount per unit, the less likely it is for the association to recover its expenses.
  4. The amount that can reasonably be collected from the owners.  Associations should consult their attorney to determine the feasibility of collecting delinquent assessments from owners.

Should an association have questions about budgeting for bad debt, it should consult its attorney, CPA, or manager when configuring its budget.  A properly adopted budget that includes a line item for bad debt will protect an association and its members from special assessments that can lead to financial difficulty for an association’s members, and ultimately the association itself.

By William Justyk

Associate Attorney at the Law Offices of James L. Strichartz

William Justyk is an Associate Attorney at the Law Offices of James L. Strichartz.  His practice is concentrated on counseling and litigation with respect to assessments and collection, covenant enforcement, and other association matters.  William can be reached at 206-388-0600 or william@condo-lawyers.com
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Start Community Association budgets early and enjoy the holidays

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Start Community Association budgets early and enjoy the holidays

Believe it or not, it’s already mid July and time to start budget preparations.  Most associations are “multi-million dollar non-profit corporations.”  This means that the board of directors of an association is often running a small to midsize business.  Like other businesses, Homeowner Associations and Condominium Associations need to prepare their annual budget for the following year.

Gather Requirements. Get out those governing documents and review the budget requirements.  Is there a maximum assessment increase?  Who approves the budget?  Is a meeting required?  Many communities have requirements in their governing documents that specify the budget be adopted 30-60 days before the end of the fiscal year.  Draft a timeline to ensure the notice requirements are met.  Avoid late November and December budget confirmation meetings so volunteer leaders can enjoy the holidays. Starting early gives the committee and/or board members time to prepare a thoughtful and comprehensive budget for the community and can reduce the workload.

Anticipate Changes. Utility costs typically increase every year.  Contract services are also subject to increases. Call your service providers to check if there will be an increase in the coming year.  Determine your goals for next year and review your projects so that funding is included in the budget.  Solicit input from committees and owners on their priorities for the community.  Communication during the budget process is essential.  This is especially important if you are considering a rate increase.

Review Current Year. July is also an ideal time to review the expenses for the first half of the current year to see how the community is tracking to the current budget.  Identify needed adjustments for the rest of the year.  Complete the income and expense estimates for the balance of the year so that any surplus or deficit can be included in next year’s budget.

Checklist for July

  • Form Budget Committee
  • Review Reserve Study updates
  • Determine annual reserve contribution
  •  Identify goals/projects for next year
  • Solicit budget requests from committees
  • Submit budget requirements to Manager
  • Solicit bid estimates for projects, contract increases, utility increases, etc.

By Trestle Community Management

Trestle Community Management is a full-service manager of condominium and homeowner associations with headquarters in downtown Redmond, WA. Trestle’s serves associations in Redmond, Kirkland, Bellevue and other nearby communities.
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