Unit Owner Budget

I’ll be looking at the Association budget in the near future. However, to get a better grasp of the budgetary issues facing our Board of Managers, I thought it might be useful to develop a similar budget for a typical unit owner. This will provide some possibly useful information for the Unit Owner and will also reveal some aspects of the budgeting process in use by our Association. I’ll use a “B” unit in my example, which has an additional window, two baths and three bedrooms. There are a few notes at the end of this post.

It is my understanding that the correct method of budgeting is to determine the necessary expenditures and then levy the amount of fees and assessments. To do so the Board of Managers must prioritize the needs of the Association and maintain the assessments at an appropriate amount.

A unit owner personal budget can be developed in parallel to the one used by our association. Such a budget would have four components:

1. Establish a budget for day to day operational expenses.
2. Develop and save a for a Reserve budget for future maintenance and replacement needs.
3. Develop and save for an Emergency budget for unforeseen or unpredictable items.
4. Re-evaluate each of the previous three annually and adjust each budget accordingly.

Each of our Board of Managers should have the capacity to understand the concepts outlined above. If they do not, it is impossible for them to honor or to complete their fiduciary responsibilities.

Unit owners may not have such capacity nor are they required to. A Unit Owner can choose not to save, and purchase appliances or whatever on his or her credit card. That is a personal choice. However, the point made here is that the Association does not have that choice. The Board of Managers are required under law to develop reserve budgets and plans which include and satisfy all of the components described above.

Our Board of Managers is required to satisfy the four above requirements and more. Unit Owners sometimes forget that and attempt to sway the board into foregoing reserves for discretionary items, or divert fees to personal causes or for personal interests, or reduce fees to alleviate the financial pressure on the individual. That is one of the reasons why each member of our Board of Managers is prohibited under law and civil penalty from favoring individuals or groups. Extreme behavior can be rewarded with fines or jail time. There are laws that govern the operation of the Association, but we must be diligent and fully support the Board of Managers in fulfilling its fiduciary duties.

Day to day operational expenses.
In prioritizing expenses, the day to day or "Operational Expenses" come first. These are required expenses for the operation of the Association. For a unit owner, such expenses would include non-discretionary expenses such as:

1. Real Estate taxes.
2. Association fees.
3. Basic transportation (excludes performance or luxury vehicles e.g. BMW, Buick, Cadillac, Hummer, Land Rover, Lexus or Volvo, etc., etc. !).
4. Insurance for basic transportation.
5. Gasoline and annual maintenance for basic transportation.
6. Natural Gas for heating, cooking and hot water.
7. Electricity for lighting, the operation of the furnace and air conditioning system, and appliances.
8. Insurance as required for a Unit Owner.
9. Basic groceries.
10. Basic clothing.
11. Basic communications, either land line telephone or cell phone.
12. Postage and stationery.
13. Basic electronics and appliances.
14. Health Insurance.

All other expenses could be considered to be discretionary or elective, and therefor optional. Why is that? After meeting basic service needs, any remaining funds should then be allocated to growing reserves and growing or maintaining an emergency fund. Only after meeting the savings targets for base expenses (operating expenses for our Association) and Reserves (future maintenance or replacement costs and emergency funds) should any funds be spent on "discretionary" or unbudgeted items.

For the Unit Owner, such additional discretionary expenses may include better cable TV, a vacation home, a better car, large screen TV, other major electronics or appliances, appliance upgrades, HBO/ESPN to the max, vacations, etc. However, such expenses should come after the first three budget groups; Basic, Reserves, Emergency.

Personal budgets have some aspects for which the Association does not. For example, each person who is employed may save a portion of their savings in a Roth IRA retirement account. This is beyond any company pension, 401K or SEP IRA. However, while such a savings program is entirely voluntary for individuals it is nonetheless recommended by many financial planners and probably should be included in base personal expenses. According to the 2009 Retirement Confidence Survey, 25% of workers have no retirement savings and 53% report savings or retirement investments of less than $25,000, excluding their home or employer pensions. Funding for one's retirement might be a fourth budget group for a Unit Owner.

So the modified budget for a Unit Owner, modelled after the one for our Association would include:

1. Basic or Operational Expenses.
2. Reserves Budget.
3. Emergency Budget.
4. Retirement Budget.

Sources of Revenue or Income

The basic source of income for the Association is the fees and assessments paid by Unit Owners. The Association will continue to collect fees from unit owners as long as it is in existence. Unit owners, on the other hand must plan on meeting those fees and other expenses from wages while working and after retirement from other sources of income. Obviously, the unit owner must also plan an income stream sufficient to meet his or her needs in retirement. If not, then discretionary items must be eliminated followed by core items such as an automobile.

To Spend or Save?
Spending for discretionary items or saving for reserves is a choice facing the Association and each unit owner. The Board of Managers has a fiduciary duty to develop viable budgets, set the fees necessary and collect the money required by those budgets, and also control spending on day to day or “discretionary” items. A viable Unit Owner budget would do the same.

The Association can choose to improve or expand services, add park benches, expanded and glossy newsletters, web sites, purchase special insurance and fees for block parties and so on. However, in so doing the association has these choices:

1. Increase the fees collected.


2. Divert funds from the reserves.


3. Reduce services.

Reserves cannot be legally mis-allocated or depleted. So the Board of Managers has two legal choices:

1. Increase association fees.


2. Reduce services.

Unit owners face a similar dilemma in their personal budgets. However I, for example, am somewhat limited in my ability to raise fees. My personal choices are:

1. Earn more from my current job or work two jobs and increase my revenue.


2. Divert money from my “reserves” and spend the funds I should be saving for my retirement, for my “emergency fund” or for replacement of the elements in my unit for which I am responsible. This option is not available to the Association.


3. Reduce my discretionary spending. For example, keep my car long after it is paid for, or when I must replace it do so with a cheaper and more fuel efficient car, go to basic cable or no high speed Internet, do less dining at restaurants, take no or cheaper vacations, do no spending on big ticket electronics, purchase fewer clothes, etc., etc.

I have the ability to mortgage my future to live well, or better, today. That is not a choice for the Association. Nor can the Association assist me if I make poor decisions or should circumstances align against me. The Board of Managers are prohibited from acting on my behalf.

Unit Owner Reserves:
Internal maintenance of my unit or of the elements for which I am responsible, can be a financial “surprise” to a unit owner. I suggest that unit owners learn from the financial operation of the Association and build a “reserve” fund for repair or replacement of windows, furnace and air conditioner, hot water heater and major appliances, etc.

Here is an estimate of the expected life span of various elements I am responsible for in my unit. Each unit owner could have a replacement fund, which I’ll call a “reserve” fund for these. This is exactly the same approach the Association uses for planning for replacement of roofs, sidewalks, streets, street lighting and so on.

The Association is currently reviewing the reserves and conducting a reserve study. One of the purposes is to determine if the Association has a savings program in place which is adequate to address aging infrastructure. Emergency funds are described as funds required by unforeseen circumstances. However, a lack of planning is not an emergency. The goal is to develop a viable plan which can then be budgeted.

I would probably review my personal “reserve study” every few years. The purpose is to re-assess the condition of the elements for which I am responsible and to determine the current cost of these elements. Our Board of Managers is required to use historical data when making a budget. So should I when preparing my own budget.

The unit owner is also wise to consider an “emergency fund”. Emergency budgeting for a unit owner is a difficult thing to determine. However, many financial planners recommend at least 6 months wages, after taxes, be set aside for use in personal financial emergencies which could be considered as medical, loss of job, legal, property destruction, etc. For a median income family here in the U.S., such a fund would be about $25,000 using median annual income figures for the state of Illinois and deducting 20% for federal, state, social security and Medicare taxes normally with-held from wages. To go further into the need or adequacy of such a plan would require financial data specific to each unit owner’s circumstance.

Personal Reserves, excluding an Emergency Fund
Such a reserve or saving program would include a survey of the elements which are the responsibility of the Unit Owner. Here is a possible list, and this list is somewhat unrealistic. It assumes a new unit with all new appliances and appointments, and then begins aging the unit and its contents. An individual plan would require determining the age of each of the components in the unit and estimating their condition and remaining life span. From that I could then determine how much to save.

For example, when I purchased my unit it included an aging stove and refrigerator. I replaced those within a year of moving in. The refrigerator was not a choice. The stove was in poor shape, but could have made it for a year or two. However, it was an electric unit and I wanted a natural gas unit; so it was quickly replaced. Approximately 5 years later I replaced the hot water heater which was showing signs of stress and imminent failure. At about 6 years, the air conditioning compressor failed. I was fortunate that I had the remainder of the warranty for the unit installed by the previous owner. My pro-rated costs with labor were “only” $900. It is possible that I will replace the furnace in less than 10 years and before its maximum rated life.

Here is a list of replacement costs. Each item has the expected life expectancy per “experts”. In many cases this is a range in years because exact dates are the result of use and abuse, unusual wear, quality of the item and for windows and doors, the weather:

1. Aluminum Windows 15 to 20 years. I have 5 windows estimate $500 each and one patio door estimate $1500. Installation estimate $500. Total $4500. Amount to save each year =$4500/15 years = $300. (Rough estimate; see Notes).
2. Garage door 20 to 25 years. Installation estimate $500. Amount to save each year = $25.
3. Hot water heater 10 to 14 years. Price installed = $400. Amount to save each year = $400/10 years = $40.
4. Washer and Dryer 10 to 15 years. Price for mid-range dual units = $1,500. Amount to save each year = $1500/10 years = $150.
5. Furnace 15 to 20 years. Price for natural gas, mid-tier unit $5,000. Amount to save each year = $5000/ 15 years = $333.
6. Gas Range 15 years. Price for mid-tier unit $800. Amount to save each year = $800/15 years = $54.
7. Refrigerator 13 years. Price for 21 cu. ft. mid-tier unit = $1,000. Amount to save each year = $1000/ 13 years = $77.00.
8. Dishwasher 9 years. Mid Tier unit = $700. Amount to be saved each year = $700/9 years = $78.00.
9. Faucets 15 years. Replacement by plumber, mid-tier unit = $200 each or $600 for two baths and kitchen. Amount to save each year = $40.
10. Shower faucets 20 years. Replacement by plumber and removal and re-installation of tile = $400 each or $800 for two baths. Amount to save each year = $800/20 years = $40.
11. Carpeting 10 years. Prices vary with quality and total square footage. Estimate $25 per square yard for four rooms totaling 75 yards = $1,875. Amount to save each year = $188.
12. Garage Door Openers 15 to 20 years. Price installed $250. Amount to save each year = $250/15 years = $17 per year.

Summing the annual amounts above determines the total required to be saved each year by a Unit Owner as “reserves” for the replacement of the items. Using the lower lifetime for each item yields a sum of $1,342. I could use the higher, but that belongs to the "Dirty Harry" school of budgeting, where, as in the movie, the question to be asked is "Do I feel lucky"?

However, there is one complicating factor and that is inflation. The purchasing power of the dollar diminishes over time. The older I became, the more aware of this I became. My first car was an Opel and it cost me $1,800 driven out the door of the dealer including all taxes, title, etc. Today such a car would cost about $18,000.

So that needs to be taken into consideration when saving for long periods of time. Planners and economists tell me that long term inflation is usually in the range of 3.5 to 4.5%. For some years it is lower and for others higher. So for simplicity, let’s assume that long term inflation is 4.0%. My saving for reserves must include an additional amount to compensate for the higher future cost of everything.

My actual saving should be increased by 4.0% per year. For example, in year two, my savings would be $1,342 plus an additional 4% of $1,342. The total amount to be saved in year two is $1,342 + $53.68 = $1,395.68.

The saving for year three would be increased by 4% over the amount saved in year two. In year three I would save $1,395.68 plus an additional 4% of $1,395.68. The total amount saved in year three is $1,395.68 + $55.83 = $1,451.51. And so on for years Four through 25.

Here is a brief spreadsheet:
























The column "Accumulated Savings" indicates how much has been saved since beginning in Year 1. Of course, if this were a true savings account, the actual amount in the account would fall as I spent funds to replace items according to the budget. For example, sometime between year 10 and 15 I probably would have replaced my clothes washer and dryer. That would have depleted some of the funds in the account and lowered the amount saved.

Is this plan realistic? Will my anticipated or planned costs meet the actual costs of these elements in 15 or 25 year? Probably not. It is necessary to assess the actual cost of replacement of the elements with the amount of reserves I have accumulated for that purpose at any specific point in time. That is what our Association does from time to time. The Board and Managers and our professional managers review the amounts saved for each item in the “reserves” to the current actual cost to replace that item. Savings to each reserve item can thereby be adjusted.

In September of 1998 the total reserves for BLMH was $86,321. Subsequent review revealed this was inadequate for th ecommon elements including 44 roofs, streets and so on. That is why the Board of Managers began adjusting the fees collected. They were honoring their fiduciary duties and acting responsibly. I can’t say why the reserves were what they were. The professional manager, whose responsibility it was at that time to guide our Board of Managers, is no longer with us. Our current profession management came on board in 1999 or so and our fees began increasing shortly thereafter.

The Board of Managers increased the Association fees to increase the amounts directed into the Reserve account. In my personal plan, I might have to do the same. For example, when I purchased my unit, the windows were about 22 years old. They have already exceeded their anticipated life and to achieve the funds necessary to replace the windows in the near future will require I increase the amount saved each year to make up for that shortfall in funds. If I save an additional $500 each year for windows, I should have enough to do the job in 8 years or so. To save additional amounts, I'll have to reduce discretionary spending or increase revenue. Of course if the windows fail in three years, I may have insufficient funds to do the work. As an individual I may have the ability to borrow funds and go into debt. Our Association does not have the option of using a "credit card" and so it must save. Financing is a possibility, if it is available. However, boards must exercise caution because fees would increase to service the debt. Reserve funding must continue and cannot be diverted to "servicing the debt". As a Unit Owner, I can escape from under the yoke by selling my unit and renting. The Association has no such escape clause. Any and all debts pass to the Unit Owners and must be serviced by the fees collected.

The result of a “personal” Unit Owner Reserve Study:
On viewing this, you might be shocked by the amount shown to be necessary over a period of 25 years. The amount of “Accumulated Savings” is the total amount saved over that period of time. From the perspective that 25 years is 300 months, the projected amount to be saved and spent on replacing the “elements” for which I am responsible, is an average of $186.30 per month.

What the chart above indicates is how these small sums can accumulate over long spans of time. To look at it another way, if I live at BLMH for 25 years I may have to spend $58,000 on appliances, an air conditioner and furnace, windows, two stoves, two hot water heaters, etc.
Of course, I may choose to attempt to use the same stove for 25 years. There are choices and lifestyle tradeoffs. It may also be that inflation will only be about 3% for the next 25 years. Should that be the case, I would only need $48,928.33 to accomplish the same. Inflation at 5% per year would require $64,049.77. So lower inflation is my friend.

Unfortunately, I’ll have to pay whatever the going rate is for the appliances and windows at the time I replace them. I can choose a lower tier product such as the cheapest possible dishwasher when the one I am using requires replacement in 2033. But I can’t predict what that will cost in the year 2033, so for now I must use inflation and current costs.

So it is with our Board of Managers and our professional managers who, hopefully are diligently attempting to guide this Association to an uncertain future!

A well run Association will always be balancing the requirements of staying the course, with the requests of unit owners to expand the programs or change the course. Some of the demands placed on the Association are mutually exclusive and contradictory and cannot be readily achieved. So it is with our personal endeavors.

I would like to make one final observation. The amount I should save to maintain the elements for which I am responsible is $111.42 each month in 2009. The association is required to paint, repair, replace, maintain, snowplow, mow, provide street lighting, clean the common elements, provide insurance hire a professional manager, provide service, etc. etc. etc.! So when I am inclined to think my assessments are "high" I think it is useful to remember that my personal budget, which excludes the exterior and common elements, is about 33% of the budget I'm allocating to the association so that it can do its work. Sounds like a bargain.

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Notes:

1. This is an example. It would be prudent for each Unit Owner to prepare a similar budget for their own use. The Unit Owner budgeting technique described above will be familiar to people who practice the technique called LBYM. That acronym means Living Below Your Means.
2. I have used the cost of "mid tier" furnace and appliances in preparing this example. These are generally mid price and moderately energy efficient. If you want "only the best" then your prices could be at least 50% higher than what I have here. You should therefore plan a budget accordingly.
3. I am using a dollar figure for windows which was mentioned to me last year. I cannot say that it is accurate and I should get an estimate and update my personal numbers.
4. Inflation may be higher or lower than what I have used here. Any plan should be re-evaluated periodically to verify that the prices being used are realistic. If not, then the plan should be adjusted to correct the amount saved. However, from time to time we go through periods of unusually low or high inflation. We are currently in a period of very low inflation and many prices are unusually low. I caution the reader that such periods are often followed by higher inflation. It would be unwise to understate the amount to be saved.
5. Day to day or "Operational Expenses" also vary with inflation. It is prudent for the Unit Owner to plan on annual increases to the cost of fuel and energy. Food too, will vary from year to year. The U.S. government provides "CPI" data each year. Annual Social Security increases, determined in the fall of each year, are useful for anticipating the cost increases to basic consumer items. These predictive indicators are not perfect and are sometimes inaccurate, but they are useful.
6. I do not include a "contingency fund". This is an amount budgeted to cover possible shortfalls or unexpected price increases. Such a fund is an expression of the Associations committment to get the job done on time, even if there be modest price changes. If you have a driveway that is disintegrating, you probably want that repaired or replaced, rather than waiting another year because the price of asphalt is high this year due to high oil prices, and the Association had no contingency amount in its budget. "Contingency" amounts vary but are typically 10% or so. If I were conservative in building my personal budget, I might include such a contingency.
7. When constructing a personal budget, there are lifestyle choices to be made. For example, automobile prices and features vary greatly. For the purpose of this budget I consider a "basic" vehicle as being a sedan that seats 3 to 5. According to Kelly Blue Book there are about 20 such new vehicles priced under $20,000. Of course, you may choose a Kia Forte at $15,430 plus tax, title and delivery. Donald Trump would probably choose a Bentley!
8. If you have a personal bias against having a budget of the type described in this post, you probably are not a good candidate for a position on our Board of Managers. I suggest that because it is difficult to leave a personal agenda at the door when putting on our "Manager" hats. Of course, many people operate differently in their professional, work environment than they do in their personal environment. However, if I do not believe in budgeting, saving for the future, seperating essential costs from discretionary expenses, etc. then it might be difficult for me to do so with the Association funds.
9. I have heard our reserves described as "deep pockets" which alludes to the seemingly large amounts in those reserves. They are not available at the discretion of individual board members. They are Association savings and belong to the Association and have a specific purpose as defined in the published budgets. This excludes "emergency" expenditures which pose an "immediate danger to the structural integrity of the common elements or to the life, health, safety, or property of the unit owners".