HOA Financial Challenges 2013

A recent post delved into the challenges facing HOAs in 2013. Financial challenges are worthy of this separate post.

Finances and maintenance including long term capital projects are probably the two most important tasks facing boards. The operating budget, capital projects, maintenance, reserves and fees are all interlinked.

Our board attempts to balance the spending, saving (for reserves) and fee levels while keeping a long term perspective. We attempt to create an annual budget that realistically depicts the Operating and Maintenance costs for the coming year. We take into account anticipated changes including utility increases, contractor costs and new contracts, insurance fees, etc. We also look at what unusual and one-time maintenance may occur in the next year; for example, specific tree removal as occurred with the willows on Gloucester. We also plug-in annual reserve updates, which we generate. However, I don't recommend avoiding professionally prepared reserve updates and suggest doing so every five years.

Budgeting is a continuous process and so we are today collecting information on possible 2014 increases or decreases to our costs so that when the October "Budget Workshop" arrives, the board in place at that time will have information available to assist making a realistic budget.

Our budgeting really does attempt to "keep fees as low as possible" while avoiding special assessments, nasty surprises, or creating imbalances that could punish future owners because of short-falls, or reward future owners because of over collections.

It is a balancing act and our budgets are "tight." That's one of the reasons we currently fund a relatively small "contingency" account each year. It's based on recent history of water main breaks, fire hydrant failures, and so on.

Step Changes Do Sometimes Occur
As I stated in that earlier post "Our board has faced many challenges in recent years. A terrible economy, an aging infrastructure, the need to accumulate reserves (via higher fees), some unhappy owners, battling agendas, issues with a neighboring college, disastrous fire at a nearby association that ensnared us, board issues, delinquencies, foreclosures, and so on."

It's my understanding that our earlier boards didn't have to deal with delinquencies of any consequence, or foreclosures. That changed after 2006. It may have caught some boards by surprise. Setting fees and collecting fees are two different matters, as many associations have discovered!

As I have stated in other posts, there is nothing better than a chart to get the point across. As an owner, I had begun a spread sheet looking back to 2006 using the newsletter information and published financials. This was so I could trend the changes to determine the financial consequences of the recession. Once on the board, I could monitor this on a monthly basis. When a new treasurer came to the board it provided an opportunity.  I broached the subject and my concerns about some aspects of our finances. Together we did the digging and developed a spreadsheet to track delinquencies and differentiate trivial amounts from more serious ones. For example, it's not unusual to have a small dollar amount listed on the delinquency report. By small I mean $0.08! These are best ignored for determining statistics and trends, although the board is aware of the status of each owner's account. That spreadsheet is updated each month and is presented as part of the treasurer's report during each association meeting.

It's my opinion that a watchful board will always have concerns. We've taken some positive steps. I assert that the quality of information is essential for making quality decisions.

Financial Challenges Include Both Obvious and Subtle
We're all aware of the low interest rates on our savings accounts. This is one of the subtle ways in which associations which have reserves have been punished by government policies. All HOAs should have adequate reserves and ours is no exception. Because most of this money will be spent on large. property wide projects at BLMH in the near future, it's a necessity to keep the funds somewhat liquid and also as safe as possible. Note: In 2013, we will have reached 60% completion levels on major projects including roofs and driveways, and should complete an additional 15% each year, thereafter.

A few years ago, we could expect 5% via safe CDs. Not today. Of course, inflation is supposedly low, but our association doesn't directly benefit from a low CPI. At some point in the future, inflation should return to historical norms and when it does, or the price of energy spikes, the cost of a lot of the materials that HOAs use in various capital projects will also rise. However, for the moment, inflation is tame and because of the recession many contractors have held the line on prices.

This should not continue forever,and so, an important question to ask is "How will our financial plans prepare for this?"

Possible Concerns About Inflation
When inflation and/or energy does rise, it will influence the cost of many materials. Cement manufacturing is an energy intensive process. Asphalt for streets and driveways uses refinery byproducts. So too for asphalt based shingles and driveway sealcoating.

Here at BLMH we've been keeping a wary eye on both the economy and the prices of materials.

Associations that are waiting for the economy to improve so they can proceed with their projects might get a nasty surprise as demand and prices increase. Those medium term and long term budgets assume specific price increases, usually somewhere between 2.0% and 3.0% annually. Those reserve budgets also assume a certain interest will be returned on those reserve balances.

Low interest on reserve balances and replacement costs higher than the current annual increases can stress the budgets. Our board is walking the tightrope between the current reality, and future possibilities.

My crystal ball doesn't work very well. So I use a range of future possibilities, so I can judge the impact and possible responses. I also evaluate and update the reserve spreadsheets each year. This includes current costs, possible changes to future replacement costs, and project timelines.

Driving While Looking in the Rear View Mirror
If we use "last year's budget" and an old reserve study that is not updated annually, then we are figuratively speaking, driving with the rear view mirror as our guide. Any association that operates that way expects that next year will be exactly like the year that preceded it. The future does not mirror the past. Step changes do occur. Furthermore, errors can accumulate, creating serious discrepancies. Any association which has fallen behind in its reserve collections, and continued to do so for 5, 10 or more years, knows precisely what I mean.

In other words, sometimes we may do our finances as if the road ahead is exactly as the one behind us, which we can see in that 'rear view mirror.'

When a curve occurs, or there are potholes or stop signs we may simply drive straight ahead, into the ditch or we may experience "an accident."

The Price of Failure
There are four possible outcomes to this year's budget. The first is unlikely if the board does a credible job:

• Expenditures lag the budget by a wide margin; in other words, we overbudget.
• Expenditures are closely aligned with the budget
• Shortfalls this year
• Shortfalls in the future via underfunded reserves.

The consequences of failure include:

• Significant fee increases next year and years thereafter
• Borrowing from reserves, to be paid via higher future fees
• Special assessments.

Certainly, we should strive for an outcome where the expenditures meet the plan. Of course, if we are under budget in November, that is not a reason to spend money.

Budget Hazards
There are a lot of ways to slip in a budget, even one which is a good one. Here are several subtle ways in which a budget may go awry:

• Failure to account for all expenditures in the current calendar year.
• Inability to pay all of the bills in the current year.
• Failure of the board to effectively communicate.

Not all bills are received by December 31. If we don't take into account those uninvoiced bills for goods or services received in the current calendar year, but allow these bills to go against the next calendar year, there is a real risk of surprises in the next calendar budget. Here's a suggestion based on procedures at BLMH. Check with vendors before closing the books for the current year. It is not unusual for contractors to control both their cash flow and taxes by delaying some invoices into the next calendar year. For an business using the accrual accounting method, receivables occur when invoices are issued. So this may be a good business practice for those companies that experience slow winters and peak summer and fall business activity.

Avoiding Surprises
At BLMH, the Treasurer, the Architecture & Maintenance Director and Management exchange budget information freely and have good communications. This provides for a more aware board, and prior to the budget workshop a series of emails are usually sent to the entire board with a list of additional items to be addressed during that workshop. For example, in 2012 we became aware of a pending change in the water and sewer rates by the county and the City of Wheaton. Each year we monitor the electrical utilities for pending rate hikes, insurance premiums, and so on.

Each year we update the reserve study. That's another way to stay ahead of the curve. Individual projects are reviewed, actual costs are used to update the projections and so on.

Upholding the Illinois Condominium Act (ICA)
The ICA prohibits the creation of sub-groups of owners. The mandates governing the HOAs in various states probably do likewise.

I think that a board is required to do a good job in the creating of budgets and should inform the owners if there are anticipated budgeting issues.

Here's a question to ponder. We usually think of "owners" as the current owners. However, if an HOA deliberately underfunds its reserves or passes budget shortfalls forward, is it not creating two distinct groups of owners which I will call "current" owners and "future" owners?

I suppose that it could be argued that most of the current owners will be here in a year or two. However, that, in my opinion, is a very dubious argument.  For one thing, this is a great way to blind side a new and future board. For another, Reserve Studies use a 30 year projection. Any board that uses a one or two year planning calendar is a scary board!

Here at BLMH our board is currently committed to all owners, both present and future. That's what fiduciaries are expected to do, isn't it?

Final Notes
If you have elections in the fall, as our association does, it would be wise to determine how to "hand off" the critical information amassed by the current board to the new board.

I also suggest we also keep the "Mack Truck" scenario in mind. I'm referring to the situation in which a board member for whatever reasons, leaves the association unexpectedly. As for example, if "Norm" were run over by a Mack truck!

I made this post "short and sweet." I realize that financial details can be both confronting and difficult. A few years ago, while observing during an association meeting, I watched a board member dozing. Yes, this can be really dry and boring stuff! Maintaining focus and priorities is why the board is here. It's easy to be blindsided if we don't do these things.

Continued in "Somewhere Between Bulletproof and the Titanic"
(c) 2013