2015 - Better Cost Accounting - Project Management

The HOA meeting went well. I did make my planning presentation for 2015. My presentation consisted primarily of a 5-page list. It really was a brief presentation. I had included color photos to support some of my concerns and to illustrate what we are planning.

One item which I promoted was better cost accounting for projects. That's a fairly extensive topic, but my primary concern in recent years has been the possible allocation of Operations and Maintenance (O&M) budgets to the completion of reserve tasks. If this occurs it will put pressure on our HOA's O&M budget while increasing our reserve balances beyond what they would otherwise be. I've been talking about this since 2011 and first broached it during a budget meeting. Any regular attendee to our HOA meetings has certainly observed me expressing this.

My Concern in a Nutshell
The inadvertent allocation of O&M funds to capital projects is to be avoided if possible. I am promoting closer monitoring and adjustment if this is observed.

Here is an example of how this can occur. Each year our HOA makes a budget. That budget includes a specific number of maintenance hours. It also includes a sum to be placed in reserves. There is an underlying assumption that all maintenance hours will be expended on maintenance tasks, which will then be paid from the O&M budget. All capital expenditures will be paid from the reserve account. It had been sometimes assumed that all maintenance hours are to be billed to Operations & Maintenance budgets. That assumption is not accurate.

We do use maintenance workers to support some capital project tasks. One example is drainage improvements on the property. Another is stream replacement, entry walks and other work related to new driveways.  Water mains are also handled via the capital (reserve) account because this HOA sets aside a specific amount for this purpose in each year. Water main work includes excavation, plumbing, concrete, asphalt and landscaping.  Some of this work is accomplished using maintenance workers.

Using the "drainage" example, much of the annual drainage improvement is related to the roofing project. If hours spent for drainage work is billed as maintenance it will be paid from the O&M budget. It won't be paid from the reserve account unless it is flagged as part of the capital project. If this occurs those hours will overstate the actual "maintenance" costs for the year while the hours attributable to the reserve account will be understated. Meanwhile, the HOA is obligated to fund the reserves as budgeted.

If this occurs it will create an imbalance in the funding process and the annual O&M accounts will be depleted and overspent. More money will be drawn from the O&M budget and less from the reserves. With a specific O&M annual budget, how is that imbalance to be paid? This is one way a HOA may inadvertently overspend it's annual O&M budget. It is also how a reserve balance may grow and exceed expectations.

It is true that the HOA annual budget is created some months in advance. It is an educated guess and some O&M tasks do come in at less than budgeted. Some additional work may be required.  There may also be surprises such as higher utility costs due to an unanticipated rate increase. Or a milder winter may reduce snow removal costs. Or ice dams and related problems may absorb more maintenance hours. Here's another possibility; our HOA currently does exterior repairs to 1/6 of the buildings on the property each year. That work is done in conjunction with exterior painting and is billed to Operations & Maintenance. It is impossible to predict the exact costs because the precise condition of the exteriors is unknown until this annual work is underway and thorough inspections are made. All of that gingerbread needs to be inspected and some will be replaced, as will some of the building exterior panels and other exterior wood. So too for those lighting posts in front of just about every building. They are also of wood.

The Problem
All work comes from the fees collected. It's all from one "pot" so what's the problem? First, it is a requirement that reserve accounts be segregated from O&M accounts. This can be accomplished physically or via normal accounting procedures. It is normal for maintenance costs to be paid from the O&M accounts. The problem is the possible distortion in the HOA annual expenditures when capital projects are paid via O&M accounts. The work is certainly being done and it will be paid for. The issue is about which internal account is being billed for such work. That is the source of any distortion. As previously stated HOAs with reserve accounts are supposed to use those funds for capital projects and not use them for O&M. However, there is no such restriction placed on O&M funds. The O&M funds can be spent for both reserve and maintenance items. This is not a desired practice, but it can occur. If it does it may overstate maintenance costs while understating capital project costs. The solution can be difficult. It requires separating manhours task by task so they may be properly billed to O&M or Reserves. This is more difficult than it might appear. For example, some maintenance work in any given year might be part of the roofing project (reserve accounts) while other work may not (O&M accounts). This is also true for drainage work.

If such separation doesn't occur in any one year, this might not be a big deal. If O&M funds fuel a portion of the capital projects, well, perhaps it can be corrected next year. However, the budget planning process doesn't look for this. Boards are genuinely concerned about transferring reserve funds to O&M accounts and so this is monitored by management. But the same scrutiny is not normally applied to the opposite, because there is no statutory prohibition for transfer of O&M money to reserve accounts. In other words, it is possible to expend O&M budgets on capital projects.  Of course, budgets are periodically reviewed throughout the year. If manhours are exceeded, the budget for the following year may be increased. That is the source of my concern. Over a period of years larger distortions can be created and that is a possible problem. It can put boards under pressure to increase O&M budgets and it can create larger than anticipated reserve balances. If not identified this situation will distort fees. If not recognized then reserves may grow and fees may increase to make up for any inadvertent transfer of O&M funds to reserve accounts.

A Solution
Recognizing the possibility that this problem might exist is a key element. This problem was identified several years ago and this HOA has shifted from automatic allocation of maintenance hours to O&M funds to the allocation of hours where identified as such to capital projects. However, this process increased overhead for contractors and management. It can be tedious. Nevertheless it is necessary and must be done.

Good tracking of maintenance hours for capital projects is essential. Only by doing so can we be assured that capital projects are being properly funded and paid for via reserves.

It's interesting, but this may be a consequence of board emphasis over the years on balancing O&M budgets. There is a desire to keep fees as low as possible, and with that, the need is created for tight budgets. After all, every excess dollar comes from owners' fees. So no one wants any excess to be collected. Over the years, there has been a lot of attention paid to O&M expenditures. However, with the aging of the infrastructure of our HOA there have been substantial increases in capital projects. Ten years ago, we weren't replacing streets, roofs, driveways and garage floors. Some of these are capital items to be paid from reserve accounts. Nearly all capital projects requires some involvement by maintenance. Our O&M annual budgets have been reasonably stable, as I have published in earlier posts. Meanwhile, our annual capital expenditures have "gone through the roof'" (pun intended).

I also suspect this problem has been aggravated by the shear volume of capital projects in recent years. This was an unintended consequence of delaying some projects as long as possible. So in 2014 we did eight roofs, which required drainage work, entrance work, attic work, ventilation work, and so on. Much of that roofing support work was done by maintenance workers. That same year a major bridge was replaced and some stream repairs were undertaken.

A change in method can also contribute to funding mis-allocation. For example, our HOA has about a third of a mile of walks and has a reserve category for these. In the past, the solution to uneven walks was to replace sections and this was done from the proper reserve category. However, our HOA is now employing "concrete grinding" or scarifying to deal with shifting blocks and cracks. If this work is done as part of normal annual maintenance it will use O&M budget hours. But this was never before considered a maintenance item and all such concrete work was budgeted via reserves because it was considered replacement.

Is this a serious problem? Well, I'd suggest it has been identified as a potential problem. I would also say it's something that needs to be managed. As is true of all things in a HOA, doing this requires manhours. Time is not free and boards are not professional staffers. If it is to be done, then someone must do it. Our HOA closely monitors the overall O&M and annual capital (reserve) expenditures. We want to be assured that work is being done that it is being properly billed by all suppliers and contractors. The annual audits clarify how much is actually being spent from year to year and the annual budget process compares the previous year's expenditures to the actual expenditures. These provide a portion of the needed information.

What remains to be determined each year is percent completion and it's opposite which is percent incompletion. This information can then be compared to percent funds expended and percent remaining. That's essential to determining if near term (5-year) capital budget projections are realistic. If this is not done it is impossible to determine if we accomplished the tasks for the anticipated costs. For example, if the cost of roofs were to increase 15% it would be important to apply that to anticipated costs for all of the remaining roofs. It might also be necessary to adjust the funding plan if this did occur. The opposite situation is also to be considered. If roofs are on track for completion at 15% less than projected, then it might be possible to allocate those freed-up funds to other capital projects, or reduce the collection of fees for reserves.

These things are discussed during open session of our HOA meetings. Doing so keeps the entire board and owners informed. It also is part of the knowledge base which allows the board to consider annual budget adjustments.

Conclusion
If there is a problem, it is this. Boards strive to adhere to a reserve funding plan. It's important to track maintenance hours expended and capital project hours expended, separate them and see that these bills are paid from the proper accounts.

The reserve funding plan is balanced against anticipated annual expenditures. It's important to keep track of what has been completed in accordance with the plan and what has not been completed. It is also important to keep track of reserve balances and how they occurred. Finally it is really important to review funding versus expenditures at frequent intervals, and I prefer an annual review.  Doing so can be difficult. Who is to do this? Architecture & Maintenance, or the Treasures and Management? I suggest it takes all of these to accomplish this.

It is also one more in a very long list of tasks to be done and it will be prioritized but it can also be displaced by other issues. Owners may have their own agenda and some could care less about the difficulties their HOA has in balancing all of these tasks. This HOA has one two-hour meeting per month. The board and management must decide in that two hour period how to proceed. I look at it this way. In one year, our HOA has about 24 hours of planning and preparation time via open meetings so a handful of owners can attend. Such open meetings are required. I ask the reader this question. Could you create an annual program, oversee it, and do a really, really good job during 24 hours of open meetings each year? In that 24 hours this HOA will oversee the expenditure of about $1.5million to $2million. During those meetings owners will attend with their list of personal issues. Some are important, some are trivial. No matter. We each get our due.

This is why many professionals recommend reserve study plan updates every five years.  It is why our HOA decided to fund an update in 2014. Pay the professionals to do their best and then decide how to proceed. However, budgets are created annually. We obviously can't wait five years to adjust budgets for reserve expenditures. Better project management and cost accounting controls are beneficial. I don't think anyone will argue the contrary. That said, I also think that not many will come forth with a realistic and reasonable method to do this "while keeping fees as low as possible." Telling the HOA Board to spend more time and to "do more" is not a solution.


Comment
If the task in the conclusion seems difficult or impossible, I suggest the reader consider that the Illinois Condominium Act which requires this was enacted by the same lawmakers who have turned Illinois into a zombie (walking dead) financial state. These lawmakers couldn't balance their own home budgets if it weren't for the generous salaries, perks and double dipping pensions they awarded themselves.

Unfortunately, they didn't apply such generous financial rules to the thousands of HOAs in Illinois. In fact, via SB2664 they attempted to kill condominiums in Illinois.