Certainty versus Chaos - Why I choose to run the numbers

This week we began the budgeting process for our association. However, one board member was unable to attend the meeting and so we were unable to complete. He and I did discuss the issues that came up during the meeting and I did provide a letter with the text about this to the missing board member. I'll get a copy to management and each board member early next week.

I was asked if I really like running the numbers. My response is that in fact, I don't. But I consider it better than the alternatives, which include uncertainty, breakdowns and chaos.

This is something I learned in real life, in my business and in my work in financial planning, which includes retirement planning, saving and investing. I also learned it is far, far better to practice preventative maintenance rather than breakdown maintenance.

I am also certain that no matter what we do there will be unforeseen circumstances and breakdowns. That's normal. However, diligent and rigorous planning can reduce the occurrence of these problems, which the unprepared will erroneously call "accidents." Boards can and do become completely ensnared dealing with the consequences of breakdowns and that includes angry or upset owners. IMHO it is far, far better to spend the time planning and preparing. However, not all agree with this approach.

It is a process
It does require many steps to put in place a workable plan for a large association like ours. The same approach has benefits for all home owners associations. Our larger association covers about 40 acres with two lakes, 44 manor style buildings, 15 acres of turf, three streams with waterfalls and ponds, our infrastructure including 84 driveways, 84 patios and decks, the electrical systems for our street lighting, the streets, walks and water mains.

What are some of the things that have been put into practice in recent years, and which I've emphasized in my 6 years on the board?

1. Regular, professionally prepared reserve studies (by outside, unbiased firms).
2. Regular condition surveys of the property. This includes nearly all aspects of our infrastructure includes the streets, driveways, garages, walks, drainage and rainwater conveyance systems, roofs, patios, decks, streams, waterfalls, ponds, gazebo, building entries, carpeting and other common area elements,
3. Regular consultation with our management and contractors and also with engineers about identifying perceived problems, dealing with maintenance and infrastructure repairs and replacements and so on. 
4. Frequent cost estimates and proposals to obtain the best possible numbers for updating the reserve studies using our internal data as well as that of the reserve study professionals. 
5. Annual or semi-annual financial reviews of the state of capital programs. Are we on track? Are we falling behind? Are we missing anything? 
6. All of the above is then incorporated into our regularly prepared reserve studies. These are prepared by outside, unbiased firms.  
7. Using professional contractors for all aspects of maintenance has additional benefits. Our managers and contractors provide regular assessments of the state of the infrastructure to the board. Obviously, there is also a real benefit to working with the same firms on a repeat basis. However, we have had board members take the position that an army of handy men could do as well, and some board members have taken the position that it is easier to hire a new firm than work out the issues with an existing firm. 

After we have done the above we also do the following:

1. Additional analysis of the 10-year plan on an ongoing, annual basis, This is in addition to the 30 year plan, The 30 year plan is "fuzzy" but we can really get a good picture for the 10-year plan. 
2. Avoid kicking the can down the road. This can create false security because reserves that are not spent in accordance with timetables will accrue. When boards and owners see these growing numbers there is a natural tendency to think that we might be collecting too much for reserves.A failure to keep current also creates "time bombs" which will show up at the most inopportune time. Certain repairs are impossible or extraordinarily expensive during our winters. Furthermore, future boards may be unprepared to deal with the cumulative effects of maintenance backlogs. 
3. Avoid knee jerk or automaticity when designing budgets. We do try to come up with realistic annual budgets, but we can't predict everything. For example, our association does maintain the streets in winter. That means snow plowing and the application of ice melt on streets, drives and at building entrances. We really can't predict how much snowfall we'll get in any year/  

There are financial choices to be made and balance to be achieved
We also have to face the issue that really long term infrastructure problems, those beyond 20 years, can be difficult to properly save for or to implement.  Can anyone really predict the cost of a replacement program 30 years distant? For example:

1. Determining how much to save for a large and distant infrastructure program can be difficult. Factors to be considered include long term inflation, impact on savings (return on investment). In recent years and for planning purposes we've seen annual inflation numbers promoted from 2.0 to 3.8%. That is quite a spread over 30 years. 
2. To prepare for really long term projects may require supplemental analysis such as engineering studies. I have a moderate amount of confidence in the professional firms who prepare our reserve studies. However, we've seen projects promoted which would have required several million dollars, one of which we determined was unnecessary and we could and were addressing via annual maintenance programs. That program was already in our Operation and Maintenance budget in the amount of $20,000 per year. That's $500,000 that will be spent over 25 years and that is much less costly than the $1 million to $1.5 million that was expected to be required. This is an example where regular preventative maintenance is superior to deferred maintenance accomplished by reserves.  
3. The above example is also superior because it more fairly applies the fees of owners. Each year a small portion of the current owners' fees is applied to this infrastructure work. 
4. In considering our fees for reserves and the amounts to be saved, the Illinois Condominium Act requires that the "budgets adopted by a board…..shall provide for reasonable reserves for capital expenditures and deferred maintenance for repair of replacement of the common elements. “ It is also stipulates that “the board of managers shall take into consideration the financial impact on unit owners, and the market value of the condominium units, of any assessment increase needed to fund reserves. “  
5. I would also think that balance dictates that we consider both current and future owners. "Kicking the can down the road" can result in lower fees for current owners to the detriment of future owners. After all, the maintenance will have to be done one day. On the other hand, Saving for nebulous and uncertain projects 20 to 30 years into the future can result in higher than necessary fees for current owners, which essentially transfers wealth into the pockets of future owners who might be the beneficiaries of lower fees in the future. 
6. In some circumstances there may be alternatives to be considered for large and expensive capital projects. There can be undesirable outcomes to be considered. For example, in 2003 a board decided to begin a more costly roofing project. That will have long term benefits for owners as it may increase the life of the roofs by 10 years. This was also the approach used in replacing a common street used by all 336 units. 
7. Earlier boards made a decision to go with a less costly street replacement and that necessitated significant repairs commencing six years after that street was put in and complete replacement at an age of about 12 years. So a street which should have had a life of 25-30 years failed, and this caused major disruption for all owners. We should strive to avoid these types of problems. 
8. Balance dictates that all owners, both current and future be treated fairly. This means that reserves must be fairly accumulated. For example, all owners should pay for the benefits of maintaining infrastructure, That includes roofs, driveways, streets and so on. If future owners want to add amenities such as swimming pools, community buildings and so on, they should pay for this in part via a special assessment and future owners should be fully responsible for paying for the benefits. Charging current owners for such distant improvements and benefits is inappropriate, in my opinion. 
9. Saving millions of dollars for distant projects can be problematic for another reason. Current owners may pay for these benefits, but future boards and owners may be inclined to spend the money saved over decades in different ways. We cannot control the actions of future boards and owners. So amassing large reserves may simply prove to be too tempting to future owners who will vote for boards to reduce their fees. There is a balancing act for current boards to consider. 

Good boards take all of the above into account. It can require more work to establish certainty for future capital intensive infrastructure projects. In HOAs comprised of volunteer boards, there may be some resistance by current board members to doing this work. It may also be viewed as something that is optional and will benefit future owners. Current boards may be inclined to pass this duty to future boards. That is a mistake as it does take many years to accumulate the necessary funds. Here at BLMH, the real saving for our mega dollar roofing project began about the same time as that project began. Too late in my opinion and it did require some large fee increases for reserves over a 10-year period to accomplish. I've pointed out that this was a major contributor to recent fees increases. In 2001 12.28% of the fees in thour HOA went toward reserves. By 2011 is was nearly 34%. Over one 10-year period the contributions to reserves increased an average of 9.64% each year. Two of those years the increases were more than 22%. In two of the years the increases were 0%. 

Note: 

1. The annual fee to deal with Operations & Maintenance for the average owner at BLMH has increased about 40.7%. However, over that same period the annual fee to deal with Reserve requirements has increased 227%. These large Reserve contributions were embedded in the total fee, so it was not readily apparent to owners what was actually occurring.