I've posted numerous times about HOA finances on this blog. There are valid reasons. For 15 years I've been observing others, including owners and boards at BLMH and elsewhere. I've concluded the greatest trip hazards for both individuals and HOA's revolve around finances. Five years after purchase I found this HOA to be in a severe crisis with a terrible national financial disaster on the horizon and bearing down upon all of us. In 2006 I prepared. The previous posts have set the stage, as it were. After all, why post about things of no consequence?
This post is about identifying the signs of financial insufficiency and points out issues and possible solutions. By 2010 the problems in the HOA were apparent to the naked eye and any competent observers. In 2010 the HOA was experiencing serious failures of some infrastructure, a large backlog of maintenance projects, a large and expensive roofing project which was undertaken in 2002-2003 but was only about 20% complete, insufficient funds and very angry and fearful owners. There has been a real transformation in this HOA. I am pleased to have been a part of it.
My secret weapon? Owners really do want to be informed. I do think owners purchase a unit for a purpose beyond an appreciating apartment. There is a distinction to be recognized between resident owners and non-residents. However, all owners are interested in financial success. Owners want to maintain their quality of life. Owners do have a financial stake in the outcome. Many, but not all owners do want to be treated as stakeholders and shareholders. I operate accordingly.
What are the Critical Steps and Priorities when Financial Disaster or Insufficiencies are Revealed?
- One must live in the present, but also recognize how the HOA got into the current situation. Recognizing reality is a prerequisite to dealing with it. These are human systems, and human beings elected the boards that failed and those voters are in various stages of denial and also in various stages of anger and upset.
- A HOA board member is performing a service as a fiduciary in a not-for-profit corporation. It is a business and the owners are the shareholders. If one cannot be of service to others and treat all owners fairly and equally, then when a crisis strikes it is a time to reevaluate one's participation on the board. There are serious and consequential problems to solve. It will require resolve and competency. It will require balancing compassion for the individual with the requirements of the whole. Boards cannot make special rules for a few. Boards cannot disempower the whole. Boards can ask other owners to pass the hat to support others in financial need. But it cannot use the finances of the HOA to benefit a few. If that is a real problem for you, then you need to state so and then resign. Your resignation may empower others to act. If you choose to stay you will disempower others and become a boat anchor to progress. If you choose to return when things improve, you are operating for yourself, not for others.
- A failure to recognize the true magnitude of the problem will disempower you. In really serious situations failure will be far easier than any success. The primary steps are those necessary to unconceal the true nature and magnitude of the problem. Only then can solutions be determined. Everything else is a "band-aid" and that was the approach of boards leading up to 2008. The easiest way to become disempowered and disabled is to ignore reality.
- Define your goals. What would you consider to be the minimum standard for "HOA success"? Then create a more ambitious goal and become committed to achieving that. Better to fail at a worthy goal than achieve an insufficient or lackluster one.
- There is responsibility and then there is accountability. To create accountability one has to step over the line of responsibility and publish. So be accountable.
- Publicise the goals for the HOA, if you truly consider them to be worthwhile. Cowards hide behind unrevealed commitments. If you truly want to accomplish you goals you must publicize them. Boards will either align or not. However if the goals truly are worthwhile you will accomplish them and boards will agree to proceed.
- Be your word.
- Don't operate as a reaction. Become a source of creation.
- Attract at least a few board members who are up to the task. As shareholders it is the responsibility of owners to elect competent boards. Getting capable people on the board can take a few years. Good luck.
- When owners are faced with serious HOA problems there will more than enough blame to go around. You must find a way to step outside of that circle. If not you will become a target for angry owners or simply another ineffective tool to be used by other board members while they plan their escape. Everyone loves to shoot the messenger.
- It would be natural to move from denial to resignation. That is not a solution. Move beyond into positive, affirmative action. Then design a system of fulfillment which will ultimately bring in other owners.
- If it really seems impossible, then create demonstration projects from the backlog list that create the statement "Yes, we can do this."
- Recognize that some will never figure this out and will prefer to practice something else.
- Create a shift in owners from blame to empowerment.
- Know your skill limitations and operate accordingly.
- Create alliances with useful experts. Partnership is vital when dealing with adversity and dealing with seemingly insurmountable problems. At our HOA the 2008 board and the owners who elected that board decided that the previous board was incompetent; all but one was replaced. They also decided that management was the enemy and acted accordingly. Going still farther, they decided to get rid of all of the current contractors because "An army of handymen could maintain this place". That was a critical error in judgement, and an act of real desperation. My first duty as a board member was to prevent such extreme, irresponsible actions from occurring so as not to exacerbate an already serious and nearly insurmountable problem.
- Focus on stability. Long term stability. There is more than enough chaos around us and what owners really want it stability, so they can go about their everyday lives, with no concerns about the roof over their heads and the finances of the HOA.
- Having friends or being popular is not the goal when running a HOA and believe me, the board does run it. Recognize that an entrenched board is a problem and combined with owner apathy is what most likely created the problem. Also recognize that creating a replacement board which uses a "buddy system" with friends in the audience is not a solution and may magnify the crisis.
- The HOA is a business. Operate it like one.
- What is required is committed partners. Find them.
- What is also required is people who will do the work. Knowledge of PCs, finance, spreadsheets, using email and word processors really is necessary. You will find that is not a requirement in many HOAs for board members. Simply another obstacle to success.
- Board members are volunteers. That means some may consider their position to be one of power. Others board members may view it as largely ceremonial and something to put on a resume, or in their LinkedIn profile. Real work may be something for others to do. Your failure to recognize this will create unrealistic expectations and obstacles to success in reaching your stated goals. Owners are not stupid. There is a reason most don't want to be on the board. You need to decide if you are more committed to the results than to personal kudos or anything else. Yes, you can create a better world, and why not begin where you live?
- Rebuild trust. Owners are shareholders but most are observers. The worst are underminers. So too for some board members. To say otherwise is dishonest and a symptom of denial. Operate accordingly. Create worthwhile goals and accomplish them. Nothing speaks louder than action. It will take a while, but real action becomes undeniable as the consequences become physical reality and manifestations of true commitment.
- When crises occur many owners will feel that they have been betrayed. Some of the perpetrators probably sold their units and moved on. The rest are stuck holding the bag and the lingering boards will do what is necessary to protect their image and will look for others to pin the blame on. Some owners think that a condo is really an apartment which gains value and appreciates. They bought for no other purpose. They are irresponsible people with unrealistic expectations. Which is why some experts say the HOA experiment is failing. However, that may not be so for your HOA, nor should it be considered to be representative of all of the owners. Put in place things and take actions to unconceal the reality. And operate with the understanding that some of your neighbors are friendly or unfriendly parasites.
- Lead by example. Some will get it but many will not. You will know them when you see them.
- Recognize that when owners are faced with the specter of huge budget problems being fearful is a natural response. Large fee increases and special assessments are scary to owners already financially tapped and trapped by the real estate collapse of 2008, as ours were. Real fear puts people into "survival mode" and they may react in unpredictable ways. When personal survival is at risk, no one else matters. Some owners will go bankrupt or abandon their unit when under financial stress. Be prepared for this and be diligent in monitoring delinquencies.
- Recognize that owners are expecting service. If they really wanted to be responsible for their personal lives, they would buy a home and be 100% responsible for all of the maintenance. They decided otherwise and chose a HOA where others can deal with the problems. Is it a fair system? Of course not. But you decided to purchase in a HOA too, and there are benefits. If you choose to serve, do it well and then move on.
- Tighten up delinquency monitoring and fee collection systems. There are responsible ways for HOAs to do this. Consult with a competent attorney and do what is necessary. Payment programs may be acceptable but must be structured to accommodate the financial requirements of the HOA and the needs of the owners. Every owner is to be treated equally, fairly and impartially and must keep the rules. Paying fees is a requirement, not an option.
- Determine the magnitude of the problem. That is a multi-step process requiring detailed evaluations of infrastructure and finances.
- To determine the condition of infrastructure interview knowledgeable experts. Conduct detailed surveys of everything.
- Develop a financial plan. This requires identifying costs and determining collections. If there are significant owner fee delinquencies, that reduces the ability of a HOA to pay for those infrastructure programs.
- Establish maintenance and infrastructure priorities for 5- and 10-years.
- If you haven't had a recent reserve study, get one. It is a valuable tool for boards if used properly, and another source for good decision making and planning.
- Then develop the expenditure plan.
- Then determine the funding plan.
- Adjust the expenditure plan and funding plan to accommodate reality. When faced with a large infrastructure backlog and serious funding issues, it will be necessary to make adjustments.
- Present the findings to the owners in a responsible way. An annual meeting is the best place to do this as such meetings usually have the greatest attendance. As an alternate, announce that a special finance presentation will be made during a monthly meeting.
- Improve the communications. You HOA newsletter is a powerful tool. Use it well.
- Treat all owners equally and fairly. That is essential to rebuild trust. The old "squeaky wheel gets the grease" and any favoritism based systems must be dismantled. Treating owners who attend meetings differently than those who do not is to be avoided.
- The actions of previous boards may have created dysfunctional or at a minimum inadequate systems. These need to be dismantled and replaced. The previous steps describe some of the steps necessary. There will be a lot of personal image protecting going on. Some entrenched former board members may work hard to protect their legacy and defend their bad decisions and even the poor decisions of other boards. That's "survival" for politicians. You will have little access to counteract such obfuscation because their machinations will occur behind the scenes at social events and among "friends" who will spread this dysfunctional gospel. This doesn't mean that contractors, management and a variety of board members cannot be used for useful purposes. But do be aware that incredible damage to the HOA management systems has occurred, the owners are distrustful, some are really angry and some do feel betrayed. Some will attempt to undermine the board or any board, as will prior board members who created the situation; the best way to hide a lie is to perpetrate it. In such circumstances it is natural for owners to be distrustful and to go into "survival" mode.
- Recognize that people are who they are. Some are incapable of change, although they may throw that word around with abandon. You must operate in recognition of this. I have learned that sometimes "You really can't teach an old dog new tricks". They are embedded in their ways and lack the skill, vision and fortitude required. Their primary purpose is maintaining the past.
- Recognize that the solution will require years. It is absolute folly to think that a problem created over a decade or more can be resolved in a year or two. A lot can be accomplished in 5 years, but 10 might be a minimum necessity. Design accordingly and so advise the owners.
- Do what you can to educate the owner body. It is important that you as a problem solver recognize that you are merely one in a continuous chain of other problem solvers. When you go, and you will, there must be others to carry on the task. Do what you can to cultivate your possibly unknown replacements. I address owners during annual meeting with "I'm telling you what follows because every board member is, has been and will be an owner and the future board members for this HOA are among you". The solution is out there.
- Properly maintaining a HOA, particularly one that is large and 40 years old is a never ending challenge. Once boards fall behind they may never recover and the HOA could fail. Whatever you do, treat it as a program. Something that requires continuous improvement and diligence on the part of boards.
- If you don't want to make the commitment required then you must decide to hope for the best or sell you unit. If you choose not to make the commitment then you will be in the position of "taking what you get" and it will probably be ugly.
- Recognize your personal limitations. There is also a proper time to move on. Entrenched boards are a hazard to HOA health. Some owners really don't care. You do need to be responsible for your actions.
- If, after all of the above the owners refuse to buy into the solution then I recommend that you sell your unit. If you remain you will only experience frustration and pain.
If you are a board member and in this HOA financial predicament, what to do?
This is not a place a new board member wants to find himself or herself. Of course, upon achieve a board position some owners viewed me as the problem rather than the solution. Previous boards had done a good job of sowing confusion or creating obfuscation. There was a lot of confusion among owners. Who were they to believe?
If you are a board member who finds himself or herself in such circumstances what to do? If you were part of the team which created the problem, then you should resign. After resigning if you have useful skills then approach the new board and ask to be on a committee that is working to solve the problems. However, as you were a part of the problem, you should not be entrusted with the opportunity to vote, simply to guide and empower. If you think you can't do that, then move on.
If you are a new board member, point out to owners and older board members that you are part of the solution, not the problem. Point out that others created this and you will work to solve it. Do so publicly during the HOA meetings so the owners are informed of your intentions. Write articles for your HOA newsletter about progress and solutions. Let others publish the stuff about parties and entertainment. Being on the board has other purposes. Design some realistic demonstration projects, announce the intentions and carry them out. Nothing speaks louder than actions. Demoralized owners will need to see that there are possibilities.
Why this post, now?
If finances can become a hazard, then posting about the nature of the problem is reasonable. This post looks at what happens when HOA finances go seriously awry and at the approaches to deal with the problem. It is a real world example of turning around a desperately struggling HOA. Back in 2008 some of our owners were desperate. Some had given up and sold their units in desperation at the bottom of the real estate market. Some believed the problems could not be solved. Some put their heads in the sand and hoped. A few were really angry and lashed out at anyone they perceived to be a problem. The perpetrators ducked and covered. It takes guts and integrity to communicate the issues and boards did not do that.
I'm here to say that most problems really are solvable and that there are people who can do this. What is lacking is commitment and skill. If one has commitment one can find those with the necessary skills. I have both and there are many, many others like me. There are also many who cannot yet purport to be capable. As one former board member said to me in 2008 "There really is no place for politics in a homeowners association". That is true, but nevertheless there are politicos among us and the uniformed are easily swayed. Which is why I decided to transform the newsletter of our HOA. That of course, required getting on the board.
Work on the Budgets
One of the duties and responsibilities of a HOA board is determining budgets. A companion task is setting owner fees. Budgeting is always an interesting exercise, with real world consequences for owners. The annual operations & maintenance (O&M) is straightforward. This can be particularly so if one has a professional management firm which practices good bookkeeping. If a HOA has been in existence for a few years or decades, the task is basically about identifying annual cost increases.
The other aspect of budgeting is reserves. That is more difficult than the O&M budget, IMHO. Particularly so if boards sidestepped this for years or used an imprecise, guesstimate approach to determining reserves. But eventually there comes a time when the piper must be paid, and when it does the board must make difficult and unpopular decisions. Which board will make those decisions? Most likely not the ones that made the decisions that arrived at the financial crisis.
The Role of Reserve Studies
In 2010 my first act on the board was to review a recently completed reserve study that indicated a 10% fee increase and a loan for more than $1 million was immediately required for this HOA. After about 60 hours of serious spread sheet creation and analysis, many additional hours of infrastructure reviews and discussions with management I concluded it was not necessary and presented my findings to the board. I had about 4 weeks to do all of this. To assist the board I made a series of charts which laid out the finances for all critical infrastructure. At the time the HOA was in the early stages of a very large re-roofing program for 44 large buildings. There was a genuine concern about how this would be completed and other pressing projects such as our failing streets would also need to be addressed. Some board members were nearly catatonic with fear.
In 2010 our HOA annual contribution to reserves was $330,000; that's a sizeable amount, but barely adequate. The problem had been created more than a decade earlier. In 2001 the reserve contribution was a paltry $57,000. To put this into perspective, the insured value of our HOA infrastructure is about $90 million. Boards were annually setting aside 0.06% of the value of the infrastructure to accomplish 30 years of maintenance.
In 2002 the contribution was increased to more than $148,000 and it was increased every year thereafter. Not coincidentally the board had begun a very expensive roofing project. By 2009 the contribution had increased to $330,000 but that was declared to be inadequate by the first reserve study in 2010.
In 2010 the problems were a large infrastructure repair backlog, insufficient accumulated reserves, a large and expensive roofing project undertaken in 2002 with less than 20% completion and streets that began failing 5 years after replacement. For perspective our 2017 our reserve contribution was 7 times larger than that of 2001. In other words, we'll probably collect more in 2017 for reserves than nearly the entire decade of the 1990s. Our recent owners had paid more than their fair share. Shame on the earlier boards.
These problems when combined indicated that the HOA had a serious problem and possibly insurmountable. There was a possibility the HOA would never recover. Angry owners, trapped by the financial disaster of 2008 and the collapse of residential real estate prices added to an already toxic mix. The newly elected "revolutionary change" board elected in 2008 looked at the reserves and the large increase in collections since 2000 and were convinced that "We have enough money" as were the block owners who elected them. So convinced that in 2010 they undertook the first ever reserve study to prove that the HOA did, in fact, "have enough money". To the contrary, that study proved that the HOA had serious financial and infrastructure problems. Shortly thereafter the majority of that board left prematurely, using whatever pretense was handy to them. I didn't. I honored my commitment.
In 2010 I provided a detailed analysis to the board and then to the owners at an HOA meeting. Here is one chart I produced and presented to both the board and to owners. It indicated that we could complete the roofing project in 2016, and we did!
I also created a program to deal with our prematurely failing streets. We have about a mile of streets and we did not only replace our major thoroughfare, but also the water mains below. Here is projection (goal) I provided to owners in 2014. We have completed Lakecliffe and Salisbury Court . We did some "mill and grinding" of Harrow Court in 2016 and have let the contract for replacement of Thames in 2017. We do have a program in place for the replacement of all of the cul-de-sacs at the pace of one each year. But it will be the responsibility of future boards to accomplish this:
15 years of Dramatic Finances
I've had the opportunity to study the finances of this HOA for 15 years. I've learned a lot about how boards and owners operate, how serious financial issues are approached and avoided (passed to future owners) and I've observed what happens when large budget shortfalls are revealed. I've made spreadsheets about the finances of this HOA for as many years. I've picked apart several reserve studies, revealed the serious flaws in one and I listened to the arguments made to avoid making the first independently prepared study for this association. I've observed the machinations of a variety of boards, and the convoluted logic that is sometimes applied to get the numbers to where someone on the board wanted them to be. I've watched boards argue in favor of holding fees stable and then watched the same boards flip and argue for even higher fees. I call that "whiplash budgeting".
HOAs are supposed to be operated as a business. Sometimes they are operated as a hobby, or worse.
How does one go about setting a reserve budget in the absence of professionally, independently prepared reserve studies? I'd say a difficult task becomes impossible. Boards really don't know where to start without such a study.
Reserves are long term funds saved for long term infrastructure repairs or improvements to HOA common elements or limited common elements. Examples include roofs and driveways. Long term finances go hand-in-hand with long term planning. Reserves therefore include funding and expenditures. Studies attempt to balance these for 30 years into the future. However, boards do have the ability to schedule repairs, so one method a budget can be balanced is to push some repairs into the future. In moderation, this might be a reasonable approach. Eventually the future becomes the present. At that point in time the money had better be available. We've had boards that channelled all reserve finances into a few large projects. Most notably the roofing project which commenced in 20002-2003 and was finally completed by me in 2011-2016.
If an association fails to accumulate sufficient reserves and simultaneously pushes maintenance into the future, this is a dangerous approach. I do have the evidence. When things reach end of useful life and the funds aren't available serious compromises will be made. Some vital repairs will be compromised. Boards may play "squeaky wheel gets the grease" and cater to some owners. Which will those be and which owners will be put at the end of the line? Whose property values will be negatively impacted while others are enhanced via improvements? Boards really don't want to be in the terrible situation of picking winners and losers, but it does happen. When it does, it gets really ugly. Then there are board determined winners and losers. No way to run a business.
Avoidance is preferred to reaction; it is best to be diligent, make difficult decisions rather than popular ones each and every year. It is best to undertake reserves studies made by qualified, competent people and to use them properly. Why? Some day those entry doors will need to be replaced. When that occurs, a board will dip into the reserves for the necessary money. Studies alone won't be sufficient. They will need to be updated to include current realities. That requires intimate knowledge of the state of infrastructure. I call that "Knowing the condition of infrastructure via detailed and frequent condition surveys". Are there impediments to this? Of course. Boards are comprised of volunteers and doing all of this work is, well, it is work. Some board members may prefer to run the HOA as social clubs, popularity contests, personal fiefdoms or monuments to themselves. Others prefer to follow the "party" line and vote with their friends.
Bucking these trends creates enemies. It has at BLMH. Would you like to be walking in your HOA and have a little old lady scream "I hate you!". If not, then own a personal home or live in an apartment. If you choose to own a condominium then join the oblivious and
never attend a HOA meeting or donate your time and services as a board member, as so many of our owners have chosen to do. Then you can come to HOA meetings and complain "How could this happen" or simply stick your head in the sand and hate the HOA and every board.
When Financial Problems Occur
Owners and boards may be inclined to give reserve planning little or no attention. If that occurs, there will also be long term consequences. This post is about methods to deal with such consequences when they occur. There can be a light at the end of the tunnel, but that tunnel may span a decade, or more. In other words, it would be best to approach the problem as one which cannot be quickly fixed, if it is a serious one. That will require enlightened and educated boards who can demonstrate perseverance.
Yes, perseverance is a necessity. In our "instant gratification" entertainment, Facebook and Twitter based society that can be a real problem. Boards are elected for one or two years. Totally inadequate, in my opinion, but good for getting points and kudos in the modern school of accomplishment. Something to add to our resume on LinkedIn.
There are a number of resources available. I'd also suggest that boards reevaluate why owners purchased in the HOA. Consider those things as important and maintain them as a priority. Develop long term plans and promote positive outcomes. Stay the course, and if the problem is serious, be realistic about what can be achieved in a year, or 5 or 10. Determine methods to improve communications and implement them. Then roll up your sleeves and begin the real work of solving the problem.
If serious problems are revealed or occur, be prepared for some nastiness. Solving budget shortfalls requires raising fees higher than required for inflation. It may require special assessments. It could require cutting services, or transferring the maintenance of limited common elements to the respective owners. Any of these solutions will be upsetting to people. Some people detest change. Some of the very people who argued for low fees may be the nastiest. The boards that governed earlier will attempt to deflect criticism. There will be finger pointing. Be frank and honest and if you are really lucky owners will elect someone else next time, because "shooting the messenger" is one way to deal with unpleasant facts. If you lose your position, consider it a blessing and move on.
Dealing with Reserves
A shortage of reserves always begins with the discovery of the problem. Once the problem is discovered, what is a board to do? Once that owners become aware of the problem, what are the owners to do?
There are two types of reserve shortfalls.
- Minor
- Serious.
In a larger HOA there may be 50 categories of reserve expenditures. If it is discovered that funds are insufficient for one or two categories, funds can probably be moved into that category from another, and if necessary fees can be adjusted over a period of several years. Minor inconsistencies can be dealt with if the HOA has overall adequate reserves.
However, the longer the period of time that funding problems and shortfalls exist, the more difficult it is to overcome. For example, in 2001 BLMH put $50,000 into reserves according to the balance sheet; that was apparently the normal amount. In 2002 the board tripled that to $148,108 and by 2011 fees budgeted for reserves had reached $424,000. They have since been reduced. That's an amazing collection increase of more than $4 million. There were good reasons for these increases, and they were simply normal infrastructure aging. Previous boards simply hadn't saved enough.
We can do our best, but it is inevitable that there will be some shortfalls. Keep in mind that reserves are planned for and accumulated for decades. There will be annual fees, accumulations and expenditures. The typical reserve study spans 30 years. Such very long term planning is rife with problems because it is difficult to make predictions so far into the future. I prefer to focus on the future for 5-10 years because accuracy can be achieved. Longer term, finances will become fuzzier. The life of some infrastructure is more difficult to determine and certainly determining expenditures becomes more imprecise the farther into the future we gaze. I actually bring a crystal ball to our HOA meetings to emphasize to owners the degree of uncertainty.
The fact is we only have general ideas about the useful life of infrastructure. So planning 20-30 years distant is an educated guess. Who really knows what boards will be actually doing and spending each year in the future period 2027 to 2047?
Here's an example. In 2008 I asked the board what were the reserve plans for our trees, which were 30 years of age, and some older. Included were hundreds of ornamentals, old willows and ash. I was told "trees live a long time." With the emerald ash borer, the hollowing of the willows and the dying of ornamentals and conifers, our "tree" replacement budget hit $58,000 in 2017. That was not a one year event and a lot of people simply didn't anticipate this. Furthermore, a lot was spent simply removing dead and dying trees. People also failed to comprehend the cost of removal. Landscaping in 2016 as remediation was more than $50,000 to deal with about 90 tree removal locations identified in 2015.
If we don't have reasonable reserve accumulations, dealing with such issues can be impossible. This HOAs budget increase for 2017 including reserves was 1-1/2%. Such a budget was only possible because of vigorous planning and applying flexibility to budgets since 2008 while pursuing an aggressive maintenance program. We are catching up.
It is also inevitable that there will be some excess funds in some categories. Good reserve budgets include some excesses. For example, the actual cost of street milling&grinding and curb repairs may be under the reserve budget.
Boards must be diligent and closely monitor reserve expenditures and funding. Some bookkeeping methods and frequent board turnover makes this task even more difficult. I've observed that some boards have little interest and even less skill at doing this. Everyone wants to vote, but there may be little enthusiasm for doing the work required.
So boards do what they can. Sometimes they succeed well, and sometimes they fail spectacularly. How best to avoid horrible failures? In one short sentence: "Accumulate and develop quality information and budgets which accommodate what is discovered in that information, and use the information as a tool".
Major Reserve Failures
Dealing with major reserve failures is difficult. What's major? I consider funding shortfalls that require greater than 5% annual reserve funding increases to be treated as
significant issues. One might argue that point and say "If reserves are only 20% of the budget then why obsess over a 5% annual increase to 20%" After all, 5% of 20% is only 1% of the total annual budget. Here's my opinion:
- Reserve funding is a 30 years rolling task.
- All long term funding plans for reserves assume adequate current funding levels. That is a really huge assumption, and in our HOA that assumption in the absence of an adequate reserve study darn near destroyed the HOA. One must be operating at realistic funding levels before making general assumptions.
- Generally speaking, it should be expected that annual reserve contribution increases should match inflationary pressures.
- Using 2% for inflation can be an acceptable approach if one wants to achieve fee stability, but there are exceptions. This percentage could increase to 4%.
- Annual 2% fee increases will increase fees by nearly 22% after 10 years. Annual 5% increases will increase fees by nearly 63% in 10 years and will nearly double fee contributions (100%) in 15 years. BLMH actually increased such fees by 783% in 13 years. Reserves as a percentage of annual fees increased from 7.7% in 2001 to a peak of 33.6% in 2014. Ouch!
- I think most of us would prefer to avoid special assessments.
- Increasing and decreasing reserve study inflationary numbers needs to be approached with caution. No one really knows what inflation will be over the 30 year life of a typical study. Using short term event can be dangerous. For example. if there is a "spike" in inflation due to some disaster that effects oil and gasoline, that will impact maintenance and many materials. However, it is not wise to assume such changes will continue for decades. A change from 2.0% for inflation to 3.8% is significant. At 2.0% annual inflation a roof that costs $10,000 today will cost about $15,200 20 years from now. At 3.8% annual inflation that same roof will cost about $22,000. If your HOA has 44 roofs as ours does, such a change makes a huge difference. Does a board plan for spending about $667,000 on roofs in 20 years, or does it plan to spend 4963,000 in 20 years? Coming to a solution will make a huge difference in owner fees. My suggestion is only make small incremental changes based upon frequent reserve updates, which will determine the future requirements based on the current "best guess" for inflation. How frequent? Not less than every 5 years.
When special assessments are avoided, the only alternative when there are really serious financial issues are annual, continuous, substantial fee increases. That's apparently the decision of boards at BLMH in 2000 and beyond. This choice can collect the necessary reserves, but not quickly and it also penalizes future owners. Special assessments will hit current owners particularly hard. Most of the owners probably voted for the board(s) that ran the association and were present for the creation of the problem. This is particularly true at HOAs with long serving boards.
Incremental annual fee increases are a way of "paying it forward". If such fees include modest, continuous, incremental annual reserve increases they are fair to all owners, both present and future. If not, they may be kicking the can down the road and penalizing future owners.
If a board ramps up fees by large annual amounts, it implies that owners a couple of decades ago got a bargain while the current owners are carrying the budget.
That's an interesting question. Remember, boards are fiduciaries who represent the owners. The owners are shareholders and all owners are to be treated fairly and equally. But let's look at discovery, first.
How are shortfalls discovered?
- Suppose a reserve study deviates substantially from accepted norms. Something appears to be awry. If this is your HOAs first reserve study it needs to be scrutinized and maintenance methods, situations, etc. need to be evaluated.
- A reserve study deviates substantially from accepted norms. This might be genuine and it should be approached as such while professional management and the board evaluates it.
- An unusual bid could be an indicator. For example, a board might think a roofing project is $800,000 but on getting bids, discovers the long term, real cost will be $1,700,000. Of course, there is the possibility a very high bid is a flawed bid. That's easy to determine.
- Common sense is something a board is supposed to exercise. For example, if an HOA has 84 driveways and a replacement costs $5,000, then it is reasonable to assume that at least $420,000 is required to replace the driveways over 10 year useful life (84 x $5,000).
- Common sense is also necessary for evaluating lifetime of common area components. Any roofer can state that a simple asphalt roof probably has a useful life of 20 years. What this means is such roofs will have a useful life of 18-22 years; some will fail at 18 year and some at 22. Likewise, an asphalt driveway probably has a useful life of 10 years and some may provide 12 or more years of good service, but some may not.
- Boards should avoid "lowest possible cost" solutions. In most competitive situations labor and material costs are similar for licensed, bonded and insured contractors using similar materials. A very low bid probably includes quality deficiencies (less material, inferior material, alternative installation approaches, etc.). If a board chooses "lowest possible cost" solutions it should also consider that the "useful life" may be compromised and shortened. Simply choosing such approaches is a failure generator. While some might argue they are saving money for owners, it is more likely they are building reserve failures. Only proper specifications and bid analysis can provide confidence.
- If boards always use "lowest cost" approaches, that in itself may be an indicator of impending failure. Such approaches require adjustments to future costs, as roofs, or driveways or even streets may require more rapid replacement and won't have the "useful life" that was anticipated.
- If there has not been frequent, professionally prepared and unbiased reserve studies that is an indicator of problems and one should assume the worst.
- Failure of boards to communicate with owners is an indicator.
When problems are discovered, boards should act
vigorously and immediately to take steps to resolve the problem. Delays only make things worse, as budget shortfalls will accumulate. If a board fails to act upon discovery one could argue that someone isn't doing their duty. Failure to get reserve studies or reasonably frequent updates can also be argued to be a duty failure. After all, how can a HOA accumulate "reasonable reserves" if a board doesn't know the answer to the question "What is reasonable?"
A Reserve Problem is Discovered; Now What?
On discovery of reserve issues, the treatment is determined by the magnitude of the problem. If the problem is a major one, the best thing is to:
- Reevaluate the entire reserve budgetary program. If one area is seriously flawed, it is possible that other areas are also flawed.
- Reevaluate maintenance plans. Some adjustments may be required.
- Do not stop maintenance! Once a HOA falls behind in infrastructure repairs it becomes nearly impossible to catch up. That is unfair to future owners and future boards.
- Re-evaluate 5-, 10- and 15-year plans. What adjustments can be done? What fee increases are realistic to reach necessary goals?
- Should the "necessary goals" be restated?
- When problems are discovered, there may be significant board turnover. The old boards may "duck and cover." Owners should consider financial issues as the underlying cause of any large board turnover, particularly if there are board resignations.
- Owners may choose finger pointing and elect new boards. That in itself will not solve the problems.
- New boards should roll up their sleeves and get down to work. It is reasonable to assume that previous reserve numbers and programs were flawed or inadequate.
- New boards on discovering serious flaws may choose to walk, using any convenient excuse. After all, these are volunteer positions. Performing useful work may be considered to be optional. That's a duty failure. It is one thing to communicate knowledge to owners and to state "I don't know how to solve this and I suggest owners find someone who can". However, I'd suggest a discussion with professional management and then provide owners with an authentic statement about the nature and magnitude of the problem. At that point board members can choose to resign if they feel they are inadequate to the task.
- Entrenched boards may decided to do the opposite. Hang on for the wild ride as "We are best able to guide the HOA." That is a matter of opinion. However, boards should authentically communicate the nature of the problem to the owners. Owners are shareholders. Some boards forget that and think they are stewards of the infrastructure and the owners are merely fee paying passengers.
Of course, if reserve planning has been inadequate, then there are no good choices. By that I mean no choices that can avoid some financial pain for owners, and a lot of work for boards. At BLMH, our first reserve study by an outside, independent firm occured when this 336 unit PUD was 30 years old. It revealed serious shortcomings in funding and also verified that recent fee increases were absolutely necessary. Owners and boards who thought "We have enough money" were wrong. However, they had been blindsided by earlier boards who were unawares or failed to reveal the magnitude of the problems. While routine maintenance continued and on the surface everything looked fine, in fact major infrastructure was failing and funding inadequate to manage the situation.
How to deal with major financial problems:
- Remember that this is a business and should be operated as one. Board members may have broad and varying definitions of this. Get clarity about what "running the business" means and the role of owners as shareholders. You will need it.
- Good communications is vital. If the current board won't, can't or hasn't provided good communications, it should get someone on board who will.
- Don't accept board candidates' promises of a return to the "good old days." Those "good old days" are what got your HOA to where it is today, and that includes any reserve issues.
- If there are questions about the adequacy of reserves, an unbiased study should be performed as soon as possible.
- In the interim, budget for the largest comfortable reserve fee increase. Your HOA will need it.
- If studies have been performed, then one should ask why the studies didn't work and corrections should be made.
- Owners should be reminded that they are ultimately responsible as the shareholders who elected all of the boards.
- Make independent infrastructure surveys and make detailed lists of the condition of all of the significant aspects of the property. That includes roofs, garages, decks, patios, walks, driveways, streets, lighting, entries, etc. This information will be useful to the HOA and to the firm that performs the reserve study.
- Using the detailed lists, come up with a plan to perform the necessary maintenance.
- In extreme cases, previous boards may have suspended vital infrastructure expenditures. This will exacerbate the problem and may disguise it. In some circumstances re-evaluating and altering plans may be required for up to 5 years, but after that future boards and owners will pay a steep price.
- Reduction in services may be necessary.
- Patching as opposed to replacement may be necessary.
- Communicate the solution to owners as soon as possible. In a scarcity situation owners will be concerned about their property values. They will be concerned that their immediate area won't be maintained.
- Avoid the "squeaky wheel gets the grease" approach. Boards may attempt to placate owners by dealing with the most upset owners, to the detriment of others.
- Attend meetings and ask questions. Avoid fingerpointing. After all, owners elected the boards that created these problems and elected boards will deal with the problem. Owners share responsibility for these types of problems.
- Look for the most qualified and form committees to assist the boards.
- Be prepared for a multi-year struggle. It takes years for long term problems to occur and it will take years to resolve them.
- Re-evaluate your personal budget. What can you do to deal with unanticipated fee increases?
Note:
- I have been on the board since the fall of 2010. That's 7 years and my current term ends in the fall of 2018. I have been elected several times to this position, but that is not how it began. In 2010 there were a lot of owners who did not want me on the board. They preferred to drink the Kool-Aid.
- I was not elected to the board in 2010 because I was popular. I was elected because some owners were desperate and a private letter to every owner had laid out the realities of the financial problems this HOA faced. There were sufficient owners concerned about the state of repairs and finances but I did not achieve sufficient votes for a position on the board. I missed by a few votes. However, the former treasurer who was re-elected declined a position so as to get me on the board. She has since sold her unit and moved. She obviously like the HOA and her parting act was a positive one for the association.
- Back in the 1990s I re-empowered my business to take on seemingly "impossible" projects. I was considered to be somewhat deranged. My company didn't do it on the cheap. Getting me to do this required more than $2,500 per day, per person plus expenses. Currently a pittance compared to attorneys who do almost nothing. But we created real value, improved businesses and saved thousands of jobs, a few businesses and helped to create a better future. I was paid to do this, of course. But for a few years my assistant was paid more than I was. That's the nature of change in real business. I wasn't an internet mogul, a politician or whatever. I was far more committed to making a difference than making money for myself. I suspect I am one of a dying breed.
