Reserves Update 2017 - Beware!

Our committee has been working on a reserve study update. Why now? We had one in 2015. A waste of owner fees?

Whenever significant events occur, it is time to get a reality check. We have completed several major and costly projects. One was a roofing project which spent more than $1.6 million. Another was the replacement of Lakecliffe Drive and the water mains beneath it. We are now replacing a large section of one of our streams which languished for year. The replacement of the paving of the cul-de-sacs is underway and costs have been identified.

A few years ago, boards argued against reserve studies.

Recent boards have been very observant of reserves at this HOA. However, prior to 2008 I don't recall much discussion at the annual meetings about reserves.

Recent boards have gone well beyond observations about reserves. Reserves were once a much smaller part of fees. Back in 2001 they were less than 8% of owner monthly fees.

Monthly fees more than $1,300?
Reserves collected via monthly fees are now 7 times higher than they were in 2001. That's an astounding increase. If our overall fees were 7 times higher than in 2001, the average monthly fee for an owner at BLMH would today be about $1,300 per month.

Our HOA fees aren't $1,300 a month. I put that amount out here to emphasize the magnitude of the change. Boards did a good job with O&M budgets. These are collected and spent within one calendar year. The breakdown was long term planning.

But that was then, and this is now. Boards since 2010 have worked on frequent reserves study updates and the considerable background work it takes to prepare them.

Why did our reserves remain so low for so long? Well, earlier boards were very concerned about running out of money in the calendar year and that was the focus. They missed or ignored the long term issues.  I've observed board members obsessing over the postage. Working on the Operations & Management (O&M) budgets is an important part of a HOA's annual budget process. But decades of avoiding proper reserve funding can cause substantial problems, and it did at BLMH.

These issues can be resolved, and they have been. But it took a lot of owner money collected via fees for 15 years.  There have been angry boards and angry owners.

These problems take years to accumulate. Given time and good boards they can be resolved, but not in a day. Problems that take decades to create can take a decade to resolve.

That's the point of this post, and I'll provide some things for boards and owners to be aware of.

The good news is boards since 2010 have reinvigorated the capital repairs in this HOA. A lot of work which had been sidelined for about a decade is being accomplished. What's the point of collecting money to sit on it, or to use it unwisely? We've got about 50 reserve categories in this HOA and that provides a real road map for boards.

Inconsistency can be a problem. But board do experience frequent turnover. The most capable may move on quickly. All boards need to focus on financial stability, both short and long term. A failure to set priorities, make financial distinctions or a lack of perspective can bury a homeowners association. It nearly happened here.

Avoiding a repeat of the past and keeping emotions in check
At this point arguing that we need more for reserves than we are currently collecting needs to be backed by facts. It's unfortunate but the boards in 2001 and earlier apparently didn't have the facts or ignored them. A failure to use facts created huge financial shortfalls in the 1990s. A failure to use facts today could create large budget surpluses.  Today, this potential issue is unfairly collecting from current owners, the same owners who bailed out the roofing project.

Emotions aren't a good thing when evaluating finances. But in a HOA with a $1 million plus annual budget, boards need to deal with some large numbers. That is not easy, it can be daunting and for some board members it can be downright scary.

What are the issues or positions that a board member may have?

1. Failing to be aware of the emotional difficulty of dealing with large sums of money. Many people are uncomfortable about this. For example, consider the following question. Which is better? Getting $5,000 a month in retirement at 65 or getting a lump sum of $1 million at 65? $1 million sounds like a lot, doesn't it. Yet, they are the same.  $1 million saved can provide $5,000 a month for 30 years. But we tend to approach these amounts as different. So do boards.
2. Frequent board turnover means a lack of training or inadequate time to learn the ropes.
3. Some boards operate as personal fiefdoms.
4. The real time requirements may make it impossible for any other than retirees to serve on boards. Retirees may have time to spend and the wisdom of their years. They may also have old age, dementia,  health restrictions and the financial reality of attempting to live via social security benefits. 
5. Taking the worst case scenario when planning. For example, "All of the water mains are failing". Yes, the infrastructure is aging. But it won't all collapse in 5 years if it is being properly maintained.
6. Using a 3% to 5% per year automatic fee increase approach. (I call this the "dart board" approach). There are no guarantees 5% is adequate if there isn't good data to support that decision. Even a 3% annual change adds up. My fees at BLMH will be about $122 higher each month in 10 years with annual 3% increases. At 5% annual increases, my fees will be $223 more per month in 10 years. Recent annual fee increases have been 2% per year, or less. Such increases will result in my fees being $78 higher per month in 10 years. The only reason fees have increased by 2% per month is a lot of work by a few board members. They generated the data. The differences are huge and with a potential negative impact for owner affordability. We are looking at a difference in fees of $145 per month in 10 years.  Yet, some board members have persisted in the "automatic" approach to fee increases, because it "feels right".
7. The stability approach, which attempts to smooth fee increases via annual review of both Operations&Maintenance budgets and reserves. Collections to reserves can be adjusted to stabilize annual fees. Acceptable for short time use.  This HOA did it in 2015.
8. Using the data to drive the decisions. That requires obtaining good data and using it. Not easy because all of those site surveys, condition reports and financial plans require a lot of time. Not easy if the data doesn't support one's position. Collecting data may be difficult for the retired who have limited mobility and limited computer skills.
9. Looking for methods to reduce costs without sacrifice. Monitoring cost changes over time will indicate where to put our talents and resources. Water bills, for example. Of course, that requires using the data available and organizing it.
10. Removing expensive infrastructure rather than maintaining it. For example, our streams are wonderful, but previous boards have discussed shutting them down.
11. Low ball and perhaps inadequate infrastructure repairs. That's how our streets failed prematurely.
12. Failure to identify costs before committing to expensive projects. Our roofs, for example. 
13. Kicking the can down the road and allowing future owners and boards to deal with it. Always an attractive option for any board. After all, 20 years is a long time into the future.
14. Avoiding reality by avoiding making frequent condition reports and surveys. Those reports and surveys are really time consuming. A board has to facilitate this and make it a priority with management support. Managers are busy, too.
15. Failure of  board members to understand the finances. When this occurs, we may turn to the people we trust and vote with them. It would be better to turn to the data, but that can be impossible if we don't understand it. Or of money is an emotional issue.
16. Taking the popular and most comfortable approach. No one wants to be the bearer of bad tidings to owners. These are elected positions. Easiest method is modest annual fee increases which take care of O&M first and then fund reserves via the remainder. Boards then cross their fingers and hope it works out, or that they are gone before the cr@p hits the fan.  That approach failed in the past.
17. Failure to appreciate that we cannot escape the future we create. We may hope to sell our unit before the house of cards collapses. Some do, and some don't. Gambling is not investing in our future, yet some insist they will avoid the future pain. 
18. Failure to accept responsibility for our actions.
19. Failure to accept positive change,  preferring to adhering to old positions. At BLMH those old positions did a lot of good, but they also created the financial mess that were our reserves, and the maintenance backlogs.

Having the best possible information promotes good decisions
Having the best possible information available when making difficult financial decisions is the best course of action.

However, doing the things necessary to acquire quality information can have the following obstacles:

1. Board positions are for one or two year terms. That's not much time to get up to speed and even less time to learn. Our annual budget meeting occurs one month after the elections. 
2. Board members are volunteers. 
3. It is work. Condition surveys take time. Collecting financial data takes time. Creating spreadsheets, charts and graphs takes time. 
4. Requirements are loose. Simply be capable of making common sense business decision. No use of technology necessary. Skill required is optional.
5. New board members may be treated as interlopers by older ones.
6. Training one's replacement is not popular in business. It is even less popular among groups of volunteers.
7. It can be unpopular. Providing information that goes against the norm or entrenched positions will make one unpopular. "Elect Norm and your fees will go up". 
8.  Telling people what they don't want to hear is unpopular.  Why take the hit for earlier boards? That's where integrity comes in. 
9. Some boards and board members will do everything possible to undermine your position if it is contrary to theirs. That's what bullies do. 
10. It can create enemies. In a HOA, raising fees is a difficult thing. Even promoting a reserve study "Can open Pandora's box" as it was succinctly put by a manager about 10 years ago. 
11. It requires real integrity. It is easier to take the "don't make waves" approach than it is to confront bullies, including board members and other owners. 
12. If boards operate with groups of "friends" it can be impossible to be honest and forthright.
13. It may require taking on entrenched factions or people with hardened positions. 
14. It may require breaking some preconceived notions. 
15. Many intelligent people who are volunteers would say "It isn't worth it" and so the best may choose to avoid working on a board.
16. In the best of situations is difficult. 

Approaching reserves as a budget timetable which should be used annually.
I've learned that boards may not approach reserves as they do O&M budgets. I'm not certain why that is. Some observations:

1. Reserve studies, to be useful must be used. Surprisingly some boards don't do that. 
2. Reserves are a budget item, with 50 categories. There is a timetable for each.
3. Failure to spend reserve funds to address capital improvements will increase the reserve balance, but those unattended items are waiting to be addressed. In other words, those growing reserve balances can be deceiving if the work isn't being done. 
4. Failure to adhere to timetables creates backlogs. Sometimes boards cannot catch up, in particular if appropriate funds are not collected. 
5. Backlogs can create obstacles and serious coordination difficulties. For example, a couple of years ago this HOA found itself in a situation where 16 large roofs, a major road and water mains all had to be replaced. It was done within two years. 
6. Boards need to treat reserves and reserve categories with as much care as they do O&M budgets. 
7. Boards should scrutinize projects to see if the dollars required fall within the reserve expenditure plan.
8. The easiest approach for boards is frequent professional updates. That is no substitute for proper management and control of budgets. A proper foundation is necessary.
9. Delaying such planning will only result in financial pain and maintenance backlogs, passed to future boards and to future owners.

Some substantiating charts and background information

Here's some substantiating data. Having good data is important when making decisions. Some board members have an agenda to protect and I can say from practical experience that without good information arguments become circular and some will take any position when discussing "change".

Operations and Maintenance (O&M) budgets increased modestly since 2001, but most of the costs driving owner fee increases were because of the annual increases to reserves:

Our O&M costs increased in 2015. This was a one-time situation. How to deal with this?

The board decided to reduce the contribution to reserves, to provide for the required O&M increase while stabilizing owner fees:

In other words,  the overall increase to owner fees in 2015 were 2% in that year:

The above displays an example of what is possible while achieving stability. But one board member howled about this because "It was wrong". All I can say is this. It isn't the year 2000 anymore. Circumstances have changed. This HOA put nearly 9 times the dollar amount into reserves in 2016 as compared to 2001.   Furthermore, the infrastructure is in much better condition today than it was even as recently as 5 years ago.

It's important that we recognize change when it has occurred.


How BLMH got religion about reserves
When annual reserve contributions were less than 8% of the budget  earlier boards were completely blindsided. I can see earlier boards saying "Why worry about the 8%? Let's focus on the 92%". That might seem prudent, but it was inadequate because there was inadequate information to allow such complacency about reserves.

By focusing on the 92%, the board emphasis was on Operations & Maintenance budgets. There were unintentional consequences. In the absence of reliable and unbiased reserve information, boards gave reserves short shrift. It was a 30 years void in which no outside prepared professional reserve study was prepared. As a consequence there was no force to promote change, and some entrenched board members. There is an old expression I've heard that earlier board use: "If it isn't broke, don't fix it." But it was broke.

Those boards drank the kool-aid they created as did the owners. Owners loved it, as it created lower fees. For decades everyone benefitted, but the HOA had mortgaged its future. The emphasis was on Operations & Maintenance, so buildings got painted. Mulch was spread. The streams keep running and the lawns were maintained. The facade was maintained as the infrastructure aged.

That 8% allocation to reserves was a mirage. It was fiction and it created severe financial shortfalls. Later boards discovered just how wrong earlier boards were. Significant corrections were quickly required to fund the roofing project which was already underway. Today 30% of owner fees go toward funding reserves and recent boards have moved beyond paper and pencil to spreadsheets. A lot of work now goes into managing and developing the reserve program.

History can be a good, but sometimes painful teacher.

It could have been worse. In 2001 a new management company did apparently promote a larger "Replacement Fund." So the amount allocated to it tripled in one year. Baby steps. The board began a roofing project in 2002. Simple arithmetic would reveal that reserves being accumulated were insufficient for this project. It became clear to some of the owners that something was askew as fees rose by large amounts each  and every year, nearly doubling within 10 years.  Why this change? Where was the money going? Owners were upset, but the board was nonchalant. After all, with years of experience, they were the experts. A little research into recent budgets revealed it was going into reserves. How was it to be used? Apparently to pay for that roofing project, which was delayed as the board accumulated the funds. Other project work including driveways, streams & ponds and drainage improvements were delayed, too. The board had begun the roofing project and new streets were failing within 5 years of installation.The HOA was in a serious financial bind. By 2008 it came to a head. With a National financial crisis, it was terrible timing.

The new board was comprised of owners who really thought "We have enough money" and they promoted that position. The issues were caused by waste, poor management, incompetence and so on. Their position was straightforward. With the proper board our "too high fees" would be sufficient for it all.

Reserve studies and new boards stabilize fees.
To substantiate their position a new board did authorize our first outside prepared reserve study. Management cautioned owners that "This could open Pandora's Box" and it did. In one year, 2010-2011 allocation to reserves increased another 28%.

Since then and after  additional reserve studies and a lot of infrastructure work, the annual dollars collected for reserves has stabilized. But today reserve allocation remains at about 30% of fees. Stabilizing reserves has moderated overall owner fee increases, which are now 2% or less each year. I've published numerous posts here about reserves and fees with particular emphasis on reserves. That hasn't made me very popular in certain circles at BLMH.

My real point is to avoid a repeat of the past and to provide other boards with some powerful tools. Real world examples are useful.

From 2001-2010, a period of 10 years this HOA imposed fees of $1,844,023 on owners for reserves. To accomplish this required continuous, large annual fee increases. From 2011 to 2016 or a period of 6 years the fees imposed for reserves were $2,551,492.  However, the fee increases from 2011 for reserves have been remarkably stable. In other words, there is no longer any reason for such large annual increases.

A point of stability has been reached. We can't be complacent about this. The HOA is 40 years old. At this time and into the foreseeable future urgency will be preferred to complacency.

Stability was achieved by pressing forward some really necessary infrastructure work  and building reserves for identified future conditions. T HOA has collected nearly as much for reserves in the last 4 years, than it did in that 10 year period 2001-2010. Yet at least one board member has been inclined to argue to raise contributions to reserves and owner fees to even higher levels than they currently are. Getting the gospel a bit late, as far as I am concerned.

Simplistic, automatic approaches to annual fee increases are not acceptable. They weren't in 2001 and they aren't in 2017.