Why I am Opposed to An Association Mortgage

Last year, a board member suggested that the association consider taking a mortgage to meet certain reserve funding requirements. I think it's an appropriate time to look at this subject.

I am opposed to an association mortgage with one exception, and that is an emergency.  That is the only time I would consider an association mortgage to be a viable option. Perhaps management could suggest other circumstances, such as a huge liability. As we like to say, a lack of planning is NOT an emergency!  What would be an emergency? A tornado, earthquake or other natural disaster which does substantial damage to BLMH would be an emergency. (Note 2).

Why am I opposed, you might ask? Well, it's simply this. A $1,000,000 mortgage would cost our owners about $1,470,750. That means, each owner would pay about $24.32 a month for 180 months. However, the association would only get to use about $16.54 a month, because the difference, or nearly $8 collected from each owner per month, would go to the bank in payment of interest.

That's not a good use of unit owner money! A mortgage is a special assessment, in disguise. The unit owners would pay all current association fees and in addition, a fee equivalent to the mortgage payment. If we are each currently paying $295 per month, after acquiring the mortgage, the fee would increase to about $320 per month. Why? Because the association would still be required to build reserves for future repairs and replacement. If we borrowed $1,000,000 to do all driveways in 2011, the board would be required to levy fees to replace those driveways in 15-20 years, and of course, the roofs, the streets, and so on. A mortgage is not an escape! It assures higher fees unless we ignore future requirements and intend "special assessments forever" at our association.

Here's another way to look at this. If the association raised or increased fees by $24.32 per month per owner, rather than incurring a mortgage, and did its utmost to balance collections with expenses, and succeeded, this association would collect $1,470,750 in fees over a period of 15 years. That's the same amount as a mortgage occurring over the same 15 years. There is, however, a huge difference! That difference in funds available to the association would be $470,750 more! The association could repave HALF OF THE DRIVEWAYS with that. You didn't misread me. If this association decided to take a mortgage, it would hand the bank, as interest,  a sum equal to the cost of paving half of the driveways at BLMH!

Here's some numbers, to illustrate my point.

1. Amount of loan = $1,000,000
2. Years of mortgage = 15
3. Interest rate of mortgage = 5.5%
4. 180 total payments at $8,170.83
5. Closing costs, or PMI (Personal Mortgage Insurance) would be an additional fee.
6. Amount of mortgage, per owner = $4,377.23 (Note 1).

Click on this image to enlarge:

Comments, Corrections, Omissions, References, Miscellaneous News
Note 1.  This is an example ONLY. If the assessment per owner were based on their "per share" ownership of BLMH, some owners would pay more per month and others would pay less. Interest rates and fees would also be different than this example. A mortgage might be even more costly. If interest rates are higher the monthly assessment would be higher. Loan fees would reduce the amount of principal of the mortgage and possibly raise monthly assessments.

Note 2. I am opposed to an association mortgage with one exception, and that is for an emergency. For example, the occurrence of a violent act of nature, which severely damages buildings on the property. Insurance will cover some of the necessary repairs, but possibly not all. If the association lacks the necessary reserves for its portion, that would be a reasonable and justifiable alternative to a special assessment.

That is the only time I would consider an association mortgage to be a viable option.

Note 3. An association mortgage would punish savers. How is that? Here are the numbers. Using the example, a $1 million mortgage will require payments totaling $4,377.23 per unit owner. A $1 million assessment would require a payment of $2,985.08 per owner. The difference is the interest paid to the bank to repay the mortgage. An assessment to owners would cost less than a bank loan or mortgage. Of course, that doesn't include the effects of inflation on that $2,985.08; nor does it include the interest I would collect if I "saved" that $2,985.08.

Personally, I'd rather invest the difference of $4,377.23 - 2,985.08 in a tax free Roth IRA. At 5% annual appreciation, which is very doable appreciation, I'd have $2,894.19 for my personal use after 15 years. That's better than giving it this association so they can pass it to a bank as payment of interest on a mortgage. But that only makes sense, doesn't it!

Note 4. Our current treasurer has also stated, repeatedly, that he is opposed to special assessments and that includes a mortgage. Our treasurer and I are the only current board members who have straightforwardly stated such opposition.

Note 5. This note added the morning of October 10. No one has questioned one "flaw" in this post; I'm surprised. What is that flaw? I did not mention the reduction in purchasing power over the 15 year period of the mortgage. In other words, inflation can both work for us and against us. Here's the bottom line. If the association were to take out a $1 million mortgage, it would immediately have that $1 million to spend. However, if the association were to impose an assessment to raise that $1 million, it would collect those funds over a long period of time; 15 years in the example. The purchasing power of the dollar would erode over that 15 years. As a consequence, the value of goods and services the association could purchase with the $1 million gradually collected, would decrease over that 15 year period. Does that invalidate my position? No, it does not. What this means to an association is this; if a decision is made to impose an assessment for the purpose of raising a specific amount of funds, such as $1 million over a long period of time, that fee must also be raised, at the rate of inflation, to assure that the association has access to the full purchasing power of the funds. Sounds like jargon, but in fact, that is exactly what our association does. Our fees routinely increase and for three reasons. 1) to collect and save funds to replace aging infrastructure (that's called "building reserves); 2) to cover the cost of annual operations of the association (which is money spent immediately in the current year); 3) to collect a small additional amount each year, to compensate for both the increasing prices of that which will be purchased with the reserves some day in the future (5, 10 or more years distant) and erosion of the savings in the reserve fund "piggy bank." Of course, we may hope that the interest collected on the reserve savings will completely offset the inflation. However, that does not always occur.  The bottom line: I am opposed to a mortgage. I am fully engaged in planning and preparation.

Why Special Assessments are not an Option

"Special assessments are designed as the solution for emergencies, not regular common area expenses."
.....Robert Nordlund, P.E., Reserve Associates  (1)

For the past two years I have observed an ongoing debate among unit owners and the Board of Managers regarding budgeting, fees, funding of reserves and special assessments. A few unit owners feel that fees are "too high", and I think some members of our Board of Managers are predisposed to keep monthly fees low, even though there is a question about the adequacy of our reserves.

We have a variety of people here at BLMH, some of whom are very new owners and others who have been here for 20 or more years. Anyone who has been here for more than 10 years can remember "the good old days" when fees were much lower, and annual fee increases were lower than they have been in the recent past, the year 2010 excluded. I've posted a significant amount of information about that on this blog.

Unfortunately, those same people were probably spoiled by the wonderfully low, and I do mean low, fees and sometimes negative fee increases. Yes, you did understand that correctly. Rather than fund reserves, this association, at one time, actually reduced the fees, and not just once, or twice, or three times! The consequence was low fees, reserves of less than $100,000 for an association covering 40 acres, and more than a few very happy, but totally oblivious unit owners. Some have since moved on, but many did not. Oh, in case you think this was because Illinois did not have a condominium act, think again. There were condominium laws in every state in the union by 1969. So simply having a "law" does not get a result. This applies to our association reserves just as it does to the 20 MPH posted speed, which is also routinely violated.

Fortunately for us, in 1999 a new management and a board which could and would listen, and understood section 9(c) of the Illinois Condominium Act, decided that something needed to be done. So our fees were gradually and continuously increased from the period 1999 to 2009. That board was replaced in a palace revolt or something like that in 2008 and 2009. One of our professional managers, during a recent presentation to the unit owners during an Association Meeting, used the term "mutiny" to describe this event.

In 2010, the new board, which had completely overwhelmed or replaced the previous board, decided that a 0% fee increase was sufficient. This poses the question: Are we returning to the "good ol' days"?

Well, I don't think so. Not all of us here are "oblivious" and we have more than a few knowledgeable unit owners. So we have people who understand Section 9(c) of the Illinois Condominium Act, which is very specific. It states in part:

"All budgets adopted by a board of managers on or after July 1, 1990 shall provide for reasonable reserves for capital expenditures and deferred maintenance for repair or replacement of the common elements. To determine the amount of reserves appropriate for an association, the board of managers shall take into consideration the following: (i) the repair and replacement cost, and the estimated useful life, of the property which the association is obligated to maintain, including but not limited to structural and mechanical components, surfaces of the buildings and common elements, and energy systems and equipment; (ii) the current and anticipated return on investment of association funds; (iii) any independent professional reserve study which the association may obtain; (iv) the financial impact on unit owners, and the market value of the condominium units, of any assessment increase needed to fund reserves; and (v) the ability of the association to obtain financing or refinancing."

The  operative word is "reasonable" reserves. Some people think that "reasonable" fees dictate the reserve level. That is untrue. Reducing fees is not the intent of the act, I have been told. The fees are necessary to fund operations, maintenance and for establishing and maintaining "reasonable" reserves. Our current fees are the consequence of a failure for an extended period of time, of previous management and boards under the advice of that management, to establish "reasonable" reserves in the period 1983 to 1999. However, we are today, in much better financial health. In fact, based upon some of the many HOA horror stories I have read, we actually are in very good condition. Not perfect, and perhaps not fully funded (more on that in another post).

I have sent a letter to our association management regarding the most recent fee action. I have also suggested to the President of our new board that they should consider a workshop on the Illinois Condominium Property Act and on the duties and responsibilities of the members of the board with regard and respect to their fiduciary duties and the Act. I did so from the perspective that our current board is comprised for the most part of individuals who have one or fewer years of service on this HOA board, many have no prior experience, and the board has stated during a recent association meeting that they have an interest in pursuing an education in board matters. I am very concerned that all members of the board may not understand their duties and responsibilities. It would be foolish to assume that simply winning an election "qualifies" one for the job.

I think that every unit owner should be a demand that each and every board member be willing and able to explain our fees as they apply to the operation of our association and how they comply with the statutes, and how they got to be what they are.

According to the Act, "reasonable" reserves must take into account:

• The repair and replacement cost
• The estimated useful life of the property to be maintained
• The current and anticipated ROI of the association funds
• Any independent reserve study (which includes the one submitted by management in 2009)
• The financial impact on unit owners of any fee increase necessary to fund reserves
• The market value of the condominium units
• The ability of the association to obtain financing or refinancing. 

The last item might be attractive, but consider that financing of capital repairs or improvements means that from that day forth, the monthly fees assessed on unit owners will be comprised of:

• Fees for ongoing Operating and Maintenance expenses
• Fees for accumulating Reserves for future roofing, driveway, street and other capital repairs
• Fees for repayment of loans and financing which were obtained for funding current repairs.

In other words, if this association decides to pursue a loan for capital repairs, our monthly fees will increase, because each unit owner will have an amount added to their fees each month for the sole purpose of servicing the debt. That is to say, we'll pay an additional amount each month for principal plus interest on the loan. Another way to view this is as a "second mortgage" for each and every unit owner.  

Is there any way to justify such a loan? I suppose some unit owners might view it as preferable to a "special assessment".  I also suggest that unit owners and board members who favor a loan consider the impact on unit sales. Our current treasurer has stated he is "opposed to special assessments, period". He is also opposed to loans which mask special assessments. I have to ask our board, how many potential buyers would want to purchase a unit in an association with fees which include a mortgage? Of course, the way to responsibly deal with this, would be for any such loans to include a covenant that the unit owner must pay off his portion of the loan at the time of sale of his or her unit. This would be the fair and responsible way to deal with this.  If the board stated that this is the only method under which any loans would be considered, I have to wonder if some of the support for acquiring such debt would vanish. That would indicate if those who are so willing to promote mortgaging our future, are simply doing so for their own selfish reasons, which is to say, to avoid paying their fair share of fees here at BLMH. 

However, I view a special assessment or HOA loans as both avoidable and undesirable. I also view the fact that board members would even consider financing is an indication of a willingness and preparedness to avoid their duty and put the problem on the backs of future owners. There are serious issues regarding the underfunding of reserves and delaying of fees for the purpose of collecting "special assessments" at some time in the future, i.e, strapping future owners with debt. As I have stated repeatedly, such machinations avoid responsibility and will mortgage our future. I'll quote Robert Nordlund, P.E. of Reserve Associates  (1):

"Why not just special assess for Reserve expenses when the expenses occur? It fundamentally boils down to fairness and responsible corporate planning. By nature, Reserve expenses occur unevenly through the years: some years will have minimal Reserve expenses, some years will be especially hit hard. Pieces of the corporation are continually being bought and sold, and it is unfair for owners to be subject to "good luck" or "bad luck" with respect to what Reserve expenses "come due" during the years they own a unit at an association. That is no way to treat the other co-owners of your multi-million dollar Real Estate partnership! Some owners in this scenario pay much more than their fair share, and some owners pay much less than their fair share. Boardmembers in these situations bear the additional risk of knowing when major expenses are likely to "come due", and are under extreme liability scrutiny when it comes time to decide to sell their unit… Somebody always gets holding the bag.

In most cases, special assessments as an ongoing way of conducting business at an association should not even be an option. Governing Documents of most associations specifically require an "adequate" amount of Reserves to be set aside on an ongoing basis to offset anticipated Reserve expenses. Special assessments are designed as the solution for emergencies, not regular common area expenses."


The highlighting of the text above is mine. It could be the goal of a board to assure that the bagholders are someone else. 

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References, Additions, Errors, Omissions:
(1) Definition of "Reserve Study": The art and science of anticipating and preparing for major common area repair and replacement costs."   Association Reserves, Inc "Control the future of your association"
(2) Elaborated on some of the issues.