Boards of newer common interest communities often have the view that there’s little to worry about and fund for in the first 5 to 10 years of the community. The exact opposite is true as hiring the right experts, putting in the necessary time, effort and funding for the reserve account in the beginning will help place the community on sound financial footing for many years to come. Newer communities have the advantage of time, limited expenditures and compound interest so that the community is able to build a solid reserve account balance and maintain a healthy funding level. However newer communities need to complete their due diligence in determining appropriate reserve contribution rates and not just follow Developer based decisions.
Time is on Your Side
With most expenses of a community coming in Peak Years (years when large expenses arise all at once) a newer community has the advantage of many years of budgeting for and adequately planning for the inevitable expenses that these “Peak Year” common area components carry.
- Examples of Peak Year expenses are roof replacement and asphalt overlays which are both extremely costs and have life expectancies similar to one another. A new community will typically have 15-20 years for to adequately budgeting and plan for these “Peak Year expenditures. However these are the items we see causing communities the most problems; there is a “Head in the Sand” type approach that is usually taken to keep HOA artificially low.
Setting up a reserve account and allocating an adequate amount to it will place the community on sound financial ground where are current and future boards will be able to maintain and build on a high percent funded level. With a few expenditures in the first 5 to 10 years of a newer community the amount that can be built up in the reserve account is extremely beneficial for when those first large expense items occur many years into the future.
Compound Interest
Compound interest on the reserve account balance is very beneficial for a community in the early years as the interest income is allowed to grow with few large scale expenditures draining the reserve account balance. Obviously if a reserve account is not set up and adequately funded for, the benefit of this compound interest is never realized and the total cost to the membership of the community is higher. Interest income on the reserve account balance is a positive factor for a community’s reserve account balance versus the much greater influence of the ongoing negative compounding inflationary factors and deterioration factors which are happing every day.
Developers Usually Keep HOA Dues Artificially Low
When developers are selling a home / unit in a new community they market the low-cost lifestyle of a common interest community. These marketing tactics often time give buyers an inaccurate long-term view of the real projected expenses associated with the community. Additionally developers usually have extremely low HOA dues in the hopes of attracting more buyers during the marketing period during and after construction of the community. This practice typically has a negative impact on the community’s longer term financial health as the artificially low HOA dues often places the community in a low to fair funding range; where the risk for reliance on future special assessments and loans are highest. Artificially low also make it much more difficult to raise dues at a later date (to a realistic level) as membership has gotten used to paying unrealistically low HOA dues and will fight any significant increase; most families are on their own budgets and have purchased homes which are in line with these budgets – significant increases to the required HOA dues tightens their personal budgets even further and are a tough sell in this economic environment.
Statutory regulations and the community governing documents of a community often list restrictions on the amount HOA dues can be increased in any given year. This is a significant roadblock for Boards which are trying to increase HOA dues but can only increases a certain percentage annually. This can be especially problematic in a newer community which has artificially low HOA dues. We often see newer communities with HOA dues 75% or more below what they should ideally be collecting. Without any type of verification most of these Boards are surprised to say the least when a reserve study is completed.
Solutions for a Newer HOA or Condominium Community
- Best Solution
The easiest solution would be to have a reserve study completed by the developer. A reserve study completed for a developer during or right after construction of the community will provide the Developer, the Brokers and the Buyers with adequate and realistic long term cost projections with respects to the common area component replacement / repair costs. The Developer can then set realistic HOA dues and the corresponding reserve account allocation rate before any vote is necessary. There are no issues with different Board or Community Members blocking increases and no governing documents that the Developer must Follow (they have the sole vote at this point). The Developer can also create and fund a reserve account for the Home Owners Association to inherit. - Fair Solution
The second best option is that once the management of the community has been turned over to the Home Owners Association (from the Developer) a reserve study should be completed and widely provided to the community membership so the Board and Membership can have a real discussion on how they are going to address adequately funding the reserve account. At this point the Board will usually have to deal with HOA dues that are artificially low, governing document restrictions (only allowed to increase dues a certain amount) and a lack of interest in the topic by the community. Overcoming these hurdles at this point can be challenging but an independent reserve study presented to the membership of the community will provide realistic cost projections and realistic funding options that can be adopted.
- Poor Solution - Head in the Sand Approach
Unfortunately the more common approach is a “Head in the Sand Approach” as the last thing community members typically want to discuss is how much it is going to cost them to remain in the community, after all they joined a common interest community for the savings not the additional expenses. Even at this point years or even decades down the road a reserve study is an excellent budgeting tool and will provide a community with excellent options to make sound financial decisions. At this point tough decisions are inevitable (assessments, loans, significant HOA dues increase) but knowing really is half the battle in the making appropriate decisions as the costs of common area replacement / repair are real and will happen regardless of the preparation, or lack thereof by the Association.
A tailored reserve study will provide funding options that a community can follow to reach a fiscally responsible path in in a realistic time period. Tough decisions may be part of these funding options but we have seen that being open, honest and forthcoming with the community membership will result in actions being taken sooner.
It's important to realize that unrealistically low HOA dues (and a corresponding low reserve allocation rate) are not in the best interest of the community in any time period. It’s the future community membership who will be paying a much higher reserve allocation rate, are required to address costs with special assessments/loans, or suffer from deferred maintenance issues if the funds are not obtainable. Since the Board is legally responsible to make fiscally responsible decisions for the community as a whole (current and future membership), carrying on any developer based marketing decisions would be fiscally irresponsible and can lead to litigation on a personal or community.
Written by Joel L Tax - Professional Reserve Analyst - 02/02/2016