You’re a member of an Association which has a $200,000 roof replacement, a $20,000 swimming pool overhaul, a $35,000 recreation building remodel and numerous other common area expenses that are expected to be incurred in the next 10-20 years. You as a member utilize these common areas everyday and happily live the life of a condominium owner. This has worked out great for you and your neighboring community members. Life is good and you truly believe that this is the way to live, by splitting the cost between everyone, you are all able to be provided the luxuries that would be much too costly on your own.
Moving forward 15 years, there have been the everyday politics in the community and gossip circulates every board meeting. But this time there is a more serious issue that arises. The roof that you have utilized over the past 15 years is now showing serious signs of wear and is even beginning to leak in a few areas; it is time for replacement. This roof has provided comfort from the rain, snow, wind and hot summer sun and Association members depend on it 24 hours a day 365 days a year.
The Association Treasurer takes the podium and lets everyone know that the reserve account currently has $75,000 in it and that there will be no choice but to impose a special assessment. He says that to be fair the assessment will be equally split; $3,500 per unit and this will need to be paid within the month so that the roof can be replaced while the weather is good. A special Assessment? You don’t understand how this could have happened, dues have been paid monthly, where is the money...
- One member stands up and voices his opinion, he is upset because he just bought his unit six months ago and feels it's unfair for him pay as much as members who have lived there for many years.
- A woman who owns a 1 bedroom unit states that the larger 2 and 3 bedroom units utilize more of the roof. She says the assessment breakdown should be based on the size of the units, to be fair.
- Another stands up and is concerned that the value of his unit will fall as he is about to relocate and is planned to list his unit for sale within the next two weeks.
- A man stands up and asks about the other common areas such as the pool and recreation building. He has been pushing for years to have these overhauled and remodeled. How will these be paid for if all the money is going into the replacement of the roof?
- One member is unemployed and asks about the ramifications if he is unable to make such a large payment by the assessment due date.
It quickly becomes apparent, to you and the board, that this problem is not going to be as simple as assigning each unit a special assessment. You just hope it can all be figured out before the rain begins to trickle in.
Unfortunately this is not an uncommon scenario; we see it on a daily basis. Many of the aging common interest communities are just beginning to see some of the major expense items that Association members will incur. It can be very easy to put off adequately saving for a roof replacement which is 15 years away. The truth is that someone will have to, eventually, Pay the Piper.
As the above example shows and has been our experience, dues are rarely increased to keep up with actual inflation rates. This will result in an annual shortfall of reserve levels that will increase every year that dues are not raised to match inflation rates. Interest on reserve balances will help to offset this but are typically much less than historical inflation rates of 3-4% in the construction industry. This results in a reserve balance that may grow over the time but will fall short of the reserve balance that is necessary to pay for the cost of the common area project.
The easiest way to prevent the above situation is to adequately plan for such a common area component failure and replacement. A Reserve Study would have been an excellent tool from which this Association could have created and followed a funding model that caters to their specific needs. The above storyline highlights some of the benefits this Association would have seen from having a Reserve Study completed.
- The Association could have increased their dues modestly over the past 15 years; there would have been enough in reserves to cover the expense of the roof, the expected future expenses of the pool, recreation building and all other common area components.
- The Association could have easily followed the reserve study's recommendations for monthly dues which would have shown an annual escalation in dues that was in line with inflation rates. The Association could notify its members, in advance, of the scheduled increases so there would be no surprises.
- The dues would have been collected from members who were utilizing the common area components during the times in which they lived in the community. Association members who have recently purchased their units are not unfairly paying more than their fair share of the project cost.
- The Association and board members would have been fulfilling their duties to the members which would include making sound financial decisions for the community as a whole and over time.
Associations young and old can all benefit from a reserve study.
Newer communities will be in a more advantageous position as they will be able to benefit from time; large common area projects are likely in the distance future which allows plenty of time to adequately reserve for them. Dues can be raised modestly over time versus a large special assessment later.
Older communities will be provided a clear report on the current situation of the reserve level and they will be able to plan for future expected failures/repairs. If assessments are to be incurred they can often be minimized with adequately forethought.
Written by Joel L Tax - Professional Reserve Analyst - 03/24/2016