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Reserve Budgeting – One Day… or Day One

Boards can have a very difficult time budgeting for reserve project expenses as community members often don’t see the point of saving for component project expenses many years into the future. There is a perception that the homeowners in the community at the time of the replacement project should be responsible. This view often spills over into Board decisions as they are pressured to keep dues as low as possible, an easy situation to fall into when projects costs like roofing or asphalt resurfacing can be decades into the future. I’m going to touch on some of the more common reserve budget issues we see regularly and provide some examples of scenarios that we have encountered.

 

One Day Funding Strategies versus Day One Funding Strategies

Common interest communities have elected boards that make annual budgeting decisions for one fiscal year at a time. We see well-meaning Boards making long term budgeting decisions years in advance; they may plan on a special assessment 5 years down the road or decide to phase project costs over many years instead of a more cost effective route of doing a project once. Even though these may be well meaning there is no requirement of these future Boards to follow this plan so the current Board has essentially made a plan for someone else to try to implement later with no binding power. This is a common scenario and results in the can being Kicked Up The Hill (Link: Kicking the Can Up The Hill - Inflation & Costs) continually until the deferred maintenance has impacted marketability and costs has risen significantly.

 

Example: A community we were working with kept putting off an asphalt resurfacing (overlay) project as it would cost about $120,000 per their bid and would require a special assessment due to an insufficient reserve account balance. After an additional 5 years the asphalt had deteriorated to a degree that the vendor would no longer do a resurfacing (overlay) project and instead stated they would have to do an asphalt replacement project (remove old asphalt and put new base down). The final costs were $215,000 for this asphalt project; pushing off the project ended up costing them about $95,000. They still had to special assess the members but now it was approaching twice the amount that was originally estimated – and only because they decided to kick the can up the hill.

 

In looking back at the history of their decisions the past Boards had acknowledged that they were well aware of the asphalt that needed to be resurfaced but opted to plan for a special assessment a few years later. So what happened a few years down the road… you guess it that Board also decided a special assessment would be needed just not in that year either. So how can numerous Boards  be aware of the project but still ended up in a worst case scenario which resulted in lower market appeal in the community, unhappy community members and a project costs that skyrocketed?  They just decided to refrain from acting now; they chose a One Day scenario, instead of a Day One Funding Strategy. The very first Board (and the next three) really should have made decisions for their fiscal year, the project was needed then yet decisions were made to place this difficult task of a special assessment, dues increase or both on the shoulders of someone else, a very costly mistake for the community.

 

**Reserve Analyst Advice
Do what can be done now and make decisions that will make a difference in the fiscal year that the Board is responsible for, a Day One funding strategy, and relay the message to the community that putting things off will only result in higher costs and the potential for marketability issues in the community.

 

Budgeting for Reserves is to Offset Ongoing Deterioration

Reserves are for current deterioration (use) of the common areas in the community. Members living in a community should have a view that it is only fair that they pay their fair share into the reserve account for the use of the common areas. This can be a difficult concept to convince people of when at the same time you let them know the dues must be increased. Everyone wants to do the right thing until the bill arrives in the form of the monthly dues.

 

Example: A condominium community we were hired to complete a reserve study for was concerned about their reserve account sufficiency after a recent water leak in the roof and being told by the Vendor that it needed to be replaced as soon as possible. The vendor gave them a bid of $72,000 to replace the roof and they had $16,000 in the reserve account (an amount they felt was sufficient before this roof bid). So the Board was obviously concerned and community members didn’t understand how there was essentially no money for the roof even though they had been paying dues that they felt were already too high.  

 

In fact we found this community had much lower dues than what they really should have for the prior 24 years; this roof was approaching 25 years old and prior community members had been paying in to the reserve account only an amount that was enough to pay for the smaller project expenses like painting and minor repairs. The community had not reached an age where they had yet encountered a roof replacement project , or numerous others like, asphalt overlay, siding repairs, etc. So what they had been viewing as “sufficient” for 24 years was now dramatically shown to be very “in-sufficient”.

 

This community had gone 24 years without any issues and 24 years’ worth of Boards and Members felt that they were doing a great job as dues were kept to a minimum and the site/building looked great to them. After our analysis were able to show them that the prior budgets were just not taking into account the true long term costs.  The community members should have been paying a much higher amount to the reserve account for the prior 24 years – they utilized the roof (24/25 Years = 96% of the deterioration occurred in this first 24 year period) and should have paid their fair share into the reserve account, an amount that should have been 96% of the cost. Underfunding the reserve account instead resulted in a situation where only the members in year 25 were paying for 100% of the roof through a special assessment instead of a fair amount of only 4% (1/25 = 4%).

 

**Reserve Analyst Advice
When looking at a reserve project timeline remember the project costs may only happen at one point in time but the use of the common area is constant and the deterioration is constant. To be fair to all the community members, the project costs should be spread out to all community members over time. Placing large costs, dramatic dues increases and special assessments for predictable expenses on the shoulders of those who just happen to be living in the community during the replacement year is just not fair.

 

Board’s Changing Interpretation of Governing Documents

Another issue that has become increasingly common in recent years has been Boards changing they way they are interpreting the governing documents of the community. Within the governing documents should be an outline of who maintains what in the community; under names like common areas, limited common areas, limited common elements, etc. The issue has been that in communities where they have found their reserve account to be insufficient some Boards just change how these are being “interpreted”, as can be easily done when most governing documents are drafted in a way that leaves gray areas.

 

By interpreting that some common areas are really the Unit Owners responsibility all the sudden the reserve account seems to be more sufficient and dues are kept lower. It's very easy to do when no actual change to the governing documents occured – just how they want to interpret them. A community can absolutely make whatever alterations to the governing documents that it sees fit but they really need to be guided by an Attorney familiar with the matter and follow the protocol that is set up in the governing documents as well as statutory requirements.

 

Example: A community of townhomes we were working with had decks/lanais at each unit. Being a little over 30 years old these needed full replacement. They had a severely underfunded reserve account and, apart from a special assessment, were not in any way prepared for the very large expense of replacing them all. So what did the Board do? A few years prior the Board decided they were no longer the Association’s responsibility but now the Unit Owner’s – just like that a $175,000 project off the books. Within the few years that had passed some owners replaced their decks/lanais while others did not. Now there were grumblings from some that everyone needed to replace their decks as the older ones had become unsightly (they bordered a golf course) and they felt were hurting the marketability in the community for everyone. Then some of the people that had lived in the community for over 5 years spoke up… stating the decks had always been the Associations responsibility until just a few years ago, they felt the Association should replace them. This is not a good scenario to be in, you have one group with new decks paid out of pocket, another group who has old decks that are unable to financially pay for their replacement and yet another group who had old decks and stated they were refusing to pay for them out of pocket as the governing documents were not being followed.

 

**Reserve Analyst Advice
Utilize the services of a qualified and experienced Lawyer who can help guide a community to more accurately interpreting the governing documents – and before decisions are made. if a change to the governing documents is needed then they can also help to make sure the process is completed correctly and leaglly. In the above community they did eventually hire a Lawyer but only after one of the community members filed a lawsuit. The final verdict was that the Association was responsible for the decks, so the costs were placed back into their component list and they again had to take it into account when funding reserves. Obviously the group of people who paid for the decks/lanais out of pocket were now unhappy and probably were going to seek some kind of recourse in the matter; ongoing issues all stemming from a decisions made years prior. Changing one’s interpretations of the governing documents should not be a budgeting tool. It will absolutely result in situations like the above or worse and will likely cost much more due to legal fees and the impact on marketability in the community (Buyers and Lenders do not like pending litigation).