Published in the ECHO Journal, May 2011
A housing tract, set amid tree lined streets in suburban Sacramento, faces huge financial problems: About 50 percent of its homeowners are not paying their association assessments, leaving neighbors with higher assessments and reduced services. Owners in default of assessments also fail to maintain their owner obligations as well; allowing lawns to brown and trash to accumulate in patios.
It’s a scenario being repeated across the country. Delinquent assessments at community associations are a direct result of the mortgage crisis. Community associations are in financial trouble because of unpaid fees from struggling homeowners. Communities are scraping to pay for landscaping, maintenance, pools, recreation centers and other amenities.
To cope with unpaid fees, community leaders are becoming creative. Many are negotiating service contracts, cutting insurance coverage and aggressively attempting to collect delinquencies from members. Unfortunately, some communities are not contributing to their reserve funds as a result. Reserve Funds refers to money the association has set aside for future repair or replacement of major components which the association is obligated to maintain. Associations must visually inspect the common areas every three years and prepare a reserve study listing all major components, the remaining useful life of those components and the cost to repair or replace them.
Boards are required to exercise prudent fiscal management of the association’s reserve funds. If the reserve fund becomes dangerously low, it means that insufficient funds are accumulating for projects. This will result in deferred maintenance and/or special assessments for those projects. If the board has properly built up reserve funds they will spend the money for the necessary maintenance obligation. Without adequate funds, projects will get delayed and major components will become neglected.
Boards may be forced to immediately increase assessments and/or impose special assessments to build reserves for subsequent required projects. Without adequate reserves, associations rely on special assessments. Since special assessments are unpopular, the tendency is to postpone major renovations. This deferral accelerates the deterioration process, detracts from curb appeal, and ultimately erodes home resale values. This lack of board action adds to the decline in housing prices and an increase in defaulting homeowners.
A reserve funding plan with regular monthly contributions from each owner is fair and insures that major maintenance is done when needed. Boards that ignore their duties to fund reserves are in breach of their duties. Deferring maintenance to avoid spending money or raising assessments is harmful to the membership. It exposes the association to litigation and potential liability for damage caused by the repair deferrals of major component items. It may also expose directors to claims of gross negligence, breach of governing documents, breach of statute, and breach of fiduciary duties. Under those conditions, the association may not be able to protect the directors from personal liability.
To lessen the impact of special assessments on members, some boards may choose to borrow funds from a bank to fund large projects. When applying for a loan, the associations must provide financial statements and disclose delinquencies. If an association has high delinquencies and/or failed to comply with statutory requirements for annual financial statements, it is possible the association will not be approved for a loan.
Associations with good cash flow and low delinquency rates are usually a good risk for lenders because of their ability and track record in collecting assessments. Therefore communities most in need due to poor assessment collection are sometimes the ones that cannot get the funding. Additionally some banks require that the association be managed by a professional common interest development manager. Self-managed associations may find it hard to get the help they need in this department.
Boards may also borrow from their reserve account to meet short-term, cash-flow problems with operating expenses. With the increase in lost income due to delinquent assessments, many communities are falling short of funds to pay for daily operating expenses. When borrowing from reserves accounts for operating expenses, boards are required to give notice of their intent to borrow reserve funds by listing it on the agenda of a board meeting. There must be a notice including the reasons the reserve transfer is needed, options for repayment, and whether a special assessment may be considered. If the board authorizes the transfer, the board must record it in the board’s minutes, explaining the reasons for the transfer, and describing when and how the money will be repaid to the reserves. Without regular assessment increases or special assessments, the repayment of a reserve loan may become very difficult or impossible.
Failure to fund the reserves per the reserve study preparer’s recommendations will lead to extra costs to the owners. Realtors and buyers are getting more wary of this under-funding problem. Buyers and lenders look closely at how reserve funds are handled by the association. Lack of reserves is a red flag for an inevitable special assessment. If purchasers are given the choice between an association with healthy reserves and one with little or none, it is an easy choice for new owners. They will choose the most solvent organization.
Lenders usually will ask: “Have there been any special assessments in the last three years? Are there major maintenance or improvement projects anticipated in the next 12 months? Are there sufficient reserves to cover those expenses?” Multiple special assessments or low reserve funds are signs of poor planning. Purchasers feel it is unfair to purchase a unit from someone who had enjoyed artificially low condo fees for years, only to have to cough up immediately a large special assessment when a major component item needs replacement.
Regardless of the economy, repairs must be made to the common areas. Therefore boards cannot ignore their fiduciary responsibility. Many communities will need to face the repairs of reserve components with special assessments or community loans. Some communities will even need to address funding of daily operating expenses because of the loss of income. One thing is for sure—communities across the nation will need to be aggressive with the budgeting and collection of assessments, become more aggressive when negotiating operating expenses and approve special assessments when necessary.
Susan Oliver is the president of Oliver Network Management, Inc., in Sacramento, The company is a member of ECHO and is also active with CACM.