Homeowner associations are tasked with maintaining the property of the community, and this often entails extensive reconstruction with hefty price tags. Learn how to manage your HOAs money to determine what financing options are available, and how to successfully plan and execute your next construction project.
Road Map to Financing and Launching a Project
This article will describe the road to the successful financing and launch for any HOA construction project. There are two keys elements that every successful reconstruction project has:
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Solid foundational financial analysis that determines what viable financing options are available to your association. |
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In-depth project analysis with detailed specifications and drawings. |
These two preliminary steps are fundamental to having a successful project and obtaining the financing to support it. Many steps of the plan can be completed simultaneously with the help of a knowledgeable, dedicated team. Here are some key players your HOA may want to consider investing in: Association Manager, Banker, Construction Manager, Attorney, and Reserve Study Professional.
If you’ve already planned and prepared for your HOA’s reconstruction, learn the right steps for managing a successful project. For the rest of you, let’s begin planning your project with a reserve study…
Preparing for the Project
When preparing the reconstruction project, three major tasks must be completed:
- Perform a site review.
- Create a specification.
- Request bids.
While an HOA can accomplish these tasks without the use of professional services, we recommend hiring a construction manager to oversee this process. The construction manager is selected by the board of directors and will be the HOA’s agent for day-to-day management of the project. For the purpose of this article, we’ll assume the HOA has chosen to hire a construction manager.
Each of these tasks is a necessary component in creating a successful project and each takes time to complete. Plan to spend about two weeks for the site review and another two weeks to prepare a specification. The bidding process, including delivering the specification to the contractors and receiving them back in bid form, will take three to four weeks.
Conduct a Site Review
The initial site review will determine what is required for reconstruction. Take roofing for example: the site review will reveal whether the roofs require replacement or if they can be repaired. Perhaps the sloped roofs can be repaired but the flats roofs require replacement.
A site review therefore helps determine the extent of work and the details required. If the determination is a new roof, what other components may be involved, such as siding where the roof terminates, fascia board, sheet metal and other components? All construction projects, whether major or not, require thorough detailing in the site-review.
Obtain a Specification
Once the site review is complete, a can construction manager can compile the specification. The spec (as it is often called) includes a variety of subjects designed not only to inform the contractor on how to build the project but also includes items for the safety and protection of the HOA such as:
- Insurance requirements
- Mandatory safety practices while the contractor is on site
- Payment and retention protection
- Storage and sanitation facilities
The spec also outlines change order limits in the form of line item costs and allowable mark ups. The spec will contain drawings with detailed information describing the method and materials required to perform the construction, particularly in the difficult detail areas where construction components collide. A clear and detailed spec allows the HOA to receive comparable bids from contractors while controlling the quality of the work.
The spec should also set forth warranty requirements for the work, which should be backed by material manufacturers whenever possible. The State of California requires a three year warranty, and the Uniform Commercial Code requires a five year warranty.
Solicit Bids
With the specification complete, the construction manager will choose qualified contractors to bid the work. Keep in mind that not just any contractor can work on common interest developments. The contractor must be properly insured and must have experience working on major construction projects in occupied dwellings, particularly HOAs, and be financially stable enough to carry a large construction project with a payment schedule.
The contractors will perform their own site visit, usually with the construction manager, to get a feel for the project, better understand the details and take measurements. From this information, the contractors will fill out the bid form and submit their quotes to the construction manager by a pre-determined deadline. The construction manager will review and compile all of the information received from the contractors in a summary spreadsheet that is provided to the association board for their review. The board, in consultation with the construction manager and association manager, chooses the contractor to perform the work.
Loan Application Process
Associations may finance a project through savings (reserve funds can cover reserve expenses), special assessments, bank loans, or any combination of those options. Because most associations are familiar with special assessments, we focus on bank loans in this article – a common option for urgent repairs when cash isn’t readily available.
Begin with a Reserve Study
Reserve studies are an important component not only for the financing of your project but as an incredibly useful tool for the association to understand their future needs for maintaining the property. A full study is required once every three years, and it should be reviewed annually for three years thereafter (Civil Code Section 5550).
A bank will need a current reserve study to assess whether or not the association will be able to repay the loan, continue funding future needs including reserves, and pay planned expenses throughout the term of the loan. The bank will assess the quality of the study and the professional that prepared it. This key component adds time to the process: two to four weeks for an annual review or update of a study more than one year old or six to eight weeks for a new study if your current one is older than three years or if you’ve never had one completed in the past.
Reserve studies are a critical and required component to financing, so be prepared.
Questions to ask about your HOA’s reconstruction project:
- What components in the study are included in the planned project?
- Will there be any other components to be worked on during the life of the loan?
- Should they be bundled with the current project?
- What other expenses will there be during the life of the loan?
- Will work on other components need to be delayed during the life of the loan?
Preliminary Financial Assessment
A preliminary financial assessment will be completed by your bank to aid in the determination of your repayment source—whether it can be from current cash flow, a combination of current reserves and current cash flow, or whether a partial special assessment or a full special assessment is needed. This will prove helpful as you explore your options and build your plan. Your bank should be your consultant throughout the process. This process will take somewhere between four to six weeks. To conduct this preliminary assessment, the bank will look closely at the following items:
Association Size: The larger the HOA, the less concentration in the repayment source for the loan, which come from the monthly assessments.
Monthly Assessment: Assessments are the primary source of repayment for the loan and are critical to the cash flow analysis. If the current assessment stream is not sufficient to cover the loan payment plus continue to reserve and cover operating expenses, then some special assessment may be needed to qualify for the loan.
Rentals: The lower the percentage of rental units on the property, the less risk there is for interruption of the repayment source, since there tends to be more commitment if a unit is owner occupied. A rental percentage higher than 25% – 30% is typically considered as additional risk.
Foreclosures: These pose a serious impediment to assessments and would be included in the delinquency percentage that a bank would review.
Project Amount: By this time you should have a good idea of the price tag of the project. This, along with a contingency amount, should provide a number for your bank to conduct its analysis. Banks will generally finance a portion of the entire project.
Association Management: An experienced, reputable, professional manager with credentials is an extremely positive influence and will be a critical member of the team that will ensure a smooth and successful process.
Financial Documents: Current year budget along with quality CPA-prepared financial statements will reflect the cash flow of the association.
Reserve Study: A quality study, prepared by a reputable, experienced company, will be used to ensure that future major expenses are accounted for.
Accounts Receivable Aging: Delinquencies are an important consideration for banks. Remember, that the cash flow of the association is the primary repayment source for the bank loan. Banks will look closely at your historical account receivables and collection policy to ensure there is not a consistent high level of delinquencies and that you are diligent with your collection efforts. Generally, banks look for delinquencies to be maintained below the 5-10 percent range. Here are two important tips about your monthly account receivable reports:
- Keep your accounts clean. Remove old fines, interest charges and other fees that drive up your delinquency percentage and move them to your “bad debt” account and off the report. Banks will look at your bad debt line on your financial statement to ensure it is not excessive, but these small or uncollectable delinquencies belong there, not on your account receivable reports.
- As soon as there is a new owner, whether it is a new resident or a bank, beginning to pay assessments, move the uncollectable delinquent balance to “bad debt.”
Bank Proposal
At the end of the preliminary financial analysis, the bank will provide you with a proposal. The loan is considered an unsecured commercial loan to the association; it is not a loan to the homeowners. There are no liens placed on individual homeowner units. As mentioned above, banks will generally finance 70 to 75 percent of your project costs. In addition to the amount they will finance, most banks will have the following elements in their proposals to you:
| Draw Period | 6-18 months for construction period of project |
| Term Period | 1-15 years |
| Interest Rate | Either fixed or variable interest rates are available |
| Fixed Rate | 6-8% (at the current time) |
| Variable Rate | Bank’s reference rate plus 1.5-3 percent |
| Application Fee | $0 – $3,000, generally refunded if the loan is declined |
| Loan Fee | 1-2 percent of loan commitment |
| Prepayment Fee | Generally none on variable rate loans, but there may be a fee on a fixed rate loan |
These rates and fees change frequently and by bank; check with your banker for its current loan pricing. This provides you with a good sense of all the elements that will be part of a loan.
Formal Approval
A vote of the membership is generally required if a special assessment is needed or to obtain approval for a loan; check your governing documents. If so, once you have the bank’s proposal in hand, with the aid of your attorney, you will be able to develop and articulate the special assessment and/or bank financing in the official ballot.
As soon as membership approval is secured, the bank will proceed with formal approval. The association will trigger this by accepting the proposal and returning it to the bank. The remaining documentation and information required may include:
- Additional Financial Information–Includes tax returns and bank statements.
- Contractor Information–Includes name of contractor selected, contractor’s license, proof of workers compensation, and proof of general liability insurance.
- Approved Ballot–From the homeowners vote. Should also include an opinion letter from legal counsel.
- Final Budget–Will be provided by construction manager.
- Governing Documents–Includes articles of incorporation, CC&Rs, and bylaws.
- Other Information–Such as board minutes, board member listing, and homeowner listing.
Loan approval and documentation will take two to three weeks, and then, you are ready to begin!
Project Launch
Many tasks are required prior to the project launch including signing the contract by both the HOA and the contractor, a Notice to Proceed, preconstruction site review, color choices and final schedule. These tasks are time consuming and involve a lot of different people arranging their schedules. Allow a good four to six weeks to complete everything needed to complete these tasks. If attorneys are required, double this time frame.
Signing the Contract
Often boards require more than one member to sign contracts of major expense. This will require getting both parties to sign the contract before it is returned to the construction manager. The construction manager will then contact the chosen contractor to also sign the contract to fully execute the document. Copies are returned to each party and a Notice to Proceed is issued to the contractor.
Notice to Proceed
The Notice to Proceed is an official document telling the contractor he is to start the project and what is required prior to job start. The contractor will have to provide a copy of his current state contractor license with proper designation for the work to perform (i.e. roofing requires a C-39), a current certificate of insurance showing the required coverage, a preliminary schedule, a site map with possible construction yard locations, an emergency contact list naming the project manager and the superintendent in charge of the project, and 24 hour contacts for emergencies.
Preconstruction Site Review
The construction manager will now schedule a preconstruction site visit to discuss the details of the project. The construction yard location will be chosen determining which location minimizes impact on the residents. Each building will be reviewed to determine access and equipment set up to minimize the effect on homeowners and occupants during the construction work.
Construction workers’ personal vehicle parking will be reviewed. Often the complex will not have sufficient parking to accommodate the construction technicians’ vehicles.
The preliminary schedule will be reviewed to determine what building order the work should proceed. This is often determined by the buildings with the greatest needs. The safety of the occupants and workers during construction will be carefully considered. The final schedule will be discussed and the specification and details reviewed prior to the project launch.
Selecting a Color Scheme
Choosing colors can often be the most time consuming portion of the project. When reconstructing a roof for instance, not only does the roof color have to be chosen but also gutter, downspout and edge metal colors. This often requires visits to other complexes to get a feel for the colors being chosen. Typically the more people involved with color selection the longer it takes.
After these final tasks are complete, the project is ready to start. Since planning a major reconstruction project is a timely endeavor, we recommend starting the process in the fall and plan on a spring start to take advantage of dry weather. This schedule will allow enough time for both the planning portion of the project and securing the necessary funding.
Teresa Powell is the senior vice president in charge of community association business at Focus Bank. Brian Seifert is the chair of the ECHO Maintenance Resource Panel.