Published in the ECHO Journal, August 2008
Once an association board has made the difficult decision to proceed with a large association project—whether it is to replace the roof, siding, windows or to update the overall look of the property—the next question will be how to pay for all that work. Unfortunately and all too frequently, the existing reserve funds are inadequate. This can be a result of underfunding over time, or a reserve study had not anticipated the scope of work required—hidden damages, construction management, code changes, etc.
There are only few options for funding:
- A special assessment
- An increase in regular assessments
- Further deferral of the work
- A bank loan in conjunction with assessment increases.
Deferring the work won’t generally save much and may in fact increase the overall project costs because of inflationary factors and the possibility of additional damage to the buildings. In addition, your annual budget disclosures will have to indicate the deferral and plans for future funding. Also to be considered are projects looming in the future that will continue to need funding. That leaves special assessment or ongoing increases in the regular assessments. In conjunction with either of these options, a bank loan is often a good choice, allowing the association access to immediate funds so the work can be completed. Then payment for the project is made over time as the membership income is received.
While an increase in the regular assessments may generate sufficient funds to make the monthly loan payment and to continue to fund for future projects, it is generally better to consider a special assessment for the following reasons:
From the Bank’s Perspective
- The bank’s collateral is the association’s future assessment stream. A special assessment represents a more secure collateral for the loan.
- Once a special assessment has been voted and levied, it is a “done deal.” Homeowners are obligated to pay the full amount, whether all up front or on a payment plan that matches the bank loan terms.
- If the loan payments and funding for future reserve expenses are coming from future increases in regular assessments, the bank has no guarantee that future boards of directors will actually approve and implement the increases. Granted, this requirement would be a part of the loan agreement and in theory, the bank could force the increase; but banks don’t like to go into a project, especially for a loan of a substantial amount, with that sort of uncertainty.
From the Homeowner’s Point of View
- The special assessment gives owners the options of paying all at once or by a series of payments over a year or so, or longer time. Home owners may have an existing home equity line of credit or other funding source that they could utilize. By using an equity line, owners may be able to deduct any interest paid on the borrowed amount.
- Some owners may prefer to pay up front and get it over with, rather than paying a higher assessment rate for an extended period of time.
- Using regular assessments, your assessment rate will quickly increase more than the other associations in the area, making the units less attractive to future buyers.
- When a special assessment is chosen, only those owners choosing to pay over time will bear the burden of the bank loan interest. If regular assessment increases are used, everyone pays the interest. Owners have no option.
- When regular payments are made to the reserves, in accordance with a good reserve plan, unit owners are paying their share for the wear and tear (i.e., using up) of the reserve components while they live/own in the complex. When owners fail to fund the reserves, they are pushing the burden of paying for those components on to future unit owners and are in essence getting a free ride on their fair share of payment for the depreciation. If regular assessment increases are used to fund the current project, future owners will be paying not only for their share of the reserve funding while they are owners, but for the failure to past unit owners to fund adequately.
From the Association’s Point of View
- When a special assessment is used, as units sell the balance of the assessment would be due and payable at the close of escrow. The association can then use those payments to pay off the loan more quickly. If owners are paying through their regular assessments, it is unlikely that an early payment would be feasible.
- Future budget disclosures will be cleaner without the need to disclose the ongoing assessment increase plan. In other words, rather than having to disclose in the budget that there will be a minimum 12 percent (for example) increase each year, a board will be able to note that the project has been completed and that no other major increases are anticipated for reserve items! This is certainly a much better picture to show any future buyers.
It is generally better to allow the membership to have input on how to proceed and fund large projects. If good presentations and information are provided by the board, management, and your project coordinator, most owners will understand the need to proceed in order to enhance and protect their property values. When unit owners are given more choices, they then become vested in the success of the overall project, and there are fewer contentious meetings, letters and complaints.
Geri Kennedy is Vice President of Focus Business Bank. She has been a member of the ECHO Board of Directors, continues to serve on the ECHO Legislative Committee and several Resource Panels, and is a frequent speaker and contributor to ECHO events. She was elected the ECHO Volunteer of the Year in 2002.