HOA Boards need to keep reserve budgets fully funded
Editor’s note: This column was authored by my colleague Peter B. Miller, a reserve specialist with Miller Dodson Associates. He is a frequent author and lecturer on the subject of capital reserves. Q. Our condominium association last raised our assessments in 2010, which left us with a small surplus above our annual expenses to fund our reserve account. With no assessment increases since then, but increasing expenses, we are no longer able to meet our operating expenses, much less contribute to reserves. We are debating whether to have an annual increase so we can cover each year’s operating expenses as well as a 10 percent reserve contribution, or just approve a larger one-time increase that will keep our monthly dues amount the same for the next five years. A. Let’s break this question down into two parts: 1) the need for annual assessment increases and 2) maintaining adequate replacement reserve funds. Just like any organization, your association needs to generate adequate income to meet the annual maintenance, operations and reserves expenses. That income comes from the usual annual assessments that your association charges. This income and the related expenses it is designed to cover should be reviewed annually for any changes, including adjustments for inflation. Currently, we are being told that inflation in the U.S. is very low. What most people don’t understand is that there are two categories of inflation: the Consumer Price Index (CPI) and the Producer Price Index (PPI). HOA board members, finance committee members, and community managers need to know which to use. Both the CPI and the PPI are published by the Bureau of Labor Statistics. The CPI (previously called the Cost of Living Index) is the one that is referenced in the media the most often since it directly affects consumer prices. The PPI gauges cost increases in manufacturing and construction output. The PPI is historically twice as high. For HOAs and condominium associations, the PPI has a greater effect on how much it costs to operate, maintain and replace elements in your community. And the costs to operate and maintain HOAs are continually rising. Annual budgets need to keep up with these cost increases. This is especially true for replacement reserve funds. The 10 percent rule of thumb you’ve likely heard often is meaningless. The only way to know if your reserve fund is going to be adequate is to have a professional reserve study done. In today’s condo and HOA world, it’s safe to say that everyone recognizes the need for the replacement reserve fund to be part of the annual budget. We’ve all heard the arguments about “everyone paying their fair share” or “reserve funds prevent special assessments.” Never mind the fiduciary duty of the board or the bank loan or FHA requirements. Too many community associations still delay or ignore adequately funding their reserves. And many times these are the same people who complain about higher assessments. These two issues are interrelated – one causes the other. To make that point, let’s look at a typical horror story: Mrs. Jones, a retired school teacher living on a fixed income, is being foreclosed on by her community association. It seems that Mrs. Jones can no longer pay her annual assessments. Her own board of directors is forcing her out of her home! We will probably find that Mrs. Jones’ income has not gone down over the years. The real culprit is that the board has not funded the reserve fund over the years as they should have. And now the parking lots or roofs need to be replaced. To raise the money, the board has increased the assessments to unit owners. And all the “Mrs. Joneses” are caught in the squeeze. Like a musical chairs scenario, those unit owners are forced to pay the unfair burden when there is not enough money in reserves to pay for those major replacements. Let’s just hope that the music doesn’t stop while you own a unit. Or better yet, make sure the board of directors is adjusting the budget properly for inflation and adequately funding the replacement reserves. This column was originally published in the Charlotte Observer on December 6, 2014. © All rights reserved.