Financial Articles

Rainy Day Planning
A homeowner association (HOA) board's responsibilities can be summarized as "the maintenance and enhancement of association property and harmonization of the residents." To achieve these objectives, rainy day planning prevents disaster from "raining" down. Rainy day planning is anticipating events far in advance and being prepared to deal with them.

One key rainy day planning strategy is the scheduling and funding of future repairs and replacements, called "Reserve Planning". A Reserve Plan is the outcome of a "Reserve Study" which identifies all the grounds and building components for which the association has maintenance responsibility that have a 3 to 30 year life span. Each component is measured, assessed for condition and repair or replacement cost computed. This information, when combined with an inflation factor, tax considerations and return on invested reserves, produces a custom thirty year maintenance schedule and funding plan designed to keep the association assets looking good and home values their highest.

Reserve planning became popular in the 1980's when twenty year old homeowner associations started falling apart. Twenty years is the time when roofs, siding, decks, fencing, pools and roads begin to fail. HOAs that failed to anticipate these events ended up in a series of large and unpopular special assessments. Above the wailing and gnashing of teeth was overheard the cry, "There must be a better way!" Indeed.

Reserve planning identifies predictable events and charts a plan that is fairly funded by all owners along a thirty year time line. Bottom line: No more special assessments and a system that anticipates the knowable.

It’s common for certain owners to resist paying money for reserves. It’s human nature to put off until tomorrow and hope tomorrow never comes. Here are some of the common saws: "Assessments are already too high" and "I don't plan to live here that long". These statements are both self serving and short sighted. A reserve plan pays only for assets being used up. It’s like refilling the tank of a rental car before returning it. You only pay for the gas used. Similarly, roofs, paint, roads and other association assets get used up. With reserve planning, the people that get use of them pay for the part they used up...no more, no less.

From a board’s perspective, planning for future repairs and replacement is part of fiduciary responsibility. Often, there are millions of dollars of assets in the board’s safekeeping. And more importantly, the board is entrusted with the biggest and dearest asset most people have...their home. Reserve planning recognizes the importance of that trust.

Prospective buyers also consider the issue of reserves. No reserve plan and little money set aside exposes the buyer to a frightening reality: Special assessments are certain but when they will fall is uncertain. Wise buyers steer clear of such ill prepared HOAs. Lenders also consider reserves when making loans since the ability for the association to maintain its assets directly impacts a lender’s collateral. Attracting buyers and financing is fundamental to sustaining high market value. If buyers and lenders go away, home prices drop.

In many states, reserve planning is described in or mandated by law. It is also an accepted planning standard nationwide. It is fair to all owners and maintains the association assets systematically and responsibly. It’s the right thing to do. Before disaster rains down on your community, have a Reserve Study performed and begin funding it now! BACK

The Taxman Biteth
One of the reasons that municipalities mandate a homeowner association upon developers of new subdivisions is because they can require the HOA to pay for and maintain services that ordinarily would be provided by the municipality. This shifts certain responsibilities from local government to the HOA. For example, HOAs are often made responsible for infrastructure like roads, street lights, street signs, park maintenance and other services that other property owners receive from the municipality.

The sticking point is that while HOA property owners pay for these services directly, sometimes there is no credit given on the property tax bill for services not received. Essentially, HOA owners may be paying twice for some services. And instead of the tax assessor making a reasonable adjustment to all affected HOA property tax bills, individual HOA property taxpayers are forced to protest their taxes through a complex system designed to confuse and deter even the most dogged tax protester.

Since the HOA itself usually owns no property and pays no property taxes, the association cannot by itself automatically represent the owners in a class action tax protest. State law may, however, allow individual owners to grant that right to the association if they want to and, of course, pay the extra cost. The advantage would be to share the cost of a knowledgeable attorney to handle the tax protest.

So, are your community owners being taxed twice? Good question. For that, you need to examine the property tax bills for the details. If items appear there that are being taxed yet no service rendered, it may be time to make your case. Of course, being right doesn’t always justify the fight. The potential tax savings should be worth the effort to get them. But bite the taxman back if you can. BACK

Collect Correctly
Correct collection of money is essential for maintaining a strong homeowners association. If some don’t pay, guess who gets to? (CLUE: You. There is no government bail out for HOAs). Failure to pay assessments puts an unfair burden on those who do pay and impacts the ability to properly maintain the structures. Delinquencies are financial dryrot and must be arrested early to prevent extreme damage.

There are several elements to a good collection policy:

Accurate Bookkeeping. Failing to track payments undermines the association’s right and ability to collect delinquencies. It’s extremely important that payments are accurately and promptly recorded.

Late Payment Policies. Without a late payment penalty, association fees sink down the stack of payment priorities. The trick is to make the penalty severe enough to keep it on the top of the bill pile. A strong collection policy encourages timely payment, discourages late payment and allows payment plans for financially distressed owners who legitimately need more time (especially with special assessments which are unfair to begin with). Late charges must be high enough to promote action plus uniformly and strictly imposed.

Timely Enforcement. Written delinquency notices should be sent according to schedule (regardless of what an owner may promise by phone) to maintain the association’s legal rights. This means sending, for example, a Late Notice to all delinquents on the 10^th and a Ten Day Notice to Pay after another 30 days have passed. The Ten Day Notice should clearly state that after 10 days, collection will be placed in the attorney’s hands and additional attorney charges added. (Your governing documents may dictate different deadlines.)

The longer that the association waits, the more difficult collections get. Failure to process delinquencies promptly gives the impression that the policy is meaningless or that enforcement depends on "who you are". Also, if an owner is truly in financial trouble, the chances of mortgage foreclosure or bankruptcy increases daily and can seriously reduce the recovery of assessments.

Accurate Information. When a collection is turned over to the attorney, complete information is very important. The attorney needs the name of the owner of record (name on the title), owner’s mailing address if different than the unit address, and a complete and accurate breakdown of all charges and credits from the last date that the account was paid in full to the present. Failure to provide complete and accurate information causes unnecessary delay, additional expense and may affect recovery.

Efficient Collection Services. Your attorney should immediately review the new file to ensure all necessary information is included and to check for inaccuracies. The title insurance company should be consulted to confirm the owner of record and to reveal any existing liens, taxes, mortgages, mortgage foreclosures, divorces, estate probate, bankruptcy or other matters that affect the title. After reviewing the title information, a "Notice and Demand" letter is sent to the owner of record and the delinquent owner has a statutory number of days from the date mailed (usually 30) to pay the balance in full. The charges include the title search and attorney fees.

After receiving the letter, many owners call the attorney to discuss the debt. Sometimes this reveals an error in the association's records. Usually, however, the association has a valid debt that the owner must pay.

If the owner fails to make payment by the deadline, the association has the right to place a lien on the property to secure the debt. The association may also have the right to suspend privileges like access to the pool and voting. There may also be the right to terminate association provided utilities. Foreclosure may be an option of last resort, however, each state has procedures on if, when and how that is done. These options should be discussed in detail with the attorney.

Each stage of a good collection policy contributes to the final success. Combining accurate bookkeeping, late payment policies, timely action and efficient legal services set the stage for quicker payment, more money and fewer delinquencies. Collect correctly to avoid the avoidable. BACK

How Mortgage Rates Are Set
Many home loan experts have predicted that 2002 will be a record year for mortgage loans because expanded economic growth next year along with lower interest rates. Some have been talking about mortgage rates in the mid 5 percent range. But rates skyrocketed in November 2001 to levels not seen since summer. In fact, the 30_year mortgage rate was about 3/4% higher than four weeks previously. What happened? Didn't the Federal Reserve cut rates 11 times in 2001?

Actually, the short-term Funds and Discount Rates controlled by the Fed have little to do with long-term fixed-rate mortgages. They're designed mostly to stimulate the economy by making it less expensive to borrow short term money. But in November there was a perception that the economy would turn around and that stock values would move higher. As a result, investors buy stocks in expectation of higher values. If investors put money back into the stock market, they're probably taking that same money from other investments such as treasury bills, treasury notes and mortgage backed securities.

Of late, there's been quite a bit of selling of these traditionally lower-yielding investments. When there are fewer buyers of a fixed note, the sellers have to lower the price of that note to attract buyers, which also increases the yield on that note. Suppose a $1,000 note pays 5 percent interest. If investors bid up the price of the note to $1,100, the value has increased but the interest rate remains 5 percent of $1,000 or $50. $50 per year is equal to an interest rate of 4.545 percent for an investment of $1,100. Now imagine that the note price falls to $900. There is still a $50 annual payment. An investor who acquires this note for $900 will yield 5.556 percent.

When investors generally switch from bonds to stocks, bond values fall __ and yields rise. When investors flee the stock market and look for safer investments such as bonds and notes, prices rise and yields decline. The bottom line: Mortgage rates reflect the price movements of notes and bonds, especially 10_year debt instruments. Why 10 years? Because that's about how long many mortgages remain outstanding as people move or refinance.

Higher yields mean higher mortgage rates. In fact, the 6% Fannie Mae mortgage bond has lost nearly 200 basis points since early November. And it appears that the record low rates seen earlier are in the rear view mirror. While no one can predict where rates are headed, if current trends hold and investors see a light at the end of the stock market tunnel, then higher mortgage rates will result.

If you've been floating your current mortgage refinance application, it might be prudent to reconsider. If rates have increased by as much as 3/4 of a percent and you're hoping they'll go back down, well, good luck. If rates move back down or go below recent record levels, that also means that our economy is still anemic and investors are pulling money out of stocks. And aren't we really ready for a recovery? By David Reed for RealtyTimes.com BACK

Board Denial
The Board of Nottacare Condominium has just convened to discuss a painful but avoidable issue, a special assessment. The roof is five years overdue for replacement and many of the temporary patches have failed, drenching four different units repeatedly. Mary in 1A has made many desperate appeals that something be done and Bob in 4B peppers his demands with four letter Anglo-Saxonisms. The other two owners are talking to their lawyers. There is a smell of tar in the air. And as bad as it is for these residents, the cure will be painful for one and all.

Nottacare's situation is not unlike that at many HOAs across the country. Nottacare's failed roof is what accountants call "an unfunded liability". A liability is a debt or obligation, in this case, the obligation is to replace a roof. Unfunded means there is no money to fulfill that obligation. Do the math: UL + $0 = MSA. (Unfunded Liabilities + No Dough = More Special Assessments) Caramba!

Most HOA boards trip merrily along seemingly oblivious that all things wear out, ignoring the high costs of imminent repairs, failing to prepare for those events and clueless how to overcome being clueless. Denial is not a river in Africa. It's a deadly mindset that not only leads to erosion of HOA assets and home values but also creates a pervasive mistrust, hostility and resentment within the community. So at Nottacare Condos, some are wailing "Raindrops Are Falling on My Head" and all are steamed because here comes another unwelcome and unfair special assessment!

Okay, you get the picture and it ain't pretty. But the good news is that Nottacare is a mythical place and your HOA is real and the Board fully prepared to meet these challenges. What's that you say? You just had a special assessment or the Board's talking one up as we speak? Holy guacamole! Don't they know that special assessments are the product of poor planning? Don't they know they penalize innocent victims (the current owners) that are forced to pay for former owners who bailed out before the ax fell? Don't they know a properly funded reserve study could have avoided all of this and made them heroes instead of zeros?

A reserve study is a scientific approach to analyzing future repair and replacement needs and charting a maintenance and funding plan that the Board, the manager and members at large can follow with ease. It answers the bottom line question "How much is enough?" The funding plan shares costs fairly among all owners, not just the poor suckers who get stuck at special assessment time. And with money in the bank, the Board will never have the excuse of not doing things when they need doing. No more Raindrop Water Torture. The place will look so good, you'll never want to move!

Denial is a dangerous place to be. There is lots of turbulent water and crocodiles waiting to munch the Board in denial. Before you round the bend and meet face to face with avoidable catastrophe, investigate the benefits of a reserve study. BACK

CYA: Cover Your Assets
From time to time, a story is run about a homeowner association that had thousands of dollars embezzled by a trusted manager or board member. More times than not, the story is never told. Because of the embarrassment to the Board caused by these events there is a natural tendency to sweep it under the carpet. But let's face it, when thousands or millions of dollars are dangled as bait, someone, sometime is likely to take a bite. It happens and it could happen to your HOA. But there are things you can do to avoid such calamity. Use the CYA formula: Cover Your Assets.

If Managed by a Property Manager:

Maintain control of your funds by keeping both operating and reserve accounts in the name of the homeowner association.
Limit the size of the check the management company can sign keeping in mind regular expenses like utilities and service contracts. In other words, don't limit the manager to $500 if the monthly water bill averages $1500. Set a limit that allows the manager to deal with the routine. Anything above that amount should require the signature of the Board President or Treasurer or other officers included on the bank signature card. It's best to have the President sign whenever possible.
Writing checks or transferring funds from the reserve account should be restricted to authorized Board members only since the need to access reserves is infrequent.
Make sure your manager has a fidelity bond in an adequate amount insuring the HOA against loss. The recommended formula is the amount held in reserves plus two months regular assessments.
Send duplicate bank statements to the Board President. It may cost a bit extra but it's a deterrent to a would be embezzler to know someone is watching.

If Managed by Board or Employees:

Purchase Fidelity/Employee Dishonesty Insurance in an adequate amount that includes wrongful acts of officers and managers.
Restrict check signing authority to the President and Treasurer.
Require the checking account be balanced within a week of receipt of statement.
Send a duplicate bank statement to the President.
Never pre-sign checks
Keep blank checks secured

In General:

Have a CPA perform a full audit at developer or property manager turnovers or at least every three years, annually if the budget is large ($100,000+) or when state law requires.

When it comes to handling HOA funds, a CYA policy is absolutely essential. Setting boundaries is healthy for all money handlers, reminds them that others are watching and builds trust among the members. Remember to cover your assets and you won't have to cover your...well, you know. BACK

Budgetizing the HOA
Money is the grease that makes a homeowner association's wheels turn. Having enough of it in all the right places ensures the common elements are maintained and member property values sustained. While HOAs have their own governmental system, they have the ability to draw the members into the budget process in a way big government can't. With a bit of planning, the budget can be a harmonizing exercise instead of a battleground of discontent.

Philosophically, it's important for the board to adopt a "we're one of you" attitude because, frankly, it's true. All HOA members, including directors, pay their share of the HOA freight. Even if the board has the power to unilaterally adopt the budget, approaching it as a consensus building exercise will work wonders in how the message is received.

Form a Budget Committee. It is often difficult to get members to volunteer for board positions but getting some to serve on a Budget Committee is not so tough. There are always a certain number of bean counters out there that would make time for a 4-6 week stint crunching numbers. Targeting CPA or bookkeeper members is logical but there are others that can provide valuable service, particularly if they are long time residents who know the HOA's history or have served on a past board.

Poll the Members. Asking the members for budget suggestions is usually largely symbolic, like raising the flag and see if anyone salutes. There may be a couple who do but most don't even notice. But the mere fact that all are asked goes a long way toward building support. Those that respond may be thoughtful or total flakes but the board doesn't need to commit to including the suggestions, only to consider them. Gather this information the month prior to Budget Committee meetings so it can be included for consideration.

Budget Review Meeting. Once the Draft Budget has been compiled, a Budget Review Meeting should be scheduled. This could be part of a regular board meeting if the budget is simple or a part of a special meeting if the budget is complex or contentious. All members should be invited and encouraged to attend. A formal presentation should be made and presenters prepared to answer questions or justify line items.

Budget Approval. After the review is held, formal approval of the budget should take place. If this requires a quorum of members to vote, sending out formal announcements, ballots, etc. are in order. If the board has the authority to approve the budget, it's still a good idea to inform the members when and where that approval will take place. It should happen at least 30 days prior to the start of the new fiscal year. Assuming the budget has increased (and it usually should due to inflation alone), the board should give members at least 30 days notice of any homeowner fee change.

Circulate Approved Budget. Once the budget has been formally adopted, a copy of it along with detailed notes explaining each line item and a side by side comparison of the past and future budgets should be sent to each member. A cover letter should explain what the new homeowner fee will be if equal or include a matrix showing the different fee levels if prorated by percentage or fraction. This would be the perfect time to distribute payment envelopes and coupons if you use them.

The whole budget process generally takes 4 to 12 weeks from start to finish depending on complexity and the requirements for approval. There are few exercises that have a more profound effect on the HOA's destiny so don't downplay it. The budget is a chance for a new beginning, improvement and team building. Don't miss the opportunity to engage the members. BACK