Financial Articles
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Greasing the Wheels
Money is the grease that oils the homeowner association’s wheels. Without it, the HOA screeches to a grinding halt. Without money, bills go unpaid, needed repairs are delayed, property values fall and tempers rise. In most HOA budgets, there is little margin for slow or no payers so attention to timely collection is essential. Yet, it’s a recurring problem in many HOAs because Boards are reluctant to enforce collection on neighbors and/or friends. But there is no government bailout for HOAs. If all don’t pay, the remaining members must make up the difference. The picture ain’t pretty.

While the governing documents empower the HOA to collect the money it needs to operate, the details on collection is left to the discretion of the Board. There is much to consider:

• Should a Late Fee be charged?
• How about charging interest on the outstanding balance?
• Bad check charge?
• Should a lien be filed?
• Should an attorney be used for collections?
• Can the HOA get reimbursed from the debtor for costs of collection?
• Should the HOA consider foreclosure in some cases?
• Can the HOA garnish wages?

The answers to these questions is "Yes". And all should be integrated into a Collection Policy that should be adopted and followed consistently by the Board and Manager. The primary goal of the policy should be to keep the HOA bill at the top of the debtor’s bill paying stack.

Since a Collection Policy is complex, it should be formalized in a Board Resolution which recites the governing document authority and the details of the procedure. As with all resolutions, it should be circulated among the membership prior to enactment for review and input. Once adopted, the Collection Resolution should be posted on the HOA’s website and attached to each attempt to collect a delinquency. That way, members know exactly what the process is and are forewarned of consequences.

Collection Policies vary in procedure but the following reflects a sequence commonly used unless the governing documents indicate otherwise:

1. Homeowner fees (dues, assessments) are due on the first of the month.

2. On the 10th, a Late Charge is applied and Notice of Balance Due sent which includes a Right of Appeal and Repayment Plan Request.

3. After 30 days, a 10 Day Notice of Intent to Lien is sent.

4. After 40 days, the account is turned over to the HOA’s attorney for further action.

5. Attorney immediately sends a 10 Day Demand for Payment letter again citing the Intent to Lien.

6. By 60 days late, attorney files a lien against the debtor’s property and may, if appropriate, invoke termination of HOA paid utilities provided to the owner, restriction to amenities (like pool, clubhouse, etc.), acceleration of fees due for the remainder of the fiscal year, garnishment of wages, seizing assets for resale (cars, boats, etc.), taking an assignment of rents if the unit is rented and other allowable options.

7. By 120-180 days late, the HOA should consider processing a foreclosure action.

Here are details on selected actions:

Late Charge. A late charge is appropriate for each month the account is delinquent. Generally, a flat fee of $10 to $25 per month is acceptable. If partial payment is received, it should always be applied to the oldest balance so that Late Fees are levied for each month there is a balance due.

Notice of Balance Due. This statement advises the debtor early of the Late Fee. It usually results in a speedy payment. The debtor may have an explanation (check’s in the mail, Post Office lost it, dog ate it. etc.) which can be considered.

Right of Appeal. The debtor may dispute the validity of the debt, especially if there are fines and other charges that are not part of the regular fees. They are entitled to appeal the billing. Of course, convincing evidence must be presented that negates the charges. The Board has the final say and Appeals should be heard quickly and not delay the collection schedule.

Repayment Plan Request. There can be extenuating circumstances like injury, disability, job loss or other unavoidable financial setback that the Board should consider in allowing a repayment plan. Repayment plans should not be granted automatically since they put an additional burden on the other members to fund the shortfall. However, filing an aggressive collection on someone that is unable to pay for valid reasons could alienate an otherwise good neighbor, unnecessarily increase the debt on someone who can’t even pay the principal and tip the debtor into premature bankruptcy. If there is a reasonable expectation of financial recovery, it’s often in the HOA’s best interest to work with the debtor.

In general, repayment plans should serve as a stop gap measure only and extend only a few months. The plan should be strictly adhered to so the HOA doesn’t lose ground as time passes. Approving the plan needs to be considered in the overall scheme of the HOA’s cashflow. If the HOA needs every penny every month, approving a repayment plan means others will have to ante up the cash so bills can be paid. This translates into a "special assessment"(the longest four letter word there is). In other words, if the HOA has no excess cash to draw on, the members should approve the plan.

Notice of Intent to Lien. This warning notice advises the debtor of the costly consequences for non-payment. In most cases, outstanding balances are resolved before the deadline.

Lien Recording. Recording a lien against the debtor’s unit/home is the most important collection action the HOA can take since it secures payment of the balance due. It is very important that the lien be properly prepared and recorded. A knowledgeable HOA attorney should always be used for this purpose.

The attorney will need:

• Copies of all notices sent to the debtor.
• Copies of appeals, repayment proposals and responses, if any, from the debtor.
• A copy of the unit deed verifying who the legal owner is.
• Mailing address of the legal owner.
• Property Tax ID number.
• A current account balance with all charges detailed including late fees and interest charges.
• Copy of the Collection Policy.

Acceleration of Assessments. Some governing documents provide the right to accelerate the balance of the current fiscal year's assessments in the event of default. Invoking this right is subject to the Board’s discretion which includes the number of times a particular owner has been delinquent and the amount of the delinquency. If your HOA has this right, it’s best for the Board to establish the criteria under which it is invoked (like, if the debtor has been delinquent twice in the previous 12 months or the balance exceeds, say, $1000).

Foreclosure. Foreclosure of debtor property is the most extreme form of HOA collection and not particularly easy to pull off. The HOA must be able to buy out prior lien holders like lenders and, possibly, the IRS. Debtors enjoy Homestead Right protection in most states which protects tens of thousands of dollars of equity. After all prior lien holders are satisfied, there must be enough equity remaining to justify the action, that is to say, to pay the outstanding balance owed.

Foreclosures are politically charged inasmuch they usually involve a person’s home. If the owner is disabled or elderly, the issue gets even more sensitive. For a variety of reasons, the Board should seriously consider whether foreclosure should be pursued. Unless the debt is significant (many thousands of dollars), it is generally more prudent to wait until the property sells. The attorney should make a recommendation to the Board after all the facts are known and discussed at length. Foreclosure should never be undertaken lightly or automatically.

Money comes and money goes but mostly goes. Money is hard to come by. Keeping the HOA wheels greased is a never ending task. To ensure that your homeowner association never lacks the lubrication it needs, develop and follow a fair but firm Collection Policy. Then hire a professional manager to enforce it. Keep that HOA rolling

For a sample Collection Policy, see "Policy Samples" section.  BACK

W-9 Formality
The IRS has stepped up its enforcement of tax dodgers by putting the onus on their clients, in this case, HOAs. HOAs are particularly vulnerable since they frequently hire unlicensed workmen to save a buck. These "contractors" usually insist on cash payments and show no evidence of licensing, bonding or insurance. That’s because they have none of these things.

W-9 Forms and Instructions are available at the IRS’s website: www.irs.gov   BACK

Overcoming Reserves Resistance
The scenario is common. The HOA is aging, roofs is overdue for replacement, decks are too, paint is peeling and, on the whole, the community is looking pretty ragged. Previous boards have muddled by with patch and repair rather than renovation but the new board sees the writing on the wall: major work can’t be put off any longer.

The Board meets, discusses the needs, priorities and assigns a committee to get bids. Within 60 days, the committee tenders its report which indicates the reserves are woefully inadequate to the tasks at hand. Applying the pittance in reserves to the project costs and (hang on to your wallet) that leaves it $10,000 per member short. $10K is not chump change but considering what needs to be done, it’s a bargain so the Board organizes the information and presents the findings to membership in a "Coming Soon to Your Neighborhood - A Special Assessment" letter.

The day the special assessment letter hits launches a scene out of the French Revolution. Angry phone calls rattle the lines, mobs pound on board member doors, and cries of "OFF with their heads" are heard. These guys are angry! Friends and neighbors are turned one on another and recriminations abound.

Does this sound familiar? After years of previous Boards living in Wonderland, this Board had the common sense to recognize simple physics: All things wear out and return to the dust from whence they came. They also recognize that the Board was elected to manage the business of the HOA. Managing the business does not include sitting idly by while the buildings deteriorate and property values tumble. The fiduciary duty they assumed demands that action be taken.

This avoidable scenario invariably happens in HOAs that lack a proper reserve plan. The Reserve Study, as it is called, identifies all the building and ground components that are the HOA’s responsibility to maintain, measures each of them, assesses their condition, projects a useful life and repair/replacement cost. All this information when projected out 30 years with an inflation factor provides the Board a schedule to follow for both repairs and funding. It answers the mystery "How much should we have in reserves at any given time?"

Funding reserves by monthly contributions is the only fair way to address this need. Special assessments penalize those that have to pay them since former owners where able to skate without contributing a dime. With a 30 year reserve plan funded monthly, each owner contributes a fair share based on the time in ownership. For example, if an owner owns for three years, he pays 36 of 360 months; one that owns for two years only pays 24 of 360 months worth. There are no gaps in contributions and all pay. More importantly, the money is available when needed and the Board knows when to spend it. Advance planning! What a concept!

While a Reserve Study is indispensable for future planning, it can’t solve immediate and pressing needs like our scenario. For this, the Board must follow a different strategy. In most cases, the Board has the authority in the governing documents to pass special assessments. The fact that some owners voice dissent doesn't mean the Board shouldn't move ahead with their fiduciary duty. In HOAs, majority rules not consensus. However, out of respect for members and their concerns, the Board should hold an informational meeting explaining the whys and wherefores and to answer questions.

If the Board does not have authority to pass special assessments, the matter must be formally presented to the members. If so, do this at a special meeting called for this purpose along. Send and retrieve proxies from members prior to the meeting so a quorum is assured. DO NOT mail ballots out on a matter of this importance. It’s too easy to ignore them or mark them NO without considering the Big Picture. The meeting should include a detailed presentation of the facts and recommendations from professional consultants that have no financial interest in the contracts.

Having informed third parties helps tremendously and it’s well worth it to pay an architect or engineer to make the case. Do not skip over the case building phase of this meeting. Like a good trial lawyer, establishing the need for special assessment should be made point by point until the jury has little option but agree. The Board can usually sense when that point has been reached. A strong indicator is when individual members stand and give their support. Take your time on this one.

If the Board, after careful planning and case making, still cannot muster the majority vote for special assessment, the next Board Meeting minutes should reflect the facts so the directors won’t be held accountable for the results. And don’t let this die on the vine. Matters will only get worse as assets get older. Move forward with a professional Reserve Study to help build the bigger case, analyze the reasons for failure and repeat the process taking a different approach until successful.  BACK

Simplifying the Numbers
Fall is the time many HOAs do their budgets. To many people, budgets look like a mess of meaningless numbers. But, like it or not, the Board is responsible for understanding what those numbers mean so it can properly guide the financial course of the HOA. Be there’s hope! Dr. Bea Anne Counter to the rescue.

Financial statements can be prepared according to three methods: Cash, Accrual, or Modified Cash. You must know and understand which method is being used in order to understand the financial statement. Which method is used has a huge impact on the numbers that appear in the financial report. The methods differ as follows:

Cash. Cash method accounting is like a personal checkbook which tracks when cash is received or paid out. Income is recorded when a deposit is made. Expenses are recorded when a check is written. Cash method financial statements are easy to understand and to prepare. However, they don’t give the full picture since they omit information on unpaid bills or uncollected assessments.

Accrual. Accrual accounting tracks all transactions, even if cash is not received or paid out. Income is recorded when the assessments are due instead of when collected. The same is true for expenses. Expenses are recorded when they are incurred. For example, if the HOA buys new equipment, the purchase is recorded even if the bill has not been paid. Because it tracks all income and expenses, accrual method accounting more accurately records the financial activity of a particular time period.

Modified Cash. Most HOAs use modified cash method for record keeping. It is a blend of cash and accrual methods. With this method, most transactions are recorded on the cash method, but some are logged on an accrual method. For example, accounts receivable (amounts owners owe the HOA) are recorded as they are billed (accrual method). Expenses are recorded as the bills are paid (cash method). Other accrual adjustments, such as prepaid expenses and income tax accruals, are not made. The modified cash method is less complex than accrual method but during an audit, a CPA often must convert the financial statements to accrual method since it more accurately groups income and expenses in the fiscal year to which they apply.

There are two basic types of financial statements: the Balance Sheet and Income & Expense Statement. A Balance Sheet is sometimes called an Assets & Liabilities Statement. The Board should receive both statements usually monthly, or at least quarterly, shortly after the end of the reporting period. Reviewing the financial status will inform the Board of needed corrections early.

Income & Expense Statement. The purpose of this report is to keep you abreast of income and expense status over a period of time; for example, "for eight months ended August 31, 2003." The income statement generally shows the current period - either the month or quarter - as well as a year to date totals. At the end of each fiscal (accounting) year, this statement "closes out" and starts again with the beginning of the new fiscal year.

An important feature of the Income & Expense statement is the Budget to Actual comparison which shows if a particular budget item is over or under budget. If there is a significant variance, it will easier to spot. The accounting method used, cash or accrual, impacts the report. If cash method is used, income is recorded as assessments are paid and deposited. With accrual method, the income is recorded as it is "earned." For this reason, an accrual report will typically show a much greater income figure than a cash report unless all assessments have been paid on time. Same scenario for paying bills. With accrual accounting, that electricity bill which applies to December but not received until January, is still reflected in the December report. Not so with a cash method report. These differences can greatly distort an HOA’s financial position if the Board is not aware of them.

Balance Sheet. The balance sheet takes a "picture" of the HOA’s financial status on a particular date. It is comprised of Assets, Liabilities, and Equity.

Assets. These are items the HOA owns. Cash method financial statements generally list only cash as an asset. An accrual method financial statement may list cash, assessments receivable, prepaid expenses, and deposits (money held by the HOA, which will be returned).

Capital assets like furniture, vehicles, tools, equipment and depreciation may appear on either a cash method or accrual method financial statement. Capital assets can also be items that the HOA holds title to and generate considerable cash flow like a golf course or parking garage. However, most common area property is not included on an HOA’s balance sheet.

Liabilities. These are amounts owed by the HOA, whether for products, services, or taxes. Cash method financial statements generally do not contain liabilities. Liabilities may appear on a modified cash method statement, but they are only updated at the end of the year, since the expenses are not accrued monthly or quarterly.

Equity. This is also known as Retained Earnings and generally states the current balance in the reserve and operating funds. However, some accountants prefer to list reserves as a liability item. The sum of the Assets must equal the sum of the Liabilities and Equity. Thus, the term "balance" sheet.

Reserves is money budgeted for future repairs and replacements of the common areas. It is often the amount of cash the HOA has set aside but may also be the amount the HOA projects it will have in its replacement fund by a particular date. The presentation of amounts allocated to reserves varies greatly. The HOA should discuss this with a CPA knowledgeable in HOA operations and the financial statements should be adjusted at year end to show the amounts budgeted for reserves, spent from reserves, and any transfers between operating and reserve funds.

Interpreting Financial Statements, The Board is responsible for the HOA’s financial stability. It is a fiduciary duty to understand them. Some questions the Board should ask:

• Is there enough cash to cover operating expenses?
• Is operating cash increasing or decreasing since the previous report?
• If it is increasing, should the excess is transferred to reserves?
• Are reserves being properly invested at the highest rate with the lowest risk?
• Are the HOA’s reserves on target with projections?
• Are reserve expenditures being paid out of reserves?
• Has the HOA borrowed from reserves to meet monthly expenses? If so, is there a plan to repay the amount?
• Are the amounts members owe the HOA increasing or decreasing? If increasing, does the Board needs to increase its collection actions? Does it need to "write off" bad debts or set up allowances for them?
• Are there miscellaneous income items? If so, do you know what they represent?
• Are collections keeping up with the budget?
• Are you over or under budget? If the HOA is severely over budget, you may need to curtail spending.

There, that wasn’t so bad was it? Didn’t hurt a bit. Now review the article one more time. There’ll be a test in the morning. The Doctor.   BACK

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