Financial Articles
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Automating Collections
One of the biggest expenses and hassles for a homeowner association is collecting the regular homeowner fee. Every month, checks, money orders and cash are processed, tallied, bank deposits made and books posted. Then, letters are sent to those that haven’t paid for one reason or another. Followup phone calls are made, sometimes two or three to the same person before connecting. All of this takes time and money. Meanwhile, the HOA’s finances suffer since there is no government bail out to fill the coffers. Isn’t there a better way? Absolutely.

Many folks already take advantage of automated bill paying for mortgage, auto, utilities and a myriad of other regular payments. Automated payments ensure that bills are made on time and in full. Vendors know it works and welcome those that take advantage of it. Here’s one of the most important factors: Folks set up for automatic payments rarely default. The payments are made directly to the HOA’s bank so making bank deposits is no longer necessary.

So how does your HOA take advantage of this boon? First, set up the system with your bank or find a bank or financial service that has the capability. An alternative is available from Vanco Services at www.vancoservices.com which provides an internet based option. Then, offer a financial incentive to all members that use the automated payment system. Your budget may need to adjusted somewhat to pay the fees but eliminating most of the collection problems more than offsets the cost.

The HOA can also make automatic payment mandatory as part of the Collection Policy. There is nothing sacred about check and cash payments. If it’s in the HOA’s best interest to go paperless (and it is), the Board should formalize it as policy. Then, every current and new owner should receive the information, forms, etc. required to get set up for the plan. A transition time of 30-60 days is more than enough time.

This collection strategy is simply too good to pass up. It gets to the root of the HOA’ greatest need: money to pay the bills. By eliminating most collection problems, the HOA will come closer to the ideal than previously thought possible. Automate and enjoy some of that carefree living the developer marketed.

Thanks to Tom Fisk of Rochester MN for this innovative management strategy.    BACK

Growing Reserves
In recent years, the importance of accumulating reserves has dawned on many HOA Boards and Managers. Proper reserve planning drives an HOA’s ability to adequately care for the assets by having both the funds and a maintenance schedule to follow. A well executed reserve study calls for a funding plan that systematically grows reserves to address future repairs and replacements without the need for special assessments.

As a rule of thumb, the average garden variety condominium should have around $3000-6000 per unit in reserves, depending on amenities. There are many HOAs that should have much more than that because of deferred maintenance or extensive common elements. Even the most modest properties should have tens of thousands of dollars socked away in reserves. Larger, more complex properties should accumulate reserves in the millions. To truly know what level of reserves applies, a reserve study must be performed by an experienced and qualified reserve analyst. (See www.apra-usa.com for a list).

As reserve funds grow, it’s extremely important that the Board have an investment plan. Wisely investing reserves can reduce owner contributions by thousands of dollars over time. While your friendly banker always has some investment options available, the Board should explore other options for higher yielding instruments. (See www.bankrate.com for options in your location.)

Because of fiduciary concerns, the Board should usually only invest in guaranteed and insured investments unless the membership votes to be more aggressive. In either case, there should be a clear and written investment policy for the Board to follow.

A word about depositor insurance. FDIC Insurance is limited to $100,000. But some banks catering to homeowner association business have additional private depositor insurance that protects a much larger amount of HOA funds. While this addresses the depositor insurance question, the Board still needs to consider whether the bank offers the best rates.

One of the greatest pitfalls of reserve fund investment is losing track of yield because it’s out of sight, out of mind. Interest yields ebb and flow. Currently, savings and money market rates have fallen to historic lows. But that will change at some point so having a reliable investment tracking system is important to ensure that the return on reserves stays as high as possible without risking principal. There are free online investment portfolio trackers available at www.fool.com and www.morningstar.com for those that like to self manage. Or, your HOA has been blessed with substantial reserves, hiring a financial advisor to track investments and advise the Board makes huge sense.

If your reserve fund and investment plan have been out of sight, it time to expose them to the light. Growing reserves mean good stewardship and is one of the Board’s highest callings.    BACK

Fee Fairness for All
In a previous article called Passing the Baton, the subject of the HOA charging new owners a fee at closing was discussed with a recommendation of not to do it unless current owners have paid it also. But this topic needs further discussion.

Some governing documents call for a Working Capital Contribution which all purchasers must pay at closing. This provision is fair because all pay it. But there are HOAs that view a sale closing as an opportunity to tag a new owner with a fee, sometimes thousands of dollars, to fund the operating and reserve fund. And there are other fees that the HOA might charge both new owner residents and landlords which are related to actual turnover costs incurred by the HOA

To determine the fairness, the basis for the charge must be considered. An administrative or service fee charged for unit turnover related to actual cost for account setup, entry access programming, parking tags and pool keys is merely reimbursing the HOA for costs related to an owner’s sale or a landlord’s rental. This is not, nor should be, a common expense. However, a turnover fee charged to fund either the operating budget or reserve fund constitutes a reallocation of common expenses,. In some states, changing the common expense formula requires 100% approval of all owners.

Regardless of the law, the HOA needs to make all such charges both fair and reasonable. Newcomers that feel penalized aren't likely to think kindly toward the HOA or their new neighbors. The way to avoid this is if Working Capital Contribution is needed to fund the budget, all owners, current and future, should pay it. But more importantly, the Board needs to examine how budgeting is done. These kind of turnover fees almost always come up due to failure to budget adequately in the past. Ultimately, the under budgeting cycle must be broken to cure the real problem.   BACK

Presenting: The Budget!
Number crunching...what a drag. But money is the grease that makes the HOA wheel turn and having enough of it in all the right places ensures the assets and property values are maintained. HOAs 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.

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 (hopefully yes), 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

Refined Over Time
A Reserve Plan (also called Reserve Study) is an essential part of running a homeowner association. It provides the Board with a systematic way to track the repair and replacement schedules of HOA assets over a thirty year period and a fair way to distribute the costs of those events to all the members who benefit from them over the timeline. A properly funded Reserve Plan eliminates the need of special assessments which are unfair to those that have to pay them. And with adequate funding, maintenance gets done when it needs to be done instead of piecemeal or deferred.

There are just too many advantages to reserve planning to ignore. The Board that follows a reserve plan is succeeding in a fundamental charge: to protect and maintain the HOA’s assets which have a direct correlation to the members’ home/unit values. Conversely, the Board that does not have or follow such a plan is guilty of negligence and failing in its fiduciary duty. The implications are clear and significant and the wise Board chooses the high road.

While thirty year plans are dandy, thirty years is a long time and things can happen that are impossible to predict. Inflation moves up and down as does return on invested reserves. Construction costs can be higher or lower based on competition, the state of the real estate market and the price of oil in Iraq (talk about unpredictable!).

One of the biggest wild cards in this thirty year projection is how well preventive maintenance is done. Preventive maintenance are those little things that, if left undone, have huge impact on a component’s useful life. For example, if a roof is not kept clean of moss, or small seam separations repaired, the normal useful life could easily be cut in half. Siding that is not inspected, repaired and caulked on a regular basis can fail years sooner than it should. Failure to perform regular and adequate preventive maintenance can undermine the financial prognostications.

How well the Board invests reserve funds also have enormous impact on the funding model. Improving the rate of return an average of only 1 to 2 % over the thirty year period can reduce owner contributions by thousands of dollars (in HOAs with extensive assets, hundreds of thousands of dollars).

The message is clear: A Reserve Plan is an essential planning tool for all HOAs but to be truly useful, must be tweaked and refined over time. It’s like tending a vineyard. Left untended, the fruit (value) will gradually disappear.

The annual budget review is the logical time to assess the condition of the Reserve Plan. A judgment should be made on the life and cost assumptions of each component included in the Plan. Do they still hold true or is there need for some revision? These judgments should be made by an objective and knowledgeable source like a Professional Reserve Analyst™ (see www.apra-usa.com) or a Reserve Specialist™ (see www.caionline.org). If the reserve fund Percent Funded is below 100% of what it should be, implement a funding strategy to increase that level to the 100% goal. Are there new components that need to be added, like a major landscape or sprinkler system renovation?

As the saying goes, "Change is inevitable (except from vending machines)" and this is particularly true about Reserve Plans. If your HOA has no Reserve Plan, arrange to have one performed as soon as possible. If you have one, hurray! Now, get out your clippers and start pruning. An annual update will produce great fruit.   BACK

Reserve Study Update
A reserve study provides a homeowner association with a 30 year planning and funding plan for dealing with cyclical repairs, replacement and maintenance.  It is one of the most indispensable weapons in a board's arsenal.  While a reserve study's components and quantities may not change, the cost and useful life of each of those components often does.  Costs for these future events is impacted by forces which no one can control the dynamics of the real estate market (hot or cold), the availability of qualified contractors and the price of oil in Iraq.  These factors can swing from month to month.

A reserve study's underlying assumptions are a moving target.  Some states require that reserve studies be reviewed and revised each and every year.  But regardless of the legal requirement to do it, practical reasons abound. Reserve studies are 30 year projections that are based in the most accurate information available at the time they are completed. For the reserve study to remain useful, changing information must be updated even when no reserve related repairs have been done during a given year.  These key elements of every reserve study will change from year to year:

• Starting Balance in the Reserve Fund. Each year, contributions are made to reserves and money spent. Interest is earned and added to the balance.  While there is always a projection made, the exact balance at the start of the year will always be somewhat different.  Since the Starting Balance sets the stage for future contributions, it's critical that it be accurate.
• Reserve Fund Interest Yield.   If reserve funds are wisely invested as they should be, the return on investment will fluctuate during the year.  Compounding interest has a profound effect on the 30 year projection period of most reserve studies.  For the average condominium, interest yield can amount to tens or hundreds of thousands of dollars over that time.  Interest earnings reduce owner contributions.
• Inflation Rate. Inflation varies depending on how the Federal Reserve Board feels, OPEC oil price rigging and the effects of global warming. Who really knows except that it will change every year.  Like Interest Yield, compounding inflation has a dramatic impact on future costs.  Inflation is how future costs are predicted so using the most recent inflation factor available is critical to predictions.
• Known Cost Changes.  Each component's predicted cost should be examined.  For example, if the current price of roofing goes up 15%, so should the replacement cost of the roof in the reserve study.

So, if your homeowner association has a reserve study (and it certainly should), you need to review and revise it every year.  For more on this topic, see the Reserve Planning section.  BACK

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