Are Your HOA Dues Too Low?

‍Three Questions Current and Potential Homeowners Should Ask

Many of us appreciate living in a community with a homeowner association (HOA). That’s because it can afford us access to certain amenities or provide worry-free maintenance of common areas. The fact that there are more than 355,000 HOAs across the country indicates just how popular these types of properties are. Yet, of the seventy-four million people who pay into an HOA, how many ever question what happens with their dues?

Too many people have a limited understanding of their HOA’s financials. This is unfortunate because the monetary well-being of a community has implications for property values, insurance rates, and even personal safety. Whether you are a current or potential homeowner, below are some critical questions to ask about an HOA.

How are your dues being spent?

Homeowners have a right to know how their board spends the association’s money. Along with reviewing an annual budget, homeowners owners should ask to see interim financial statements. These reports should show how income and expenses are being measured relative to the association’s plan.

Too often, unit owners pressure HOA boards to keep dues irrationally low. That may sound good on the surface; however, having consistently low dues may be akin to driving a car with the check oil light flashing. The driver may save money in the short term, but what happens when the engine finally blows up? That is why the HOA dues need to account for both short-term

spending and long-term planning. These are the two major buckets to consider when developing a budget.

The short-term, also called ‘tactical’ or ‘operational’, part of a budget is relatively straightforward. It is similar to creating a home budget where you look at projected income and expenses for the upcoming year. In examining operating expenses, it is a best practice for HOAs to request more than one bid or proposal for high-cost services. HOAs often overpay for a service due to a

long-term relationship that needs reexamination — perhaps a prior board may have entered into a relationship without looking at the competitive landscape. New technology may allow for automating a previously manual or labor-intensive process. Operating expenses can and should be reduced in many scenarios. The board has a fiduciary responsibility to look at these opportunities. Unfortunately and more commonly, expenses tend to increase over time.

The ongoing income and expense parts of a budget are relatively easy to monitor and understand. Since budgets are forward-looking, it is not uncommon for actual expenses to vary slightly from the projections. Expenses rarely match precisely with budgets that were created before the year began.

A budget’s long-term planning component can be more complicated and is often overlooked. When planning long-term expenditures, boards must first take inventory of the community’s essential assets. They then need to assess the amount and possible timing of these assets’ repairs, maintenance, and/or replacement. Boards should estimate and account for these future expenditures in savings accounts that are commonly referred to as reserves. To get an accurate estimate of these likely expenses, an HOA must have what’s called a “reserve study” conducted.

Has a reserve study been performed?

HOA board members are generally fellow homeowners who have volunteered to serve in these unpaid positions. It’s not surprising that few of them collectively have expertise in engineering, construction, legal, and sophisticated accounting matters. Yet, many of the far-reaching decisions an HOA makes requires a certain level of expertise in each of these areas. Therefore, to be sure board members are doing what’s best for their community, they need to engage experts who can advise them on issues relevant to the needs of their community.

Long-term financial planning for an HOA is best achieved through a reserve study, which almost always requires the assistance of outside experts. These reports commonly list the essential assets to be addressed through the reserve accounts. A full study assesses each asset’s expected useful life, remaining useful life, and replacement cost.

Based on the projected future costs and when they are likely to be incurred, the reserve study will establish a multi-year plan for funding the reserve account to cover the future costs. Given

how much money should already be set aside, the study will indicate the strength of the reserve fund, which is typically expressed as a percentage of the recommended funding.

Are your future reserve balances appropriate?

Boards that choose to sacrifice dues increases by ignoring or downplaying reserve funding are acting at the peril of the entire community. The situation becomes more complex when the previous board’s neglect has put an association behind in properly funding their reserve accounts.

When reserve accounts are underfunded and no necessary repairs or renovations are imminent, a board may choose to quickly right-size reserve funding through special assessments or dues increases. The severity of the underfunding and the timing of upcoming expenditures may help the board determine the degree of catch-up funding needed.

Too often, deficiencies in reserve funds are not exposed in time. Some boards face impending capital-intensive projects with inadequate reserves to address the costs. Delaying repairs may only compound the problem. Moreover, deferring maintenance or repair projects can depress property values. Often when repair projects are suspended, costs increase. Most importantly, ignoring repairs can be dangerous. Common areas in need of repair may put residents, workers, and families at risk of injury.

Remedying shortfalls in reserve funds for immediate problems can be tricky. The simple answer is to ask all residents to fund the shortfall through a lump-sum special assessment. However, not all unit owners are financially willing or able to make their payment. Spreading the special assessment over an extended period may be a better solution, although this approach may not refill the reserves quickly enough for immediate projects.

Where projects need immediate attention and reserves are inadequate, the board may consider taking out an HOA loan. These loans are association obligations rather than the individual unit owners’ responsibility. Future income (dues and special assessments) are used as security for these types of loans. Because of this feature, HOA loans are considered cash flow loans as opposed to loans that consider both the underlying asset (such as a home or car) along with personal guarantees.

HOA loans can be complex. Their uniqueness and peculiarities can confuse borrowers and inexperienced lenders. However, like many financial transactions, once the curtain is lifted they are not very difficult to understand. When used responsibly, HOA loans can be an ideal tool for helping associations meet financial challenges that demand innovative solutions.

Owners living in condos and homeowners associations should ask questions concerning the current budget and the long-term plan. They should ask to see a reserve study. If that study was prepared more than five years ago, they should request that the board update the report. The

same goes for potential purchasers who are considering buying a unit in an association — they should examine both the budget and the reserve study. If the reserve study shows inadequate funding for the association, they should prepare for a dues increase or a special assessment. They may also want to see which components are underfunded to assess the liability associated with the funding gap.

Like a low-oil engine gauge, a poorly-funded reserve account should serve as a warning light. Maybe it will be okay to go a few more miles or years with the light on. Eventually, though, the owner will have to pay the piper.

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Larry Kirschner is a partner with Arch Capital Solutions. Arch Capital arranges loans for Homeowner Associations throughout the country.