The Danger of Unplanned Costs

“Do not save what is left after spending, but spend what is left after saving.”

- Waren Buffet

Most condominium associations, though certainly not all, have their annual meeting somewhere in the later fall. So, it's around this time boards of directors start looking at the budget for next year. One of the most frequently overlooked items of the budget is proper funding of your association's Reserve Plan. Put simply, your Reserve Plan is money set aside for long-term capital expense, like paving, siding and roofing, in order to avoid special assessments and loans.

(Why do you want to avoid loans? Lets say you take out a $4000,000.00 loan for a variety of projects such as siding, paving, etc. at a 40-unit condominium association. You finance at at 6.5% for fifteen years. First, that means a monthly payment of just short of $3,500.00, aka an increase in the monthly condo fee of $87.50 per unit per month for the next fifteen years, making it a bit harder to sell the unit. Second, by the time the loan has been paid off, the owners will have pain in excess of $225,000.00 in interest or in excess of $5,600 per unit. So, over 35% of the money taken out as a loan is paid back in interest. Good for the bank; not so good for your association; and not good at all for the individual owners.)

According to a recent Stanford University report titled “Guidelines for Life Cycle Cost Analysis” (a bit dry and wonky - and they wonder why such articles are not widely read) as a building ages, the cumulative cost of operating and maintaining facilities significantly impacts the overall budget, not just the maintenance budget. In English, this means that deferred maintenance grows in both scope and cost the longer it is deferred, resulting in 30 times the cost to repair versus keeping up with routine maintenance. Ouch.

So, if you think it's expensive now to fund your association's reserve account, it's only going to get worse, with an association falling further and further behind as the property ages and continues to deteriorate.

Additionally, the Federal Housing Administration now has a requirement that at least ten percent of the annual budget must be set aside for funding reserves. Without this line item it can be hard to sell your unit because many banks won't loan if an association is not certified per the FHA guidelines, meaning there are less banks from which to shop for a loan, and they might require a higher percentage of the purchase price as a down payment at closing as the association is likely underfunded and headed toward a loan or large special assessment.

Further, in 2016 the New Hampshire Legislature noted every member of every board of directors in every condominium association has an individual fiduciary duty to each owner. In other words boards of directors have an obligation to act in the best interests of the community, now and into the future. One way to do this, of course, is to openly manage the financial affairs of the association and avoid loans where 35% of the money is not going toward any project.

Some associations simply don't fund their reserve account and, instead, lurch from special assessment to special assessment. This, too, is dangerous and likely breaches a board of directors' fiduciary duty for the simple reason that special assessment punish the last owner who purchased for the financial sins of the long-timer owners who failed to save for reserves. (As one president angrily stated when the issue of reserves and the need for a special assessment or loan arose, she would fight it and not have one and delay any call for a special assessment or loan, or even for raising fees, because she was selling in two years, and there was no way she was going to pay any extra money while she owned. She's probably off now in retirement happily torturing little animals or undertaking other, similar sociopathic hobbies.)

At some point, an owner who is having a hard time selling his or her unit because of a large, impending special assessment to fund reserves or because of a large, outstanding loan is going to sue the board of directors for breach of their fiduciary duty, and they are going to stand a good chance of winning … for each owner in the association other than the board members.

Next time, some suggestions on what to look for in a reserve study.