At the end of each year, many condo associations direct their focus to the future and begin to prepare the coming years’ annual budget. While budgeting is undoubtedly one of the most challenging aspects of serving on a condo board it’s not impossible.
As with any difficult task, it helps to approach it in different stages and take it one step at a time.
The most proactive way to ensure that your community won’t be caught left field by assessments is to look at your operating fund while making sure you have enough equity in the association in case some unanticipated expenses come through.
Your budget is meant to ensure that you’re adequately prepared for the year. Read on for helpful tips on how to properly manage your HOA or condo association’s yearly budget.
The Beginning Steps
An HOA or condo association budget is primarily made up of two sections; an operating section and a reserve section as required by law.
The operating side requires that you start at a zero-base point. This means looking at your fixed contracts which are those contracts that you’re legally bound to, followed by special projects and other anticipated expenses.
Who should prepare an HOA or condo association budget?
Regardless of the size and location of the association, the ultimate fiduciary duty is with the board and not the management company. After all, the property management company is just another vendor.
However, while condo board members are doing the right thing by volunteering to serve the community, they may not have the expertise and background needed to complete certain tasks. Keep in mind that these are your neighbors and they’re working people with busy lives just like you.
They don’t have the financial or accounting background required in larger communities to navigate some of this process. Condo boards that are lucky enough to have a CPA member usually designate him/her as the treasurer, but most condo associations aren’t so lucky.
Maintain a Reserve
Keep in mind that a condo association is essentially a business and should be run as one. It’s not wise to run a condo association using unprofessional methods and it’s imperative that every association has a reserve. Yes, this might increase your assessments but it provides your community with a safety net and it shows responsible governance.
A lot of people update the reserve study in five years but a lot can change in five years. The roof could cave due to an unexpected hurricane, costing your association hundreds of thousands of dollars that’ll come out of members’ pockets.
What is a reserve fund?
A reserve account is primarily based on two factors:
- It’s a fund for planned future expenses
- It’s a rainy day fund for those unexpected expenses that pop up, such as a broken elevator or a boiler that breaks in the middle of the night, requiring immediate repairs in order to have running water.
The primary factors that an association board should consider when planning for a reserve fund include:
- The remaining useful life of the components
- The ability to get financing
- The rate of return on the investment
- The financial impact on homeowners
Reserve funds are different from operating funds, which are the day-to-day funds that are used for utilities, minor repairs, trash removal, insurance and all of those day-to-day expenses needed to keep the association operating normally throughout the year.
State laws generally regulate how and when an association can remove funds from reserve accounts. It’s generally a requirement to have an earmarked capital improvement first before removing funds from a reserve account.
This means the association should get a quote from a vendor, vote and approve the capital improvement first. Only after this process can the condo board proceed to move funds from the reserve fund account to the operating account to pay the vendor.
It’s advisable to prepare a document known as a “reserve study”, showing the CPA number of estimated capital improvements and costs. This amount is usually allocated into a long-term time-frame that shows sufficient long-term planning for capital improvements.
Ideally, a condo association should have a 30-year reserve study that gives you a comprehensive view of all items. Ideally, there should be a column for each of the years following a five-year increment increase up until year 30.
When you finally have your first formal reserve plan done, you need to be aware that that isn’t the end of it. Different items deteriorate at different speeds, and they’re impacted by a variety of outside forces, some of which are beyond your control. An extended period of severe weather could accelerate the deterioration of exterior elements. If your association has an aggressive preventive maintenance program, you may find the components last longer than your initial projections and need to be adjusted. The economy may also impact interest and inflation rates which will change your annual income totals available. So you need to annually review the financial portion of the study with respect to changing economic conditions. Also, every few years you should have your reserve advisor conduct one of the updated studies to make sure you’re still on track.
One of the easiest ways to figure out replacement costs in advance is to hire a reserve analyst who will determine the cost so that you budget according to accurate figures. For instance, if you’ve been painting the roof for $100, 000 each year and a reserve analyst comes in and says that it actually costs $200, 000 you’ll have to drastically increase assessments in order to meet that figure. However, doing a yearly reserve study makes for better preparation so you don’t run into any surprises or special assessments down the road.
Follow your budget reserve rules
There are a lot of rules on when you can and can’t spend money on reserves and it’s important to follow those line items. Some associations only use reserves for roofing, painting and other line items. However, other associations vote to give the board the authority to use that money for different purposes so long it’s an emergency.
Look at your documents too, because sometimes they supersede the law and vice versa. You have to be a stickler for details when managing a condo association and its budget.
It’s also a good idea to consult with an attorney to find out what percentage of the unit owners need to be present in order to include reserves in the condo association budget. For instance, Florida law states that unit owners have to vote on adding reserves to an HOA budget.
If you fail to involve unit owners in the process you might find yourself with an unexpected lawsuit. It’s important to obtain a formal vote from the owners before you include reserves into the budget.
Financial reporting is a joint effort between the board, the management company, and the outside accountant. But, a lot of condo boards will leave this and make other financial planning tasks to the treasurer. This is obviously a recipe for disaster and could cause accountability issues for the whole board.
Keep in mind that financial reporting is a legal necessity so you have to be very careful with it. If you have 50 or more units with an income of $150, 000 or less, you can get away with doing cash receipts and cash disbursements. But, if your association has revenue of between $150, 000 to $300, 000, then you’ll need to do a compilation. A compilation involves taking the association’s financial statements and separating them into a balance sheet, an income statement, and footnotes as required by law.
On the other hand, you have the financial review which is a requirement for associations that have an income of $300, 000 or more. It consists of inquiries about account balances and budget procedures, as well as a comparison between the current year and previous years’ budgets. All of this is part of the financial reports that must be presented to residents at an official meeting.
However, not everyone is going to attend condo association meetings. One of the easiest and most effective ways to make sure that financial reports reach all association members is to send them digitally.
An increasing number of associations are actually putting full financial statements on their websites, so it’s quite commonplace. Condo Control Central, cloud-based property management software, comes with a budget mail-out feature. This allows you to digitally mail-out your association’s yearly budget effortlessly. The mail-out template is provided for you and you can even schedule the budget mail-out to improve open rates.
Every association needs a yearly audit with a lot of third-party verification. This means you must involve attorneys, analyze invoices and meeting minutes to make sure everything is congruent. Management companies usually do the financial reports, sum it up and send it to the HOA. But, the audits and reviews must be conducted by an outside certified public accountant.
Insurance is another essential when preparing an HOA or condo association budget. It’s important to build a healthy fund balance so that when your insurance premium is due, you can just pay it without asking for assessments. A lot of associations also have insurance deductibles set aside in case of emergencies.
Putting a cap on fee increases can hurt an association because you never know when your expenses are going to go up and by how much. Your insurance rate might triple overnight and if you can’t increase your fees, you’ll need a member vote to assess it. This will obviously put you on the back foot financially and affect your association’s ability to operate.
One of the board’s responsibilities when preparing a budget is to select vendors. While you might be tempted to take the lowest bids from vendors, it’s better to opt for the most experienced first. Be prudent, shop your vendors and consider different options. Sometimes you can tell by looking at a company’s name that they’re not legit. Don’t forget to check things like insurance and other protection measures from your vendors.
Tips for HOA or condo association board members
If you find yourself sitting in an association board that has a lot of debt issues, the best thing you can do is conduct a full review of the situation to figure out an efficient way forward.
Of course, you have to educate yourself as a board member and there are plenty of resources that you can use, particularly from association organizations.
How to create condo association budgets
Here are some tips on how to create a budget for a successful condo association, based on all the information provided in this article thus far:
- Make a budget – A lot of associations still fall into the trap of not creating a budget in preparation for the coming year. It’s important to keep a regular date on which you’ll review the budget. Keep in mind that costs won’t remain the same throughout the years.
- Review the history – Look at the financial history of your association. Always review the last two budget plans to fully understand where you are and where you want your association to be. Compare monthly and yearly budgets alike and make provisions to ensure precise budgetary adjustments.
- Prioritize projects – All projects or future repairs should be prioritized accordingly. You must differentiate between association needs and wishes and remove any potential liability or responsibility before you explore any proposed community beautification.
- Increases in utility – Gas, electricity and water costs are always rising. That’s why it’s a good idea to research local and municipal rates so that you’re prepared when utility costs are set to increase.
- Supplier contracts – You should ensure a proper budget for all regular monthly service providers. Be sure to contact your property manager, pool contractor and landscaping company, to find out if they plan to increase or decrease their rates.
- Budget reserves – When preparing the budget, an association must ensure that a fraction of their income goes to the reserve account. The actual amount varies according to the association. Some condo associations will put as much as 20% of their total revenue into reserves. It’s important to remember that condo associations have a great financial obligation including outdoor repairs and maintenance of major building systems. The latter includes things like roof repairs, boilers, HVAC, etc. Not having budgetary reserves might force you to request major special assessments in the future, among other problems. A good rule of thumb is to prepare for at least two major equipment breakdowns at the same time. For instance, a roof replacement and elevator replacement.
- Cover insurance deductibles – Make sure you’re aware of the franchise levels for the various elements of the association. For instance, if roof replacement costs $500 per building for about 10 buildings or so then you’ll need a sizeable amount in your reserve account to cover that expense. For instance, if your area gets hit by forest fires, wildfires or a hurricane, you want to ensure that your association is prepared and that you won’t have to strike for special assessments.
- Calculate legal and collection costs – Legal and billing fees can increase very quickly but this depends on your association’s collection strategy. For best results, check your current system to see if there are any improvements that you can make to achieve better efficiency and ROI.
- Special assessments for special projects – If your association is struggling to cover expenses due to difficulties in cash flow, then you need to increase the number of assessments. Keep in mind that special assessments are just that; special! They’re not meant to pay your association bills. They’re mainly intended for urgent need or in case of emergencies- not to pay the utility bill.
- Stay on course – A lot of associations struggle to stick to a yearly budget because they want to improve landscaping or introduce new and enhanced safety systems etc. However, it’s important to remember that your association put together a budget for a reason and you should try your hardest to follow it throughout the year.
Creating an effective HOA budget is essential to maintaining a fiscally responsible association. Even struggling associations can achieve financial fitness in a short period of time by making minor changes.
For the best results, it’s advisable to start working on your budget from quarter three instead of quarter four. The earlier the better.
If you follow the tips provided in this article and continue to evaluate and adjust over time, your condo association will prosper.
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