May-June 2005 Issue
HOA Fees --To Increase or Not to Increase...That is the Question
The budget is used to calculate the HOA fees. Budgets should take into consideration:
- Known operating costs
- Other receipts
- Anticipated changes
- A contingency for unknown expenses
- The prior years' cumulative shortfall or overage, and
- Reserve transfers per the reserve study.
If this is properly done, HOA fees may stay the same, increase or decrease slightly or occasionally go up substantially.
TRAPS TO AVOID
Some boards do not raise HOA fees enough because:
- Some owners are on fixed incomes.
- The board members don't want to look like bad guys.
- The board does not agree with the reserve study.
- If their HOA fees are higher than those of comparable properties, the marketability of their units will be affected.
- The board member convinces the board to keep the fees artificially low. The board tells management to make the budget balance with the HOA fees set at "X dollars" without regard to actual expenses. However, operating costs are still as high as they wouldhave been if the budget were formulated correctly. When reality hits, the owners have to pay more to make it up - sometimes much more.
Each year that the HOA fees are kept at an artificially low level compounds on the prior year, making the associationís cash position exponentially worse over time. The resulting cash shortfall is often covered by underfunding funding the reserves, deferring maintenance and/or aging the accounts payable. When there isnít money to pay for some big-ticket reserve or repair item, the fallback position is a special assessment.
The problem with this philosophy is that owners buy and sell; if the budget has been shortchanged, the past owners did not pay their fair share. The reserve transfers should offset the depreciation of the capital components. When a special assessment is imposed to cover reserve shortfalls or deferred maintenance, the financial burden is shifted to the people who own "now." The prior owners were given a pass, and the current owners are stuck footing the bills.
Reserve funding is a lot like retirement planning. If Complex A starts funding appropriately early on and continues to fund reserves completely, it should have lower reserve transfers at property age 20 than Complex B that underfunded for the first 20 years and then realized they need cash now to cover capital replacements. Since the Complex B owners were underpaying for years, they have to make it up now, without the benefit of compound interest enjoyed by Complex A.
The board and management have the duty to read and understand the reserve study. If it is confusing, they need to get their questions answered. If any of the assumptions are incorrect, the study should be corrected and revised. The recommended reserve transfer should be incorporated into the budget.
WHAT ABOUT CUTTING COSTS?
Most association expenses are not discretionary. Insurance and utility costs have increased substantially over the past five years. An association may be able to increase insurance deductibles or turn down the landscape watering or retrofit to lower wattage bulbs. Associations should not defer maintenance due to budgetary considerations, as this magnifies costs in the long run.
EVERY COMPLEX IS UNIQUE
We often hear the question, "What are other similar associations paying for HOA fees?" It doesnít matter, because even similar complexes have different financial requirements at any period in time. Some have higher insurance premiums due to prior claims. Some have funded their reserves appropriately; some have started late and are catching up, and some havenít started yet. Some take care of repairs on a pro-active basis, and some have deferred maintenance that may not be readily noticeable. Some have earthquake insurance, cable TV, high speed internet access, guards, and some donít. In other words, the "HOA fee" doesnít include the same costs in all complexes. It isnít really one fee óit is all sorts of costs that are lumped together for the convenience of the homeowners. Maybe there is some gossip value in what the other owners pay for HOA fees, but that should not influence the level of HOA fees for any other association. The HOA fees should be based on a complexís specific needs, not the neighborís needs.
I have seen situations where a board is afraid to raise the fees higher than a "comparable" associationís low fees, only to later take over the management of that "comparable" complex and find out that financially they are a mess and they have deferred maintenance with no money to pay for it. Savvy realtors and lenders are leery of complexes that donít have adequate reserves.
KEEP THE ASSOCIATIONíS BEST INTEREST IN MIND
Sometimes boards listen to a board member who tells them that the HOA fees donít need to be raised and the reserve studyís recommendations are unrealistic. One treasurer had his own "five-year plan." He convinced the board to fund the reserves at a low level and to make minimal or no HOA fee increases, despite recommendations from management, the reserve study and their CPA. The board later realized that his five-year plan was to sell at a huge profit and move before his HOA fees went up. If HOA fees had increased an additional $5 or $10 per month more over the years he was the treasurer, that complex would have been in very good financial shape.
Boards must be strong and take a position in the best interest of the association, despite its possible unpopularity. Management must be courageous and stand up to those boards that disregard the needs of the association. The board has the fiduciary duty to the membership to set the HOA fees at a level that is adequate to cover operating expenses and reserve transfers as recommended by the reserve study. Not wanting to raise the HOA fees is no defense for not properly funding the reserves and not fixing deferred maintenance. Usually, if a board takes the care to explain the reasons an increase is needed, the membership respects the decision and understands and concurs, even though they may not be thrilled with the prospect of the increase.
Sue Nelson is the chief financial officer at Horizon Management Company in Torrance.
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