Trimming Association Budgets By Auditing Utilities
On average, 25% of the budget of a “typical” Condominium Association goes to utilities. “Typical”, for the purposes of this article, is an Association a) without a Master Association, which pays for some or all of utilities; b) that does not sub-meter water consumption and charge individual owners for their water use; and c) that does not contract for TV or Internet subscriptions for the benefit of the individual owners. Twenty five percent is a substantial portion of the budget and is worth looking into on a much more detailed level. We will review the most typical “common area” utility expenses Associations generally incur and ways to cut each one of them.
Water / Sewer – Associations often pay for water consumption for the entire Community, which includes use by individual Units and the common areas (irrigation systems, closed-loop hydronic HVAC systems, swimming pools, fire sprinkler systems, and more).
Tracking consumption and comparing it with prior years is one of the best things an Association can do. Doing so will quickly reveal even a relatively minor plumbing leak (it is surprising how much water a “minor” leak will put down the drain).
Pro-active and ongoing communication to the residents, advising of the importance of checking their homes for leaks, will go a long way; however, there are a few things each Association can do to simply trim its expenses even without reducing the water consumption.
Water utilities have sewer charges, which are often based on water consumption. Things like irrigation systems (roof top gardens, lawns, etc.) do not utilize the sewer systems, which is what sewer charges are designed to pay for. Many buildings have separate meters for the irrigation and the fire systems; however, they are not always designated as such by the utility companies and thus get sewer charges. If the Association has only one main water meter, sub-meters could be installed on the irrigation systems, closed-loop hydronic heating and cooling systems, and fire sprinklers. Once installed and communicated to the water utility, those sub-meters will be removed from the utility’s sewer billing system. Someone would need to take the readings and report them to the utility company. Check with the utility provider in your area for the exact procedures as most utility companies have a process in place which allows exclusion of certain water consumption.
Telephone – How many phone lines does your Association have? Are there two for each of the fire panels and two more for the elevators? One more for the intercom? At the rate of $30-$40 per phone line, the Association’s monthly phone bill will quickly surpass any “reasonable” amount an Association should pay for telephone service. Most counties (and/or cities) require a primary and a backup line for the fire panels and the elevators. The primary lines usually have to be dedicated to the equipment they are intended to serve, but secondary / backup phone lines can often times be “shared”. Piggy backing the intercom and the secondary fire alarm phone lines will cut the Association’s expense substantially.
Radio transmission, at half the cost of a phone line, is also available from most fire alarm monitoring service providers. Converting to radio transmission does require some up front capital, but it is quickly paid off by savings from the reduced number of phone lines.
Associations should also consider removing long distance functionalities from the intercoms. While, many people now keep their same cell phone numbers when they move across the country, there are creative solutions where, with a few clicks of a mouse, a resident can have an internet based local phone number, which forwards to their out of state cell phone at a little or no cost to them. Check your Association’s phone bill – the long distance charges may add up to ~ $20 / mo, which does not seem significant until it is multiplied by the number of phone lines the Association has.
Electricity – electricity is one of the hardest utilities to analyze and audit. Assistance of engineers, energy savings consultants, and the expertise of electricians is almost always required. There are, however, a few simple solutions such as replacing incandescent light bulbs with more energy efficient ones, installing motion sensors in the common area restrooms, keeping only half of the lights turned on in the corridors during off-peak hours, etc. If the Association pays for electricity consumption within individual units, owners should be encouraged to use energy efficient appliances, install automatic programmable thermostats, and use energy efficient light bulbs. A qualified consultant can perform an audit of your building’s energy efficiency and advise how long it would take to realize enough savings to cover the cost of replacing outdated windows, worn out door seals throughout the community, adding insulation where it is lacking, or taking other steps to reduce energy consumption.
Natural Gas – natural gas goes hand in hand with electricity. Natural gas generally powers fireplaces and heaters and is also tough to audit for an inexperienced person. Similar to dripping water faucets and leaking toilets, fireplace pilot lights, which are on 24 x 7, use a substantial amount of natural gas. Reminding residents to keep the pilot lights off during summer months will go a long way towards reducing Association’s natural gas bill.
There are also multiple “green living” and environmentally-friendly solutions. More and more Associations install solar panels, add sensors in the garages to run exhaust fans only when a certain level of carbon monoxide is reached, collect and re-use rain water for gardens and roof decks, encourage more recycling and composting rather than sending waste to the landfill (which is more expensive than recycling), etc. Grants and rebates to alter the existing systems are often available from utility companies and local and federal governments.
A thorough review of Association’s utility bills can greatly reduce that 25% of expenses allocated to utilities. Every Association should look into these opportunities and pass on the savings to each of the owners.
And You Are Now On The Board…
It is the end of the Association’s annual meeting and you have just been elected to the Board. Do you know your duties and responsibilities? Do you know the needs of the multi-million dollar corporation you’ve been put in charge of? How do you ensure consistency in application and effectiveness of the existing policies, maintenance plans, long term fiscal planning, etc. and where do you start?
These are the questions newly elected Board members and Associations find themselves asking when annual meetings are held and the membership elects “The Board”. One must find a perfect balance between continuing down the path toward the vision the Association previously established and trying to find ways to build community, increase property values, maintain the existing assets and be fair to all residents (owners and renters).
The administration of community associations, as a whole, is a unique industry with its own set of governing documents and policies, as well as laws at the local, state and federal levels. A community association is also a diverse neighborhood where residents have different backgrounds, ideals and expectations. Board members are often burdened with the responsibility of ensuring the Association complies with applicable laws, acting as a mediator when it comes to neighbor disputes, and being experts in plumbing, roofing, insurance, financial planning, and other matters which impact the community. That’s a tough job especially if the Association is self managed; yet being on the Board can be one of the most rewarding ways to volunteer your time (yep, you don’t get paid for being on the Board).
There are a few practical solutions to make the transition between Board members easier:
- Education – answers to most questions can be found in the Association’s governing documents; however, there are also general industry standards and other laws which apply to community associations. Community Associations Institute is a great resource for volunteer leaders and provides networking and educational opportunities. Community Association Volunteer Leadership, as a one day workshop, is just one of the many educational seminars offered by CAI that will immerse you in the basics of Condominium and Homeowner Associations. CAI also offers publications, available through its website, that are a valuable resource to current and future Boards;
- Staggered Board member terms – many Association Bylaws include a provision which provides for staggered Board member terms. The most common provision is where each Board member is elected for a set number of years, with positions expiring in different years. Some of the positions could expire in odd-numbered years and some in even-numbered years (for example, if you have five Board members, three could be elected in 2011 and two could be elected in 2012). This approach carries the wealth of information and knowledge from one Board to the other through members who remain on the Board, allowing the newly elected members to learn how the Association operates;
- “Policy Manual” – develop a comprehensive Standard Operating Procedures / Board Manual to cover items the Association handles on a regular basis. It does not have to be extremely detailed, but should include enough information for someone to quickly understand the Association’s operations. What happens when a new resident moves in? The intercom has to be updated, appropriate documents must be collected (e.g. lease agreement if a unit is rented), new residents should be given a tour of the community, etc. The manual generally includes a maintenance plan, emergency procedures, vendor list, annual budget and financials, reserve study, prior meeting minutes, governing documents and Association policies, insurance, and other information pertinent to the Association’s day-to-day affairs. If the Association is self managed, the document will allow Board members to easily carry out routine tasks and make decisions in the future. If the Association contracts with a professional management firm, it will bring clarity and consistency to the Association’s affairs.
The wealth of knowledge that an Association accumulates over the years is almost impossible to document. A good share of that knowledge is lost every time a new Board member is elected, however this loss of information can be mitigated through Board member education and communication, staggered terms and the development of a comprehensive policy manual.
Budgeting
Budgeting
Once again it is everyone’s favorite time of year… budget preparation time. The purpose of this article is to provide a brief overview of the most common budgeting approaches.
A budget is more than just revenue and expenses balanced to a net zero. A budget should be viewed as an Association’s operating plan for the upcoming year. There are two basic approaches to creating a budget – zero based and historical. With a historical approach, expenses are budgeted based on the last few years of actual expenses. With a zero based approach, the expenses are budgeted based on factual information calculated from scratch annually.
To begin, separate the budget into categories and work on one line item at a time. This will make the budget process easier to manage. Below are some of the most common categories with specific details and budgeting approaches on each:
Revenue
What to include: Member assessments, fees for common area use (e.g. cabana rental), move-in/out fees, interest income (be cautious not to use interest on reserve funds to offset operating expenses), sale of access devices, and other potential sources of revenue;
Approach: Top down or bottom up? Most Community Associations, as non-profit entities, generally take the bottom up approach. Revenue (e.g. member assessments) derives from expenses the Association will need to cover in the upcoming fiscal year. Often times, the expenses are trimmed and/or services are eliminated to minimize the necessary increases in member assessments.
Professional Services
What to include: Management service, accounting, tax preparation, audit, legal fees, reserve study, etc;
Approach: A mix of zero based and historical. Use zero based for recurring contracted services such as management, accounting and reserve study. Base the budget on the value of the contract, check with the service providers to see if they will be increasing their rates next year and update the budget accordingly. For non-recurring services such as legal fees, use a historical approach. Checking the last two to three years of legal expenses will provide an idea of how much the Association relies on its legal counsel. Take into account “special needs” that the Board knows the Association will require next year such as a Declaration Amendment.
Personnel Expenses
What to include: Gross payroll, payroll taxes, bonuses, benefits, recruiting expenses, staff education, etc.
Approach: Zero based for the most part. Calculate the budget based on pay rates from employment agreements between the Association and staff. Take into account projected pay increases for next year, bonuses, benefits, etc. Be sure to include a budget for extra coverage when staff members take paid vacations.
Administrative Expenses
What to include: Copies, postage, etc., fees and licenses, taxes (income and property taxes), insurance, loan interest expenses, Board education, etc.
Approach: A mix of zero based and historical. Use a zero based approach with fees, licenses, permits, insurance, loan interest, etc. Check with your insurance provider to determine the Association’s insurance needs and the premium cost for next year. If the Association has a loan, confirm the amortization schedule and work with the Association’s CPA to estimate next year’s income tax obligations. Use a historical approach for other miscellaneous administrative expenses such as copies, postage, Board education (attendance at CAI seminars/events), etc.
Utility Expenses
What to include: Utilities paid by the Association – water/sewer, garbage, recycling, electricity, natural gas, etc.
Approach: Historical for the most part. Check the Association’s utility consumption for the past two to three years. Look for unusual changes in consumption (a sudden increase in water usage may indicate a hidden leak somewhere on the property). Use a zero based approach for items such as telephone lines and sewer capacity charges. Use a zero based approach for garbage as well – review/assess the Association’s refuse removal needs, determine the size of the containers and frequency of pickups and budget in accordance with utility company’s rates to meet the refuse removal needs.
Maintenance Expenses
What to include: All property maintenance expenses. It is generally a good idea to separate expenses by type – landscaping, elevator, fire safety systems, janitorial, etc.
Approach: A mix of zero based and historical. Use a zero based approach for recurring contracted maintenance. Review contracts for each provider (elevator, fire systems maintenance, etc.) to determine the monthly cost of service and create the budget after first checking with vendors for next year’s increase. For routine day-to-day maintenance (light bulb replacement, touch up painting, etc.) review actual expenses for the last few years, account for inflation and budget extra for special projects if planned. It also helps to better track expenses if they are split up between “recurring contracted services” and “incidentals”. Using landscape maintenance as an example, landscape related expenses would be separated into two separate budget line items – “Landscape Contract” and “Additional Landscape Maintenance”. If the Association’s financials follow the budget and there is a question on “landscaping expenses”, it is much easier to see if the issue is with contracted monthly maintenance or if a significant amount of additional non-recurring work is being performed (replacement of dead plants, broken sprinkler heads, etc.). Splitting up expenses between “contracted” and “additional” also helps during the budgeting process. Contracted expenses such as an elevator maintenance agreement are generally mandatory. Things like additional landscaping work (i.e. annual summer flower plantings) are “negotiable”. One could decrease the frequency of such service or eliminate it altogether if the Association is unable to meet its financial needs.
Reserves – A reserve study should be used as a tool to budget for monthly funding of reserve contributions, and for forecasting major projects for next year and their associated reserve expenses. Separating contributions to reserves and reserve expenses from day-to-day operating expenses will provide a better picture of the true financial needs of the Association.
There are a few additional things to consider while preparing a budget. Bad Debt – many Associations struggle with high delinquency rates due to the state of the economy. It is important to include a provision for bad debt write-offs as there is a high possibility that an Association will write-off some portion of uncollected assessments, especially due to the current high foreclosure rate. Associations have several options to pursue owners for unpaid assessments after foreclosure, however if the prior owners do not have assets and/or verifiable income to garnish the Association may struggle to collect on the debt while continuing to incur legal fees to pursue the collection effort.
Contingencies – Always try to include a contingency in the budget. The level varies depending on each Association’s financial situation, however a contingency equal to 10% of the annual budget is advisable. A contingency will also assist in better management of annual increases in the Association’s assessments. If other costs drastically increase, the Association can temporarily reduce the contingency and then increase it back to the original level over time.
Monthly vs. Annual budget – A budget written by month provides better tracking of an Association’s revenue and expenses throughout the year because some expenses are incurred once annually. For ease of calculation, let’s assume the projected cost of an Association’s audit is $1,200 and it is scheduled to be completed in March. Budgeting $1,200 in March is much more accurate than budgeting $100 per month for January through December.
A note on expense allocations – many governing documents, especially mixed-use developments with commercial and residential units, include provisions as to which units pay for specific expenses. This important part of a budget is often overlooked.
Budget approval – there are two basic approaches to budget approval depending on whether the Association is an “Old Act Condominium” (pre-1990), “New Act Condominium” (created after July 1, 1990), or a Homeowner’s Association. The Association’s Declaration will provide specific guidance on the budget approval process, however typically the Board of Directors approves the budget in “Old Act Condominiums”. “New Act Condominiums” and Homeowner’s Associations generally follow a budget ratification process – the Board of Directors approves the budget and holds a budget ratification meeting with the general membership. At that meeting, unless the majority (or any larger percentage specified in the governing documents) of the Association members reject the budget, whether or not quorum is present, it becomes effective as approved by the Board of Directors.
Hopefully by the time this article comes out everyone will have at least a draft of next year’s budget ready and will find this article useful in preparing a final version for the Board of Directors to review and approve.
How to Ensure Success of Committees
Committees are a key component of a successfully run Association and are especially important in large Associations. Committees should consist of residents of the Association outside of Board members; however, ensuring success of a Committee can be a challenge. In order for a Committee to be effective, the Board of Directors must establish a clear purpose and expectations, a procedure for accomplishing the goals, specific objectives and deadlines, and rewards for a job well done. A liaison should also be appointed and assigned the responsibility of keeping the Committee on track and act as a resource. A liaison can be a Board member but that person should not be the Chair of the Committee.
It is important to determine whether or not the Committee will only act in an advisory capacity or will be given decision-making authority. If the Committee is to operate in an advisory capacity, the Board should always act upon Committee’s recommendations unless doing so would violate the governing documents or put a financial burden on the Association. Committee members will quickly lose interest in serving if the Board “dismisses” all recommendations.
The sample Committee Charter (Landscaping Committee) below address the operation of the Committee; however, the Board must remember to act upon the advice of the Committees and reward them whenever possible. Rewards can be simple “Thank You” notes in the Association’s newsletters, acknowledgment of their hard work at the Board and membership meetings, and general appreciation of what the Committees are accomplishing.
SAMPLE ASSOCIATION
LANDSCAPING COMMITTEE CHARTER
WHEREAS, Section X.X of the Amended and Restated Declaration obliges the Association to maintain all landscaping materials and plants situation upon the Common Area; AND
WHEREAS, Section X.X of the ByLaws requires the Board of Directors to “provide for the operation, care, upkeep, and maintenance of all of the Common Areas”; AND
WHEREAS, Section X.X of the Amended and Restated Declaration empowers the Board to appoint committees in its discretion; AND
WHEREAS, Article XX of the ByLaws permits committees established by the Board to exercise authorities of the Board; AND
WHEREAS, the Board of Directors deems it necessary to establish a Landscaping Committee to ensure satisfactory maintenance of the landscaping in the Common Area;
NOW THEREFORE, be it resolved that a Landscaping Committee shall be established, and that the following procedures for this Committee be adopted and implemented herewith:
PURPOSE
The Landscaping Committee shall act in an advisory capacity to the Board of Directors and be responsible for ensuring satisfactory maintenance of all landscaping in the Common Areas and Common Area’s compliance with Landscape Architectural Guidelines, previously adopted by the Association.
RESPONSIBILITIES
The Landscaping Committee shall:
- Familiarize itself with Association’s landscape maintenance agreement;
- Familiarize itself with Landscape Architectural Guidelines, previously adopted by the Association;
- Identify Common Areas which the Association must maintain;
- Oversee and ensure satisfactory performance of the Association’s landscape maintenance contractor;
- Inspect the Common Area, identify routine maintenance needs and meet with Association’s landscape maintenance contractor at least weekly;
- Respond to landscape maintenance issues reported to or noticed by residents or Association Manager;
- Submit written reports on maintenance activity and/or contractor’s performance to the Board of Directors at least monthly;
- Advise the Board of Directors of maintenance issues noted in the Common Area, which are outside the scope of the maintenance contractor.
ORGANIZATION
The Landscaping Committee shall be comprised of three (3) volunteer owners in good standing as appointed by the Board of Directors. Committee members’ term shall be annual. Members may be removed from the Committee upon their loss of good standing status or as decided by the Board. Vacancies on the Committee shall be filled by a vote of the Board of Directors.
One (1) Committee member shall be a member of the Board of Directors, shall act as a liaison between the Committee and the Board, but shall not be permitted to Chair the Committee. The Landscaping Committee shall elect a Chair at their first meeting, which shall be held no later than one week after its appointment.
AUTHORITY
The Landscaping Committee shall act in an advisory capacity to the Board of Directors, however the Landscaping Committee may authorize landscaping repairs (for example: replacement of dead plants) provided the cost of repairs does not exceed $400 in any given month. Landscaping Committee is not authorized to initiate improvements to the landscaping without prior written approval of the Board of Directors.
Adopted at the Board meeting held on _____ day of ___________________, 200__.
SIGNED BY:
________________________________
President
ATTESTED BY:
________________________________
Secretary
How to increase operational efficiency while retaining control of your Association’s finances.
We come across a wide range of approaches Associations take to managing and maintaining their Common Areas. Some Associations wish to address any and all maintenance needs as quickly as possible when they arise and some prefer to go through a competitive bidding process prior to performing repairs. We suggest developing and implementing a specific policy to provide guidance to the Board of Directors (and the Management Firm, when the Association is professionally managed). Doing so will eliminate (or at least minimize) lengthy discussions over whether or not something should be repaired, how many proposals from independent vendors should be obtained (does replacement of a light bulb really require three proposals?), how vendor invoices should be approved for payment, etc. A resolution will also provide consistency in Association’s operations as Board elections are held and the composition of the Board of Directors is changed.
Below is a sample Board Resolution. There are many things that go into development of a Resolution; however, all Resolutions should include:
- Purpose – state the reason why this particular Resolution is being adopted;
- Authority – reference / quote applicable language from Association’s governing documents (commonly referred to as Declaration; Covenants, Conditions and Restrictions (CC&Rs); Master Deed; ByLaws; etc.), giving the Board of Directors / Association the power to adopt the Resolution;
- Result – this is the main portion of the Resolution and will typically describe a specific process, implementing the Purpose of the Resolution.
SAMPLE ASSOCIATION
BOARD RESOLUTION # 09-01
GENERAL COMMON AREA REPAIR/EXPENSE APPROVAL GUIDELINES
WHEREAS, Section X.X of the ByLaws obliges the Board of Directors to provide for the operation, care, upkeep and maintenance of all of the Common Areas; AND
WHEREAS, Section X.X of the ByLaws empowers the Board of Directors to manage and supervise business affairs of the Association and to employ services of any independent contractor and to prescribe their duties; AND
WHEREAS, Article XX of the ByLaws permits the Board of Directors to authorize any officer or officers, agent or agents, to enter into any contract and to sign checks, drafts, or other orders for payment; AND
WHEREAS, the Board of Directors wishes to maintain effective control over the Association’s expenditures while providing for efficient day-to-day operations of the Association;
NOW THEREFORE, be it resolved that the following approval levels and repair procedures are agreed upon:
- Invoices for recurring services (contracts for services and maintenance and utilities), which were previously approved by the Board, shall not require additional approval for payment;
- Required repair work of non-recurring and non-emergency nature: (a) The Association Manager (or a Board member appointed to oversee Association’s maintenance) shall have authority to approve repair work and/or invoices not exceeding one thousand dollars ($1,000.00). An independent contractor’s proposal/estimate shall not be required for repairs below $1,000 unless deemed necessary by the Association Manager (or a Board member appointed to oversee Association’s maintenance); (b) President of the Board of Directors shall have authority to approve repair work and/or invoices not exceeding five thousand dollars ($5,000.00). An independent contractor’s proposal/estimate shall not be required for repairs below $2,500 unless deemed necessary by the President. In the event estimated repairs exceed $2,500, the President and/or Association Manager shall obtain at least two (2) independent proposals for the work; (c) Approval of the Board of Directors and at least three (3) independent proposals shall be required for expenses exceeding five thousand dollars ($5,000.00);
- Any one (1) Board member and/or the Association Manager shall have authority to approve repairs / expenses of emergency nature; however, such Board member and/or the Association Manager must notify all Board members of the emergency work while making the protection of life and property a first priority;
- Checks and / or drafts for operating expenses shall be signed by the Association Manager (or one (1) member of the Board of Directors);
- Checks and / or drafts for reserve expenses must require approval and signatures of at least two (2) Officers of the Board of Directors.
Adopted at the Board meeting held on _____ day of ___________________, 200__.
SIGNED BY:
________________________________
President
ATTESTED BY:
________________________________
Secretary
Why does an Association need reserves?
Equipment and major components (like the roofs) must be replaced from time to time, regardless of whether the expense is planned for. Most Association members prefer to set the funds aside now instead of having to pay a Special Assessment to cover cost of a major project such as a roof replacement. Reserve funds aren’t an extra expense – they just spread out expenses more evenly. Funds for a particular project are accumulated over a period of several years instead of a one-time Special Assessment levy. There are other important reasons why Associations put monies into reserves every month:
1. Reserve funds meet legal, fiduciary, and professional requirements. A replacement fund may be required by:
– Any secondary mortgage market in which the association participates (e.g. Fannie Mae, Freddie Mac, FHA, VA);
– State statutes, regulations, or court decisions;
– The community’s governing documents;
2. Reserve funds provide for major repairs and replacements that will be necessary at some point in time. Although a roof may be replaced when it is 25 years old, every owner who lives under or around it should share its replacement costs.
3. Reserve funds minimize the need for special assessments or borrowing. For many association members, this is the most important reason.
4. Reserve funds enhance resale values. Lenders and real estate agents are aware of the ramifications for new buyers if the reserves are inadequate. Reserve Study bill passed in Washington just recently requires Associations to disclose the amounts in their reserve funds to prospective purchasers. It also contains specific requirements for Reserve Studies.
The Tax Season for Associations
No matter what type of “business entity” (Condominium, Homeowner, Planned Unit Development, Co-Op, incorporated or not) your Association is, a tax return must be filed with IRS (some States also require Associations to file State income tax returns in addition to Federal taxes). While most Associations are “non-profit” under State corporate statutes, they must file a Federal income tax return. There are very few Associations, which Internal Revenue Service classifies as non-profit.
There are a couple of ways an Association can file its tax return – as a regular corporation (Form 1120) or as a Homeowner Association (Form 1120H). There are some benefits and restrictions with each. For example, an Association must file as a regular corporation if it is not “substantially residential”. Substantially residential usually means that at least 85% of the Association must be Residential (so, if there is a total of 20 Units in the Association and 5 of them are Commercial, your Association may not qualify to file as a Homeowners Association).
While Form 1120H has a higher tax rate (30% for Residential Associations and 32% for Timeshare Associations), most Association revenue is exempt from taxes (i.e. member assessments). Taxable items include, but aren’t limited to, interest on reserves, rental income, and “use fees” (i.e. clubhouse, Guest Suite, etc.).
There may be benefits in electing to file Form 1120. The tax rate is lower (15% for the first $50,000); however, the IRS will see the Association as a regular business/corporation. This means the tax exemption (member assessments) available with Form 1120-H no longer applies. Total taxable income is offset by total allowable expenses and you pay taxes on what’s left. So, if in a given year, your Association’s operating expenses greatly exceeded income and you had substantial interest on reserve funds (which would be taxable under 1120-H), filing as a regular corporation may reduce your tax bill.
Most CPAs familiar with Community Associations will look at your particular situation and recommend which form to file. However, you should double check with your Association’s CPA to make sure they do so as a normal course of business.
Abbreviations and Terms Demystified
Abbreviations:
- COA – Condominium Owners Association
- HOA – Homeowners Association or Home Owners Association
- PUD – Planned Unit Development
- Assn – Association
- Reserves – funds allocated to major replacement items (roof, siding, swimming pool, boiler, etc)
- Assessments – amounts paid to Association to cover maintenance, other operating expenses, and contributions to reserves. Even though these are commonly referred to as “dues”, they are not. Dues are amounts paid for a membership where the payer receives no benefit(s) other than being a member of an organization
- Common Areas – areas of an Association, which all owners can use/enjoy
- Limited Common Areas – areas of an Association, which one or more (but not all) owners have an exclusive right to use (and generally responsibility to maintain)
- Site Condo, ZLL or Zero Lot Line, Condo by Default, Air Space Condominium, etc. – all of these terms refer to a “Condominium” (as opposed to Homeowners Association/HOA)
- In a “Site Condo”, ZLL/Zero Lot Line, or Condo by Default, owners generally own a “cubicle” or “bubble” of air with everything inside it. The Declaration for the Association will generally describe the boundaries of such cubicle/bubble. Horizontal boundaries are often located so many feet (i.e. 20′) below ground level and so many feet above ground level (i.e. 60′) with vertical boundaries running along the land on which the home/condominium sits on. Site Condos are usually attached townhomes with 2 (duplex) or more homes per building/structure. Individual owners do not have “land ownership” and are usually responsible for all maintenance, including but not limited to building structure, driveways, exterior painting, roof, lawn/landscape maintenance, etc. In some instances, the governing documents may provide that the Association is responsible for maintenance of individual lawns (and/or snow plowing of driveways) and scheduled maintenance of some or all exterior components (i.e. re-painting, re-roofing, driveway replacement, etc.). Owners, however, remain responsible for upkeep/routine maintenance of such items.
- An Air Space Condominium is usually a Condominium Association located inside another Association/building. Imagine a high-rise tower with a Hotel on floors 1 through 15 and Condominium Units on floors 16 through 30. There will likely be an “umbrella” or “master” Association comprised of Two Units: One Unit will be a Hotel, and the other Residential Condominium Association, containing homes on floors 16 through 30. The “umbrella/master” Association would be responsible for maintenance of all components common to/shared by both Hotel and Residential Units (i.e. building envelope, central HVAC system, fire safety systems, roof, etc.). Hotel would be responsible for everything on their floors (excluding the building structure and other common elements) and Residential Association would be responsible for interiors of their “common areas” (also excluding the building structure). In such setup, Residential Association is commonly referred to as Air Space Condominium because it encompasses everything within the air cubicle inside the building structure above the Hotel.
“Legal” definitions and difference between PUD, HOA, Cooperative (co-op) and COA:
- Condominium Association – the biggest difference is that individual owners have no ownership of land. Owners own a condominium unit (usually specifically confined within horizontal and vertical boundaries defined in Association’s governing documents) and have an undivided ownership interest in Common Areas. Owners are responsible for maintenance of their units and the Association is responsible for maintenance of Common Areas.
- Homeowners Association – in a Homeowners Association, owners own parcels or lots of land and improvements built upon them and have an undivided interest in Common Areas. Owners have full responsibility for maintenance of their lots and improvements (house, fence, driveway, etc.).
- Planned Unit Development – is somewhat of a hybrid between a Condominium Association and a Home Owners Association. Just like in a Homeowners Association, owners own their lots and improvements, but Association may have responsibility for maintenance of some exterior components of lots and/or homes (i.e. lawn maintenance, scheduled exterior painting, roof replacement).
- Cooperative – somewhat similar to a Condominium Association but at the same time completely different as owners do not own any “real estate”. They own shares of a Corporation (Cooperative Association itself) and have long term leases for their units. Some coops have very strict “buy-in” restrictions, which are often much more complicated than those associated with leasing a home (purchase can be subject to approval by the Board of Directors, who can deny it based on just about anything; a co-op will likely run full background and credit report on prospective purchasers, etc. etc. etc.).
Other “types” of Associations:
There is a huge difference between a “legal structure” of an Association and “physical aspects” of homes within the Association. The above 4 definitions set the “legal structure” of an Association. Everything else refers to a “type of construction”. So, a Townhome or Townhouse Association means that the units are “townhouse style” (physical aspect) and can be a Condominium or a PUD (“legal structure”).
Aging Associations: Helpful Strategies for Older Homeowner and Condominium Associations
Are Aging Associations different from New Associations? Maybe.
Self-Managed vs. Professionally Managed
- Role of the Board of Directors and the management company: The Board of Directors is the main governing body of any Association. Individuals elected to the Board are volunteers from the Community and do not always know all aspects of managing an Association. It is important that the Board of Directors surrounds itself with experts and relies on them when making decisions.
- Which professionals work with the Association: A professional management company is just one of those experts and provides bookkeeping services and leadership to an Association. The management company does not have answers to all questions either; however, knows when to involve an independent professional.
Most Associations establish relationships with various professionals – attorneys, CPAs, insurance brokers, reserve consultants, and many others. Those professionals are important to every Association and should be viewed as trusted advisors with expert knowledge in their field.
What is an Association and what does the Board need to know?
So, you are elected to the Board. Do you know your duties and responsibilities? Do you know the needs of the multi-million dollar corporation you’ve been put in charge of? Where do you start?
- How was the Association managed in prior years?
- Does the Association have a maintenance plan?
- Does the budget cover all of Association’s needs?
- Does the Association have a Risk Management Plan?
- Do the governing documents comply with current laws?
Maintenance Issues
The Association is generally responsible for proper maintenance of all Common Areas and in some instances must ensure individual owners maintain their Units.
- Routine maintenance includes regular day-to-day maintenance of common areas. Some routine maintenance is taken care of through recurring contracts with independent vendors (elevators, HVAC equipment, fire alarms, landscaping, janitorial, etc.) There are also non-contract maintenance needs – carpets, windows, gutters and downspouts, lighting, etc.
- In addition to routine maintenance, each property has its long term needs – replacement of roofs, painting of the exterior, paving of streets and sidewalks, etc. Proper routine maintenance will pro-long the life of these major components.
The best way to identify major components is to have a reserve study (a new law was passed in Washington on June 12, 2008 requiring Associations to have reserve studies done an independent professional). A reserve consultant will visit the property, list major components, “inspect” them to determine remaining life, will provide a replacement estimate, and recommend a funding schedule for the Association to meet its long-term financial needs.
Financial Planning
Community Associations are non-profit corporations and must cover their expenses. A budget should include short-term (12 months) and long-term (up to 20 years and more) financial needs of a Community.
- Operating or short-term expenses generally include utilities, routine maintenance, professional services, and insurance.
- Replacement budget includes expenses of non-recurring nature (less frequent than annual). A reserve consultant will help with replacement budget by preparing the reserve study; however, the reserve study should be updated regularly (new law requires the reserve studies to be updated annually and at least once every 3 years by a reserve study professional) to take into account increased costs of construction and deferred maintenance of major components which may have shortened their remaining life.
Once the upcoming expenses of the Association are known, the revenue can be calculated. The majority of the revenue comes from member assessments. Some Associations will have additional income – for example, interest on Association’s cash assets, move-in/out fees, use of common amenities, etc. In addition, the Association must take into account delinquencies, if any. Non-payment of assessments may result in Association finding itself short of operating cash. While borrowing from reserves is possible, it should be the last resort because doing so will impact the long-term financial planning. New “reserve study” law has some provisions and guidelines an Association must follow prior to using reserve funds for operating and/or unexpected expenses.
Insurance and Risk Management
There are various insurance policies each Association should have. Some of them are required by State laws and governing documents. They include property policy, general liability, D&O, Fidelity Bond/Crime, worker’s compensation, if there are employees, and an umbrella.
Risk Management Plan of an Association should analyze Association’s exposures (physical and liability), take into account existing insurance coverage, and define ways to minimize risks.
Disaster Planning is another component of Risk Management. Every Association should develop a Disaster Plan and provide a copy of it to all residents. A disaster plan would include information on where shut-off valves are located, who will shut off utilities in case of an emergency, how the evacuation will work, etc.
Legal and Governance
Governance of a Community is more than just compliance with CC&Rs. There are multiple State and Federal Laws which govern how Associations operate and some of them may trump existing provisions in the CC&Rs. Because laws often change, an Association must keep itself apprised of the legislature and amend the governing documents as needed.
Staying current with industry trends is also important. As society evolves, Associations need to revise their governing documents and the way they operate to protect their interests and their members.
This also applies to decision making. The Board has to identify which decisions they have the authority to make and which decisions require vote of the membership. How decisions are made is equally important. Before the internet and email, all decisions were made during meetings. Now, Boards want to take advantage of modern technology and make decisions over email; however, it may not be legal.
Enforcement of Rules and Regulations – the Boards used to be able to send a violation letter to the owner and start levying fines or take other actions. This is no longer true. The industry trends have changed and so did the laws. Majority of Associations now must give notice to an alleged violator and give them the opportunity to be heard before any enforcement action can be taken. Boards also need to know which rules can and cannot be enforced. Restrictions which were ok in the past may not be legal anymore.
So, are Aging Associations different from New Associations?
Proactive Associations do not find themselves in Stone Age
Forward looking Associations will stay on top of their maintenance needs and ever changing society, will keep their governing documents updated with industry and legislature changes, and will have enough funds to ensure smooth operations. Community Associations Institute is an excellent resource for information and networking opportunities.
Methods of Accounting
There are three commonly known methods of accounting:
- in “Cash Basis”, income is recorded when it is received and expenses are recorded when they are paid;
- in “modified accrual basis”, income is recorded when it is earned, and expenses are recorded when they are paid;
- in “accrual basis”, income is recorded when it is earned and expenses are recorded when they are incurred. Accrual basis provides the most accurate financial reporting and is in compliance with GAAP (Generally Accepted Accounting Principles).
There are several ways to determine the basis on which the financial statements are presented. Accounts Receivable, Prepaid Assessments, Accounts Payable, and Prepaid Expenses will appear on the Balance Sheet if financial statements are prepared on an accrual basis. Accounts Receivable and Prepaid assessments will appear on the Balance Sheet if financial statements are prepared on a modified accrual basis. Since expenses are recorded when they are paid in a modified accrual financial statement, neither Accounts Payable nor Prepaid Expenses will appear on the Balance Sheet. A Balance Sheet prepared on a cash basis will not contain any of these line items.
Accounts Receivable is an Asset and indicates the total amount of income earned (i.e. assessments levied against owners) but not yet received as of the date of the financial statement.
Prepaid Assessments represents assessments, which owners paid in advance. Prepaid Assessments are a Liability to the Association as this is income already received but not yet “earned” (or not charged against owner’s accounts).
Accounts Payable represents expenses incurred but not yet paid and is a Liability to the Association. Accounts Payable may consist of actual expenses for which an invoice was received but not paid as of the date of the financial statement, and expenses accrued but for which an invoice was not yet been received (or paid).
Prepaid expenses are expenses, which were not yet incurred but already paid as of the date of financial statement. Prepaid expenses are an Asset to the Association. An example of a prepaid expense is an insurance premium, which is paid in full for the entire year when an invoice arrives. When the insurance premium is paid, it appears on the Balance Sheet under Assets but it does not appear as an expense on the Profit and Loss Statement. The premium would then be “expensed” on a monthly basis in equal monthly installments.
Profit and Loss Statement (P&L) can also help determine on which basis the financial statements are prepared when a budget comparison/variance is shown on the statement. Because income and/or expenses are recorded when they are incurred, items such as “Homeowner Assessments” in the income section of the P&L, and all “Contract” line items in the Expenses Section of the P&L, should have zero variance from the budget in an accrual basis. Member of the Association are charged based upon a budget prepared in advance, so 100% of income for a given period will be recorded at the time it is budgeted for and charged to owners’ accounts. Expenses based upon contracts should also match the budget and have a zero variance because they are recorded when incurred whether or not an invoice is received from the vendor.
-
Archives
- December 2011 (1)
- April 2011 (1)
- September 2010 (1)
- September 2009 (2)
- March 2009 (1)
- February 2009 (1)
- January 2009 (1)
- December 2008 (4)
-
Categories
-
RSS
Entries RSS
Comments RSS
Yalnes, Inc. Blog 