Budget Basics Boards Need to Know the ABCs of Association Budgets

Budget Basics

Preparing the annual budget is by no means an easy task. Those charged with preparing condominium or HOA budgets will soon begin reviewing costs, gathering data and projecting expenses for the coming year. At some point, board of trustee members will see the first capital and operating budget drafts, review line items and learn what’s facing them in the area of assessments and fees for 2015. How does it all happen?

Budget-makers must weigh increasing costs, emergencies, even the long-range weather forecast. They'll also need to know the answers to questions owners bring forward: Be prepared, as any good Boy Scout advises. Now may be the time to review current and past budgets with association representatives, in preparation for the meeting they’ll attend once the next budget is on the table.

Typically, certified public accountants (CPAs) are involved, along with key personnel: “The board and the property managers, if they have a management firm, or an on-site manager, with a superintendent involved in maintenance of the property,” says Sondi Stanton, CPA at Stanton & Co. in Woburn, Massachusetts.

“It varies, because the characteristics of the associations vary,” says Stephen Margolis, managing member of Margolis Management and Realty LLC, located in Hamden, Connecticut. “I was at a recent meeting where a board member who happened to be a CPA put it together. In other situations, board members have no or very little experience with finances, and they rely on the managers to put it together for them. Most of the time, it's the second way.”

Board members lacking experience may need hand-holding. “The manager will discuss the rationale for the different budget lines, with explanations of last year, the previous year, and projected expenses,” Margolis says.

Don’t Skimp on Time

Work usually starts in the fall, sometimes even late summer, “because assessments are made at the beginning of the year,” says Stanton. “The board approves the budget, usually in November, and on January 1, new assessments are instituted if there’s an increase.”

Allowing enough time is essential. “In Connecticut, the unit owners as a group are required to ratify the budget, which goes into effect on January 1,” Margolis says. “We have to start early enough in the year so that I may present them with a 12-month budget.” He allows for review, presentation, amendments and revisions. “That way, if the owners reject the budget, the board still has enough time to put together another meeting and present it again the following month. If it’s approved (then), you can then begin your budget,” he said. “You also need to start enough in advance so that board members can get together in time to understand and approve what capital projects are being done in the following year, what the operating budget will be like, and to understand and internalize the fact that there might be an increase.”

Operating budgets are an entirely different animal than capital budgets. “With an operating budget, the board looks at the past,” Stanton says. “They usually have a history to look at. If it’s new, they would have to try to make some determinations, but if they have at least a prior year, they will know what increases are going to happen.”

Some factors are known. “The operating budget usually includes the cost of electricity, the cost of water, the cost of sewer use—things like that,” Margolis says. “You can’t bid these things out; they’re determined by the providers, so their cost is pretty much a given. It’s helpful to look at the past couple of years, and understand there is probably a cost-of-living increase to be considered.” He includes such things as insurance costs, management, accounting, legal fees—“there shouldn't be a lot of fluctuation there, other than things like snow plowing, although sometimes an association can get a seasonal contract to be sure of that cost.”

Variables include increases, emergencies and new or unforeseen services. “Increases generally occur in a variety of areas,” said Stanton. “Insurance costs go up, or they know what their contracts are going to be for elevator contracts, landscaping, snow removal, utilities, and so on. They can figure employee raises, as well; they have a pretty good idea to start with.”

Respect Mother Nature

On the other hand, Mother Nature’s “gifts” can undermine budgets.

“New England was hit with a lot of snow in the past year,” Margolis says. “Snow budgets are busted, left and right. What are you going to do about that? A special assessment from the members? A reserve account? How do you rationalize that if you’re saving money for a capital project?”

Handling seasonal flukes is not a matter-of-fact process. “I don't think a decision is made in one night,” Margolis said. “We talk about the alternatives and give them two to three meetings to decide. The owners know what the weather’s been like; they may even be expecting an increase.”

The capital budget is a whole different creature.

“The defining line between them is, the association has a long-range plan, a reserve study, typically a well-thought-out plan that can be presented to a new owner,” Margolis said. “That owner can look at it and say, ‘Oh, the driveways are gonna be replaced over this period’ or ‘the roofs need to be replaced over this period.’ Major infrastructure objectives can be categorized under the capital plan, or capital reserve, and will be separated out from the operating budget, and really defined for the owners. They need to understand not only where the money is going, but what comprises that monthly fee.”

Future planning, Stanton says, is “normally based on what repairs are needed, or the capitalized items they need to take care of, so they probably have a study to use. They know what they’re going to be assessing for reserves. Also, they’ll have a good idea ... what needs to be replaced, or what is going to be in the pipeline, as with ongoing contracts. Most of them have a budgeted reserve transfer in there, whether it’s anticipated or going into the reserves for future costs—painting, insurance, and such.”

“Things have a useful life,” Margolis says. “Boards have to be realistic, look at the infrastructure whether it’s siding or roofing, roadways. The roof is one of the most important expenses. If you have three buildings or thirteen, you have to know the useful life of each. You don't want to get to the end of the useful life with a roof—by that point, it could be leaking. Costs are one of those things you’ve got to get way in front of. Look down the road and see what the impacts are going to be, and when they’ll occur—siding, painting, replacing roads. There are many communities that are 25, 30 years old or better that have got to be replacing their roadways; the useful life of a roadway is 25 years.”

In building that capital budget, he said, “figure out what the owners can handle on a yearly basis, and how that figures into the useful life of a roof.”

Be Prepared

The wise board prepares for emergencies. You can’t budget on the hope that nothing will go wrong, right? “Oh yes, you can,” laughs Margolis. “That’s what they do.” It’s a mistake, though. Luck is never guaranteed. He cited the May 2013 weather across Connecticut, which brought prolonged rain, hail and tornadic activity, a.k.a. “damage potential.”

“Boards have to prepare for damage claims and insurance deductibles,” Margolis said. “Some associations will actually put in their budget an item called ‘deductible,’ and put in for two potential claims a year.” He estimated typical set-asides as $5,000 per deductible claim.

Smaller associations face a different set of circumstances. “Some are like ten residents,” Stanton says. “It's a lot harder when you’re that small; it’s ‘not as formal’ is probably the better term. You don’t see large reserve funds because it’s more of, if something comes up they either put money in to fix it or they take out a loan and do what needs to be done. They just have to handle it.”

Putting aside a cash reserve, if possible, is a good idea—but not always practicable, Margolis says. “Very few of my communities have what’s considered a cash reserve, or rainy day fund they can dip into, because building that up again causes the monthly fee to be increased,” Margolis says. “But everything that contributes to creating a budget has to be funded; the owners have to pay for that.”

That’s where property managers or owners may create trouble, says James A. Tomolo Jr., CPA, in Clinton, Massachusetts. Holding back on expenses is a mistake that comes home to roost.

“The big condominium associations have the advantage of having more money to do the things they want to do, or plan, whereas smaller ones lack enough funds, usually, to effectively carry through needed planning,” Tomolo says.

Consequently, they set fees far too low, keeping initial costs down in order to attract new residents.

Their short-sightedness comes more from lack of funds than a will to deceive. Tomolo suggests they do the opposite: charge more up front. Without doing that, he says, they are likely to be short-handed when it’s time to face increased expenses. “Then they can’t get the money they need for budget plans,” Tomolo said. “People don’t want to pay to share expenses, say a roof, especially in smaller condominium residences. The expenditure is shared over many fewer people, making it more expensive.”

Costs have to be anticipated, they agree. And the truth must be in the plan.

“What an association did recently was, rather than go up on fees, they decided to do a special assessment,” Margolis says. “The theory was, ‘If we need more money, we’re gonna do a special assessment again.’ I don’t think that’s a great rationale; it’s not a true reflection of what’s happening with expenses. Boards may say, we haven’t gone up on fees or special assessments in two or three years, look at the great job we’re doing—but it’s not realistic: everything has gone up, and some expenses are not within your control. So keeping fees lower as a way to attract more owners can only come out badly in a few years, when stuff begins to happen and these owners ask, ‘where's the money?’ There is no money. It starts a lot of conflict and hostility.”

In Connecticut, if a special assessment exceeds 15 percent of the operating budget, the board must meet and owners can reject the assessment. “In a commercial condo recently, the association board recommended a very modest budget at the annual meeting. One business owner said, ‘This budget is ridiculous; there’s no money in reserves for large projects we know are coming up, and I recommend that we reject this budget and that the board come up with a budget that has more in savings.’ They raised the fees, but also raised the amount put into a reserve account. That association now happens to have a much healthier outlook on its finances.”

The bottom line, Margolis says, is to anticipate the impact of increased borrowing rates, emergencies, Mother Nature’s variations and improvements in 2015 and beyond.

And communicate, Margolis adds. “Nobody likes surprises, especially when they affect your pocketbook.”

Anne Connery Frantz is a freelance writer in Massachusetts and a frequent contributor to New England Condominium.

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