Even in the best of economic times, preparing a condominium's annual budget is a tiresome task, fraught with uncertainty, estimations and shifting numbers. Now, factor in one of the most challenging economic downturns in a century with cash-strapped owners who may be "skipping" monthly condo fees – or even winding up in foreclosure – and you have a downright daunting task.

The importance and economic challenges of this year's annual budget are not underestimated by Walt Williamsen, principal of CondominiumConsulting Services in Torrington, Connecticut. “The annual budget is the backbone of the community,” says Williamsen. “It is the business plan for the condo association, and an association can't operate effectively without one.”

Getting that “plan” into action is no small feat but does follow a consistent path year after year. Usually, beginning in July or August the management company or association treasurer will conduct the upfront preparation, analysis and initial drafting of the budget. As with most things in life, the upfront preparation proves to be the most overwhelming yet most important aspect of the budget process.

By September, the first draft of the budget will be presented to the association and after an average of three meetings, a finalized budget is put to a vote for approval by the end of December. From start to finish, close to half a year has been devoted to the budget process.

Williamsen believes a clear definition and understanding of what encompasses a budget will assist associations in this arduous task. “Most associations focus on the operational side of things, but the budget is really two parts,” says Williamsen. “The operational costs and the capital replacement fund(reserve fund) are what comprise the annual budget.”

“Fixed Costs” No Longer Fixed

It has been estimated that about 80%of a condominium’s operational costs are fixed. However, in this economy many of those previously fixed costs are up for grabs and require more careful research and analysis than in previous years.

The first step in the budget process is to review and compare the first eight-month billing cycle of the current year and compare that to the previous year’sbudget. This will yield the average projected costs. Such items reviewed would include utilities, insurance, repairs and the like.

However, what in previous years mayhave been viewed as safely averaged costs (as an example, the water bill) may not be the case this year. Other utility costs, such as electricity, will prove even more difficult to average because they are dependent on other fluctuating market factors such as gas prices.

William R. White, vice president of Boston-based The Niles Company anda 40-year veteran of the management business, has seen his share of annual budgets. He advises estimating utility costs to calculate the average utility expenses, and then pad them “to give some wiggle room.”

“In today's uncertain market, I use 10% as a buffer,” says White. Using the water bill as an example, White suggests that managers who have chosen to lock in a fixed price should “multiply that fixed price by the average number of gallons used per year to calculate their budget number. The same method could be used to get a number for natural gas.” White notes the potential for boards to question such conservative measures, but advisesthat it is better to play it safe in this economy than not.

Repair costs are more of a moving target and can fluctuate yearly. Some years experience an unexpected onslaught of repair needs, as seen by this winter's ice storm. Therefore, calculating an accurate projected cost can be challenging. Reoccurring data is fairly predictable, so experts advise reviewing the historical average cost ofrepairs and factoring in the consumer price index increase.

Repairs are not the only unexpected costs caused by this year’s winter storms. Some condominium communities willbe experiencing increases in insurance premiums due to claims filed as a result of storm damage. Associations will need to contact their insurance agents to get an accurate assessment of what to expect in increases, if any.

Contract work is one area that may potentially yield some cost savings. “Annual budget time is the time to open negotiations with contractors,” explains Joseph T. Rodgers, CPA, a partner with Carney, Roy and Gerrol, P.C., located in Rocky Hill, Connecticut. Associations looking to lower their overall costs may need to reduce services, but “if associations are willing to extend the contract, a contractor may consider lowering or holding the contract price,” Rogers says.

Other cost savings can be seen in discretionary maintenance costs. If thebuilding is normally well maintained, then forgoing work on aesthetically-based projects will not be an issue and will assist in lowering budget costs. “The overall perception is that we are in hard times, and if something can be delayed a year, than let’s delay it,” says White.

Delinquencies and Foreclosures Rising

Many condo owners, hard hit by the economy, are finding it more and more challenging to make their monthly condo fee payments. In this year alone White has seen a 10 percent increase in delinquencies. He believes this number may very well rise. Keith Fortin, property manager at Harvard Management Solutions in Merrimack, New Hampshire, acknowledges the increases as well and questions where the funds will come from to make up the difference. “If the condo is not getting the needed funds, the expenses do not change,” says Fortin. “The expenses will stay the same, and somehow the costs will need to be covered.”

Some communities have had to raise condo fees to cover the costs of negligent owners. White feels strongly that this is not the answer. “You cannot punish the condo owners for the delinquency of others,” he says. “It is just not a good practice.”

The answer may lie in proper budgeting. Rodgers suggests adding a line item to the annual budget to cover the costs of condo fee delinquency. “Association budgets have not includedthis type of line item for many years,” Rodgers says. “In this economy this problem will only increase, and associations should prepare.”

The rise in condominium foreclosures might prove an added incentive to include a contingency for bad debt to the annual budget. Although foreclosures have not hit the condominium market as hard as single family homes, they are on the rise and will affect communities throughout New England. “We are seeing it (condominium foreclosures) all over and in all sized communities,” says Fortin. “It will obviously have an effect on the condo fees.”

Reserve Funds “Dipping”

With the increase in condo foreclosures predicted, lenders will continue to heighten their scrutiny of a condo association’s financials before giving approval of loans. Of particular interest is a condo's reserve fund – the second branch of the overall budget, accordingto Williamsen.

The reserve fund is set up to provide for capital improvements, major repairs and maintenance issues not covered by the regular operating budget. Even with the typically-conservative vehicles condo associations traditionally invest in (such as CDs or government securities), reserve funds might be seeing a “dip” in value. This “dip” may impact futuremortgage approvals as many financial institutions are becoming more stringent with requiring reserve funds to maintain a specific percentage of the association’s overall budget.

Both Fannie Mae and Freddie Mac have such a requirement in place. Both require 10% of the condominium budget to be earmarked for the reservefund. The purpose is not only to protect the lender’s investment but also the buyer.

“The intent is to ensure the project’s long-term success,” explains Brad German, senior director of public relations for Freddie Mac. “As you know, when projects (homeowner associations) begin experiencing financial stress, reserves are often reduced. This in turn can affect the overall project’s condition, its ability to maintain adequate insurance coverage and ultimately the market value of theindividual units.”

Amy Bonitatibus, senior media relations manager for Fannie Mae, agrees. “This (requirement) is intended to ensure that a project is well managedand that prospective buyers will not be faced with unanticipated financial hardships like special assessments or large increases in the condo fees due to the lack of an adequate reserve funding strategy.” She also notes that in some cases, the requirement can be waived if it is determined that an association is still able to fully operate with “less than 10% reserves built into the budget.”

With reserve funds playing a part in everything from mortgage approvals to increases in condo fees, it is important to adequately maintain the fund, but equally important to have a realistic plan in place for its use. This is where a reserve analysis study comes into play.

In its simplest terms, a reserve analysis study is a physical checkup of the condominium building and grounds. Typically, the study reports the life expectancy (when repairs will most likely need to be made) on such “big ticket” items as the roof or the pool. Most studies project out 20 to 30 years. Williamsen suggests condo associations get a study every three years. “It should be mandatory and in some ways it is,” says Williamsen. “People want to know how much more life there is in the building and know that there is a plan in place.” Having this plan will assist associations with future budgets and the budget at hand.

Drafting a budget in uncertain times is no easy task, and nailing down the financial moving targets that this year’seconomic landscape is presenting can have condominium managers and board members biting their nails.

But ultimately, the creation of a sound annual budget can prove to be the difference between fiscal stability and a sink-or-swim scenario for many associations. Having a solid financial plan in place will also allow condominiums to build a firm foundation, for this year and years to come.

Hillary Pember is a freelance writer and a frequent contributor to New England Condominium magazine.