Shared interest communities like condominiums, co-ops and HOAs are non-profit entities. That means they’re dependent on residents paying their monthly fees in order to meet the community’s projected expenses. Unless a community leases space to a commercial tenant like a garage, ground-floor retailer, or exterior signage company, those fees are the association’s sole source of income. With so little margin for error, unexpected expenses can pose a real danger to the financial health of any community.

Operating vs. Capital Expenses

A community’s expenses usually fall into two categories: operating expenses and capital expenses. 

Operating expenses are recurring bills for things like shared utilities, real estate and labor expenses, supplies, and general maintenance of amenities and common spaces. In a co-op, those shared expenses include the building’s property taxes, whereas in a condo association or HOA, those taxes are paid directly by the individual unit owners. The association only collects and pays for that portion of these expenses that apply to common areas, and those items are budgeted for annually.

Capital expenses include things like replacing the entire roof or sprinkler system, and are budgeted for separately from taxes and janitorial supplies. Most communities have a reserve fund to cover capital expenses, fed and maintained by a line item in their annual budget. The useful life of a roof or a boiler can be estimated, and its replacement cost planned for well in advance—but what about big, unexpected, unbudgeted-for expenses, like damage from a hurricane or a fire, for example, or a fine for violating a local law, a judgment in a lawsuit, or even a major jump in insurance premiums? Those contingencies are sneaky, costly, and can blow a budget to smithereens in one fell swoop.

A Hole in the Hull

Like a hole in the hull of a ship, an unexpected expense can quickly sink an annual budget, says Dan Wollman, CEO of Gumley Haft, a management firm located in New York.  “Budgets are zero-based; there’s no profit,” he notes. “Some have built-in contingencies, but many do not. If something out of the ordinary or unexpected happens, it affects the budget. If [an expense] is of a capital nature, the reserve fund can kick in—that’s why you have reserves in the first place. But sometimes that’s not enough.”

The two main culprits when it comes to a budget derailment are rising costs and unexpected repairs. Costs are beyond a board’s control, and can go up because of simple inflation, or as a result of a crisis, like the supply chain disruptions during the Covid pandemic, or the current war in the Gulf. Both situations caused prices for goods and energy to jump worldwide. Regardless of the reason, however, those bills must be paid—which is easier said than done for a building or HOA working within paper-thin financial margins. 

While attentive, on-the-ball board-management teams plan well in advance of need for things like roof replacements or HVAC upgrades, there’s always the chance of a sudden, unexpected emergency and the higher costs that come with having to get crucial work done on extremely short notice. (This isn’t the same thing as deferred maintenance, when a board puts off recommended repairs to their property in the interest of keeping residents’ fees low, and then winds up paying a premium for emergency repairs they could’ve gotten for far less had they been proactive.) 

“When funds are limited,” says Jacquelyn Dion, a community association manager with Evergreen Management based in Bedford, New Hampshire, “urgent infrastructure upgrades should be evaluated and then prioritized according to risk and expense. It is important for boards to understand the differences and whether delaying a project will increase future costs.”

That said, sometimes stuff just happens. “A mid-season breakdown of your pool pump that showed no signs of advanced wear and tear can cost thousands of dollars to get your pool running again,” says Anthony Rotundo, a community manager with FS Residential.  “The unexpected breakdown of a rooftop exhaust fan on a high rise could lead to increased costs if it requires a crane for repair. If these items aren’t accounted for in your reserve funds, or you do not have the proper funding in deferred maintenance, these could cause large deficits in your budget.”

Taking a Long View

While a board can’t control inflation or anticipate every crisis, they can definitely pay attention to market trends, understand their insurance claim history, and know the age and condition of their building and its systems. They can then use that information to budget more intelligently. 

“There can be some predictability based on existing data and experience,” says Michael Kim, of counsel with Schoenberg Finkel Beederman Bell Glazer, a law firm based in Chicago. “For example, if your elevator is way overdue for modernization and service calls are becoming more frequent while needed parts are becoming less available, rather than simply wait for catastrophic failure to prompt an expensive project under adverse conditions and a major inconvenience, it would be advisable to increase your regular repair and maintenance budget and/or increase your capital funding to accelerate that project.”

Utility use is another metric that boards can examine for both waste and potential savings. Dion points out that “utility costs are the most unpredictable expenses of many association budgets. Electricity, natural gas, fuel oil, and water and sewer rates can fluctuate significantly due to market conditions, weather conditions and infrastructure costs. Even minimal increases can create budget pressure, particularly in communities where utilities represent a large operating expense. Communities that track their utility consumption are generally better prepared to identify problems before they become costly.”  

Insurance is another financial friction point that it pays to stay on top of, says Dion. “By reviewing previous insurance loss run history and deductible exposure, boards can better identify opportunities for protection from unexpected expenses.

“Another very important consideration is for boards to proactively monitor industry and regulatory revisions,” she continues. “A current example of how legislative and lending guideline changes can impact future financial decisions is the anticipated update to Fannie Mae and Freddie Mac reserve funding requirements. Effective January 1, 2027, applicable condominium associations will be expected to increase reserve funding amounts from ten percent to fifteen percent. Changes like these can significantly affect an association’s budgeting, reserve planning and overall financial obligations.”

Boards can also apply some common sense. For example, one of the most common mistakes boards make is assuming that if an expense didn’t occur last year, it won’t occur next year. A more strategic approach to budgeting for upcoming operational and capital costs would be to review the past several years of financial statements to identify spending patterns and evaluate aging infrastructure for maintenance and repair needs. Many associations increased the frequency and quantity of cleaning supplies and PPE purchases during the pandemic, for example—did they scale back those orders when the crisis ended, or are they still paying for extra bleach and KN95 masks? 

Check the Fine Print and Watch the Clock

Another place to look for financial ‘leaks’ is the small print of any contract you have—or are considering having—with vendors and service providers. Specifically,  any clause that permits cost increases to that vendor to be passed along to your community. 

“When filling a budget gap,” says Jonathan Klein, a partner with Marcus, Errico, Emmer & Brooks in Braintree, Massachusetts, “there’s little you can do other than try to get fixed cost contracts going forward, not indexed costs. Accounting for inflation would raise costs to your association, so be very cautious about language in contracts that permit pass-throughs from contractors. Watch out for this in contracts with trash removal or laundry companies—they’re notorious for rate pass-throughs.”

Another not-so-minor detail for some communities, particularly those with large staffs is overtime. “We build some overtime into our budgets,” says Wollman, “as there will always be some. Maybe someone doesn’t show up and the person on the prior shift has to stay. That’s overtime. It’s not necessarily a budget buster, and you can never eliminate it entirely, but you have to do what you can to minimize it” by setting reasonable schedules that don’t chronically run overtime. 

Urgent vs. Emergency 

While triage is tough in a moment of crisis, boards and managers should always assess whether an unexpected situation requiring a repair or other fix is merely urgent, or actually catastrophic. The first question to answer is whether residents are safe, says Wollman. 

If and when they are, the board and management must determine whether the situation requires immediate emergency action to stabilize it by whatever means (and at whatever cost) necessary, or whether it’s urgent, but can wait til morning, or the next business day. “An example of the former would be installing a supporting brace to prevent immediate structural failure while a longer term fix is being formulated and implemented,” says Kim. “So both categories are not exclusive, but rather complementary concepts.”

Issues with anything involving life safety and building integrity, like fire protection systems, electrical hazards, water main breaks and roof leaks are true emergencies, and should be treated as such by boards and management. 

“Emergency repairs take precedence over all other items,” says Rotundo. “For example, if there’s a deficiency noted in our annual sprinkler inspection that could lead to a system failure and an enforced ‘fire watch’ by the local municipality, that must be rectified without delay, because additional fines will only make the repair more expensive.”

On the other hand, Rotundo continues, “A security camera failure would be considered an urgent matter as it affects the security of the building, but doesn’t directly compromise the safety or habitability of the association itself. That might be a project that’s delayed until the funds are available.” 

Budgeting in a zero balance world is difficult to begin with. Emergencies and contingencies will always arise, and the bill for them will always come due eventually. While no board can see the future or project costs with complete accuracy, they can pay attention to past and current trends, familiarize themselves with their physical plant, know their association’s claim history, and draft their budget accordingly, making the tough choice to increase fees or assessments as needed to keep pace with real-world economics and the cost of running a multifamily community. 

A J Sidransky is a staff writer/reporter for New England Condominium and a published novelist. He may be reached at alan@yrinc.com