While natural disasters causing catastrophic property damages are on the rise, associations also have to be prepared for other unexpected pitfalls such as a roof repair and replacement project or the installation of a new heating and cooling system. These major capital improvement projects typically come at a great cost. Residents often deem the process as burdensome, taxing or both. Association boards, on the other hand, should make sure that adequate funds are available for such projects; however, all too often this is not the case.
But what exactly are capital improvements as defined by industry professionals? When talking about capital improvements as related to a residential community one is speaking of the property components that have a defined useful life and will need replacement at some point in the future. Experts point to such things as roofs, sidewalk pavement and roads, exterior siding and boiler and HVAC components as having a certain life span that over time will need to be replaced.
While usually well-intended, associations, regardless of location or residential income levels, tend to make common mistakes when it comes to budgeting for required improvements such as new roofs, windows or paving.
“The biggest problem boards face is not having the information they need to adequately budget and make critical decisions,” says Stuart Wilkinson with the Reserve Study Group, a national consulting firm. “Boards need to arm themselves with information, including a reserve study that helps them not only understand their current circumstances but what options they have moving forward.”
Nik Clark, director of client services for the Milwaukee-based Reserve Advisors says “failure to plan” is probably the most common mistake he sees on a regular basis. “Historically, many associations just didn’t plan/budget for major capital expenditures and took a ‘wait until it breaks’ mentality,” says Clark. “Other common mistakes are trying to do-it-yourself (DIY) without the expertise and knowledge to compile a comprehensive forecast.”
Ralph Noblin, a professional engineer and principal of Noblin & Associates, a consulting engineering firm in Bridgewater, MA and Dover, NH, has been preaching to the choir about associations not having adequate reserve funds for many years.
“I’ve been singing this mantra for a very long time,” Noblin says. He wholeheartedly agrees with Clark in that poor planning is typically to blame for insufficient funds.
Noblin warns that as many as 90% of the associations he sees and deals with on a regular basis throughout New England are either unfunded or seriously underfunded.
“We lay out real numbers all day, every day. We know from experience what the roofing costs, what the siding costs, what deck replacement costs, and we’ll tell them with good accuracy when all that’s going to take place, whether it’s five years from now, 10 years from now. The industry looks out 30 years, that’s kind of a standard that’s been adopted for a long time. If you think you have 25 years left on your roof, you really should be saving 1/25th a year from this point forward if in fact you have nothing. That’s not unusual—many places have nothing or close to nothing,” Noblin says.
Bob Burns, a professional engineer, consultant and owner of Burns Associates—Engineers in Portsmouth, NH, says that boards understand budgeting but fall short in areas of asset management. “Most boards are pretty up to speed on the financial aspect of things, you know the budget. They’ve got a good handle on that. Where their weak points are—is in the technical performance of the assets themselves, how are the roads, the roofs, you know, what they need and how they perform in different environments. That’s where they kind of need some help.”
There seems to always be resistance to putting money aside for something that seems too far down the road, says Noblin, especially in active adult communities where many residents are seniors. “I just met with an over-55 recently, and this over-55 group, said ‘I don’t really care about the future… I’m not going to be here.’ The industry has acknowledged that this really should be a pay-as-you-go system. If you’re living in a place and that roof is providing you protection from the weather, you should pay something for that,” Noblin says.
As for red flags, in an area like New England, weather is the number one culprit, says Noblin. “If you take New England, pretty much everything outside is going to wear out, it’s just a question of when.” There’s an expectation, especially due to sometimes exaggerated manufacturer’s claims, that siding will last 25 or 30 or even 50 years, but in reality it could fail in as little as 10 or 15 years, he says.
Understanding Reserve Studies
Regardless of the state or location, a board of trustees should take the same approach to assuring that there is enough money in the association’s reserve fund. This isn’t a rainy day fund because there is no question certain big ticket projects will come to pass. While management companies are usually excellent information resource for boards looking for budgeting answers, often times it is prudent to seek the advice of experts in this niche field as they can better prepare timelines.
“We recommend reviews annually although it depends on the complexity and condition of the association and its common areas. The more variables involved the greater the need for regular review,” says Wilkinson. “At a minimum, associations should have an on-site review at least once every three years.”
As far as Massachusetts goes, funding is required. “Under Massachusetts General Laws Chapter 183A, Section 10(i)(2)—(i) All condominiums shall be required to maintain an adequate replacement reserve fund, collected as part of the common expenses and deposited in an account or accounts separate and segregated from operating funds.”
However, once control of the condominium is transferred from the developer to the unit owners, the association can vote (67% required) to modify and, presumably, eliminate the reserve fund requirement. If the association hires a manager, the agent must maintain a separate account for a replacement reserve fund.
As far as other New England states, Connecticut mandates that the annual budget must include “adequate” reserve contributions. Resale disclosure statements must include current reserve fund balances. For more information, see Connecticut Common Interest Owners Act (CCIOA), General: Section 47-202, Budget: 47-261e, Resales: 47-270. New Hampshire, Rhode Island and Maine have no such provisions, and Vermont requires resellers to disclose the amount of reserves set aside for capital expenditures.
Timing and Costs
While fees for reserve studies vary, Wilkinson offered ball park figures. “The cost of a reserve study is dependent on the complexity, size and location of an association. It is basically a function of the time taken to prepare a report. We have seen studies cost as much as $12,000 and as little as a $1,000, so the cost can vary significantly,” he says.
In Clark’s estimation, the cost greatly depends on the size, age, complexity and the number of amenities offered by the association. When asked how long a reserve study assessment takes to complete, Clark responded that time frames vary but in general 45 to 90 days is a good range. Noblin recommends that boards and associations perform a reserve study approximately every three to four years and costs should run a minimum of about $2,000 in most cases.
Noblin says in his experience, time-wise, “a busy firm is probably going to need about a 12-week window to complete a mid-sized study.” He says he gets requests all the time for an expedited one. “I get a kick out of my condominium clients/my managers who will call me thinking I’m sitting around hoping for something to do that day and they’re going to fill that bill asking me to get them a proposal for a reserve study and then can it be done in two weeks. It really can’t. A 12-week window is what should be planned for.”
Burns too says it depends on the complexity of the infrastructure, the nature of the amenities; the buildings, roads, pools, tennis courts and recreational facilities. He just did a reserve study for a community on Lake Winnipesaukee where they had to do an underwater survey of the pilings for the boat launches.
Wilkinson explained that reserve studies should be prepared by professionals trained and certified in the field. One such certification is Reserve Specialist (RS), which he holds and is available through the Community Associations Institute (CAI). “To obtain this certification, candidates must have prepared at least 30 reserve studies within the past three calendar years, hold a bachelor’s degree in construction management, architecture, or engineering, or something equivalent based on experience and education, and comply with industry standards and codes of conduct.”
When a professional is hired to conduct a reserve assessment, they are looking for both the obvious red flags as well as problems that are hidden to the untrained eye. “In many cases it’s the obvious. Signs of deterioration, staining, cracks or an apparent lack of maintenance are in some cases overlooked by those who may see a property day in and day out,” says Wilkinson. “A lack of ongoing and preventative maintenance generally raises concerns that the condition of a community’s capital assets is well beyond its physical age and may fail prematurely.”
Burns’ firm uses a proprietary software program called Reserve Manager in which condo clients can monitor the life spans of the community’s various assets and use it as an interactive tool as they plan for future needs and expenses.
“What Reserve Manager does is it monitors the physical condition of the capital assets of the association,” Burns says. The program contains templates where amounts can be tabulated and it allows an association to track when they do maintenance, when problems come up on different components like the roads, and the roofs and the decks, and so forth. When projects have to go out to bid, they can enter the information into a database in the Reserve Manager, he explains. Then you can contrast and compare this data with what’s in the actual reserve study spreadsheets and cash flow projections to help design the reserve portion of the community’s budget.
Most, if not all, management companies have experienced boards that were not prepared for a capital improvement project. While they might have had monies in respective reserve funds, it simply wasn’t enough to underwrite the project. This results in major headaches and troubles for boards and residents alike.
Burns says that having a plan in place like Reserve Manager goes a long way in preventing those headaches. “Had they been tracking these conditions and seeing how things would deteriorate over a period of time, they’re in a much better position to go ahead and use the money and justify that—it’s very defensible before the membership,” Burns says. ”When they got a plan like this, a program, they don’t get caught in this situation of deferred maintenance. They don’t wake up someday and say ‘how did that all happen?’ Oh gosh. ‘Wow, we need a sudden cash inflow here of a million dollars.’ You were watching the numbers, you’re watching the dollars, but you weren’t watching the conditions of the assets that you’re responsible for,” he explains.
“The worst case scenario is that associations can, and have been condemned if assets are not properly maintained. This is a worst case scenario which results in huge financial burden for unit owners and sometimes loss of investment. More common are substantial special assessments that can be almost equally difficult for associations,” says Clark.
The special assessment is a double-edged sword. While monies can be obtained, it doesn’t adequately prepare for the future. It is deemed a stopgap approach to project funding and doesn’t always end well. “If a roof begins to fail and water damage is occurring an association may have no choice but to special assess to the tune of thousands upon thousands of dollars. Unpaid assessments can result in liens and foreclosure,” says Clark.
There are some traditional methods of funding, according to Burns. Independent of methodology used—there is baseline funding; full funding; statutory funding; and threshold funding:
• Baseline funding means to establish a capital reserve funding goal of keeping the reserve cash balance above zero.
• Full funding means setting a reserve funding goal of attaining and maintaining reserves at or near 100% funded.
• Statutory funding means establishing a reserve funding goal of setting aside the specific minimum amount of reserves as required by local statutes.
• Threshold funding means establishing a reserve funding goal of keeping the reserve fund balance above a specified dollar or percent funded amount. Depending on the threshold, this may be more or less conservative than “fully funded.”
As an example, a condominium roof has a 20-year life span. The roof is 10 years old with an estimated $50,000 replacement cost. If the reserve fund has $25,000, the board or association must collect $2,500 over the following 10 years.
Boards must also differentiate between short, medium and long-term goals. With board members often in flux, it can prove difficult to budget for a capital improvement project that is 20 years down the road when many residents and board members will have moved on. This is why it is important for boards to take a collective long view with the assistance of industry professionals so boards don’t fall behind. Burns points out that one of the benefits of having something like the Reserve Manager program is that it can be transitioned over to a new board or new management company fairly easily.
“First and most importantly is to gather all the information and data you can to make informed business decisions. This means conducting a reserve study to see where an association is at. Once you have that data you can begin to make decisions effectively,” says Clark. “That may include increasing assessments, preparing homeowners far in advance for special assessments, or utilizing the services of lending institutions, which specialize in loans for capital projects for associations.”
W.B. King is a freelance writer and a frequent contributor to New England Condominium. Executive Editor Debra A. Estock contributed to this article.