Today, communities are struggling to plan for the future when the shape of that future is uncertain. Now, more than ever, communities need to have the answers to some critical budgeting questions:
If your community association hasn’t already completed your 2021 budget, it’s crunch time. Your proposed budget needs to be ready in time for your annual general meeting (AGM) so your members can approve it.
It seems easy – simply copy the budget from last year and hope for the best, right? But that approach could have your community seeing shortfalls at the end of the year, leading to unwanted consequences.
Creating the budget is the single most important action your board can take. Your budget is essentially the board’s action plan for the coming year. And to make a good budget, you need to have a strategy…
Why Your Community Association Needs a Budget
Because community associations are non-profit organizations, there’s not a lot of wiggle room on the financial side of things. You have expenses that must be paid out – garbage pickup, utilities, landscaping, etc. You also must have enough to put aside for your replacement funds. And if the board wants to accomplish any initiatives throughout the year, like capital improvements, painting the lobby or finally resurfacing those tired looking tennis courts, you need to have enough money coming in to cover it.
For most community associations, the primary (or even the sole) source of income is the assessments. That means you must walk a very thin line to predict exactly how much money you need to take in to cover all the budgetary needs without going over.
If assessments are too high, homeowners won’t want to pay them. If assessments are too low, the board may find themselves in the unenviable position of enacting a special assessment. A special assessment is a one-time extra charge, split among the membership to cover unplanned expenses, and NOBODY wants to get that bill.
What’s in a Budget Strategy
1. Should We Raise Assessments?
One of the first mistakes boards make when working on a new budget is to start with this question. It should, in fact, be the LAST question you answer. Why? Because the assessments amount shouldn’t be based on how much community members have always paid, or whether they are willing to vote on an increase. (Though that is the driving reason most communities do not increase assessments year after year, putting them into financial trouble!)
The question of the amount of the assessments needs to be based on a formula taking into account your community’s expenses, your reserve fund amount, and board initiatives. We’ll get into that later in this article.
2. Do We Need to Update Our Reserve Study?
The reserve study helps define the remaining life of your community’s assets, from buildings, to appliances, to amenities to common ground. Based on that calculation, the reserve study lets you know how much money you need to have available in the coming years to replace important (and expensive) parts like roofs, elevators, air conditioners, asphalt and more.
A lot of people dismiss the reserves as a rainy-day fund, but that is a misnomer. There’s no telling when a rainy day might come, but a piece of expensive machinery is guaranteed to break down eventually. Lucky for us, reserve specialists have developed the prediction of when that is likely to happen into a science. Utah law requires a community to update their reserve study every 3 years, and you cannot vote to waive this requirement.
3. Do We Need to Increase Funds for Our Maintenance Plan?
By now you’ve probably heard the story of the board of directors that waived maintenance on a playground swingset for years, only to have it break on a teen, causing the community to be sued, and the members to receive a massive special assessment to cover a 20 million dollar settlement. In their 205 unit HOA, that worked out to a bill for about $88,000 to each homeowner after insurance.
Preventive maintenance is essential for your community, not just to extend the life of community assets, but also to prevent scenarios like the above from happening in your community. If you have deferred or underfunded maintenance to keep dues low, your board needs to reassess your priorities for the coming year.
4. Are our Reserves Funded Enough to Cover Pending Replacement Costs?
Your reserve study will tell you how much you are supposed to be saving, and when those amounts are likely to be needed. If you haven’t got enough to cover a breakdown when it happens, you could be headed for trouble, in the form of special assessments, bank debt, or even lawsuits.
The sad truth is that most Utah HOAs are underfunded, meaning that they will not have replacement funds available when they are needed. As a board member, it is your duty to be fiscally responsible to make sure your community is prepared for the future. Your budget strategy needs to consider how far you are behind on funding your reserves and provide a plan to increase the funding percentage to where it needs to be.
5. Do We Need to Perform a Financial Audit?
Unlike other states, Utah does not require community associations to perform a financial audit on a regular basis. Yet, it is a sound financial strategy to have an external party review your community’s finances on a regular basis. Not only will auditing reveal fraudulent behaviors before they become overwhelming, an audit can help identify poor or redundant financial issues that could have your community in a stranglehold. Too often a community will have a vendor on automatic payments for a service they are no longer using or have two vendors providing similar services and not realize it.
Even if your board chooses not to perform an audit, you should at the least consider establishing internal controls to regularly review and assess financial reports. This is one of the types of services provided by a good management company.
6. Does Our Budget Accommodate Our Delinquency Rate?
The old saying says, don’t count your chickens before they hatch. And yet, with your budget that is exactly what you are doing. To get a realistic estimate of how much money you’ll be receiving from assessment income, you need to account for assessments that are more likely NOT to get paid.
Your delinquency rate is the percentage of the homes in your community that are delinquent in paying their assessment fees. These are the accounts that go into collections. The problem is that collections is not necessarily going to produce cash in your pocket, and even if it does, it can take significant time and money to get any recovery. When this is calculated in budget dollars, we call it bad debt.
That’s why it’s important when planning your yearly budget that you subtract expected bad debt from your budgeted income. (And consider implementing a strategy to reduce your delinquency rate if it’s high. Anything over 6% is a potential concern for maintaining a healthy community.)
7. Do We Have Any Contract Renewals or Rate Increases Coming?
8. What Improvements from Our 5-Year Plan Do We Need to Budget For?
When you were elected to the board, it’s likely you had a laundry list of improvements you wanted to make for the community. Often boards have plans to add new amenities or update existing assets to attract new members, implement services for existing homeowners, or even add secondary income generators to help ease maintenance fees in the future. Whatever is in your board’s strategic plan, you’ll get nowhere if your budget has you treading water.
Back to the beginning
Those are the big questions your 2021 HOA or Condo budget strategy needs to account for. Once you’ve gotten answers on questions 2-8, you need to cycle back around to question 1: Should we raise assessments?
Rather than an arbitrary number that never increases, your assessment amount should be based on a formula. Consider your planned expenses, delinquency rate, preventive maintenance, reserve funds and planned improvements. Here’s a handy calculator that will help you determine how much you should be charging in assessments.
Need help with your strategy?
Benjamin Franklin wrote, “By failing to prepare, you are preparing to fail.” That sentiment was never more true than for community associations. You must have a strategy to prepare for the future. If all you are doing is treading the budget waters, you’ll never make it to the shore. If your board is struggling with a strategy for your Utah Community Association, let HOA Strategies help.