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After
Your Reserve Study is Done -- How to Defend a Fee Increase
March/April 2005 - SCHA Newsletter
By Chris Andrews – CAI Reserve Specialist #100
Stone Mountain Corporation – Santa Barbara
Suppose you’ve just received your reserve study
indicating that a reserve funding increase will be necessary. Without an increase, it appears that your association will not
be able to properly maintain the association’s common assets over time.
Most associations are legally obligated by their
CC&R’s to properly maintain their property.
Furthermore, California Civil Code § 1366(a) states “… the
association shall levy regular and special assessments sufficient to perform its
obligations under the governing documents and this title.”
Your board of directors has reviewed the reserve study and
some or all of the directors agree with the funding increase.
The board also realizes that the increase in reserve funding will require
an increase in regular monthly fees or even a special assessment.
From past experience, you know that a regular monthly
assessment increase will stir up resistance from a few vocal association members
who don’t like change of any sort – especially the type of change that
requires them to spend more money! And
what if some of these people are on your
board of directors? On a
five-person board, if you have a majority of three board members opposed to any
assessment increase and only two fiscally responsible ones, you stand little
chance of passing the reserve funding increase.
Your task – assuming you’re one of the fiscally
responsible board members – will be to convince the dissenting board members
that a reserve funding increase is the right thing to do.
In addition, you’ll also need a majority vote of your
membership – per California Civil Code §1366 – if the resulting regular
assessment increase is more than 20% above the preceding fiscal year’s regular
assessments or if your proposed special assessment exceeds 5% of the budgeted
gross assessments for the fiscal year. This
means you’ll have to present your argument not only to your board of
directors, but also to your membership. How
can you do so effectively?
Following are several tips on how to successfully gain
approval for an assessment increase:
First, you must break the news gently.
Association members are most receptive to hearing that “member
assessments must be increased due to factors out of our control or due to new
information not available to us previously.”
There is really no rational argument against these reasons. For example, significant increases in worker’s compensation
insurance in recent years have caused dramatic increases in roofing, painting,
and paving contractor’s prices.
Members are least receptive to assessment increases due to
incompetence by board members. Common
examples might be board member negligence that caused ultimate expenses to be
much higher than they should have been if the board had been diligently
maintaining those items. For
example, not painting trim & siding caused it to become prone to dry-rot and
warping. Or not sealcoating asphalt
frequently enough so that potholes formed prematurely.
Before uttering the words “assessment increase,” build
a strong case for the assessment increase by mentioning some or all of the
following where applicable:
ü
The costs to maintain association property have increased
significantly.
ü
Some new reserve expenses have become apparent since the last
budget and the last reserve study were prepared, for example, slab leaks,
fumigation, etc. It is easiest to
tie an increase in funding to forthcoming capital replacement projects that
people agree are necessary.
ü
The association never had a proper reserve study done before and
now that one has been prepared, a comprehensive inventory of capital assets
(reserve components) was made with up-to-date
replacement costs for those items.
ü
There have been many planned and unplanned reserve expenses in
recent years. Compile a long
itemized list of these expenses and show how they have exceeded your recent
reserve income and depleted available reserves for future expenses.
ü
The percent funded estimate provided by the reserve study
indicates that in past years, the association has not set aside sufficient funds
for these items for each year they have depreciated in value.
ü
If the percent-funded estimate is quite low, cite the fact that
mortgage lenders view poorly-funded associations as higher risk and many review
the reserve study before approving a loan.
For reverse mortgages, the FHA requires that associations are at least
65% funded for capital expense depreciation and they prefer 80% or higher.
Senior citizens who have applied for reverse mortgages have been all set
for approval but then a final review of the association’s percent-funded
status nixes the deal.
ü
If the association does not maintain its property, the real estate
values of each home may be adversely impacted.
Ironically, in a poorly-maintained association, the net reduction in real
estate values often far exceeds the amount of the proposed increase in
assessments.
After you’ve presented the foregoing funding issues, then
kindly explain that a reserve funding increase or special assessment will be
needed. Upon hearing the magnitude
of the proposed funding increase, there will inevitably be strong objections
from some members.
Following are several typical objections and how to
effectively respond to them:
Ø
“I
can’t afford the increase.”
RESPONSE: Remind them that the association is a business and it has an
obligation to maintain its common assets for the good of the community.
It is not fair for a handful of individuals claiming hardship to hold
hostage the entire association and the property values belonging to all members.
Although the association is usually run by volunteer board members, it is not a
socialist organization. The cold
reality is that nobody has a right to live in the association if they are no
longer able to uphold their responsibility to share in the costs as described in
the governing documents to which they agreed during escrow.
If neighbors wish to be compassionate to a neighbor who claims hardship,
they should personally arrange to do so outside of the association’s budget.
Once the regular assessment increase or special assessment is passed, it is
remarkable to see how resourceful people actually can be in spite of their
claims of hardship. With large
increases in home equity, some tap into a home equity line of credit.
Others with an extra bedroom in their unit decide to rent it out to a
tenant to bring in extra money.
Ø
“As
a senior citizen, I won’t be here in 15 years when the roof needs replacement
and in 10 years when the streets need repaving.
Why should I have to pay for those costs now?”
RESPONSE: Senior citizens are not the only ones who pose this question.
Young people who consider a condo as a starter home and don’t plan to
live there for more than several years ask the same question.
The problem with this “short-timer” logic is that these people are
benefiting from the use of the roofs, streets, pool, etc. while they’re living
in the association. If their roof is a 30-year roof and they live in the
association for 5 years, then the value of the benefit they derive from the roof
during their stay at the association is 5/30th
or 1/6th of the cost of the roof replacement.
It is indeed fair that they pay for their incremental use of the roof,
streets, pool, etc. even though they may not be living in the association in the
future when the actual replacement occurs.
Additionally, remind new residents that they
are currently enjoying capital improvements paid for by other members before
they moved in.
Another response to “short-timers” who hope to sell their unit in the next
few years is to tell them that the future market value of their residence may
indeed increase significantly more than the net increases in assessments if the
association is well-maintained via those increases.
Ø
“Why
don’t we just special assess for future capital expenditures like roofing,
paving, etc.?”
RESPONSE: The primary drawback to the special assessment method
of funding is that your board may have trouble collecting all of the necessary
money from all owners when large reserve expenses occur.
Suppose some owners cannot come up with $10,000 for a roofing special
assessment when your association desperately needs a new roof?
It is better to collect the money gradually every year so your
association has those funds when they’re needed.
Furthermore, using the roofing example above, if the association does not have
sufficient reserve funds to replace their roofing immediately when needed, the
eventual cost to do so may increase dramatically. While the board must tiptoe through the painful process of
levying a special assessment, more roof leaks and costly interior damage may
occur to residential property inside the units. And, during that time, the scourge of most associations –
dry rot and mold – have a chance to become established. Does anyone want a mold lawsuit?
In short, having to defer maintenance even further while levying a
special assessment is poor planning.
Another drawback of the special assessment funding method is that it unfairly
penalizes those homeowners who happen to be living in the association at the
time of the special assessment. A
reserve study calculates an annual reserve funding amount which ensures that
everyone pays equally for the depreciation that occurs while they live in the
association. (Depreciation
represents, in dollars, how much each asset such as roofing, streets, etc. is
“used up” over a period of time).
Ø
“The
fees are already too high!”
RESPONSE: Determine how much are association fees in other associations
in your area with similar amenities and share this with your membership.
If your association pays for trash, hot water, cable, etc., factor these
items out of your fees when comparing with other associations that don’t pay
for these utilities. Your members
may be pleasantly surprised to find that other association assessments are
considerably higher.
Then explain how the reserve study works and show them the list of reserve
components that the association is obligated to maintain.
Ask the dissenting members if they don’t want to raise assessments to
the appropriate level, which items in the reserve study (e.g. roofing, paving, fencing) do they
want the association to cease to maintain?
Suppose the recommended reserve funding increase they object to is $10,000 per
year more than last year, ask them to find a $10,000 per year item in the
reserve component list (or a $100,000 item occurring every 10 years) that they
deem to be “non-essential” and if they really want to vote to cease
to maintain it. Calmly ask them if
they don’t mind being documented in the minutes as having taken that position.
Ø
“I
can get a higher investment yield on my money than the association can so why
should I be putting more of my money into the association’s reserve account
that only earns CD rates?”
RESPONSE: Ask them if they sell their unit at some point in the next
few years before a major reserve expense such as roofing, do they plan to write
a check to the association’s reserve fund to cover the depreciation of their
roofs, streets, pool, etc. that occurred during their tenure?
Or, like most people, do they secretly hope to avoid having to pay for
those large expenses altogether?
The problem with the “I can get a better investment yield elsewhere”
argument is that there is no guarantee that the people who pose this argument
will, in fact, own their unit in the future when those saved reserve funds are
needed. Ask them if they are so
confident that they can get a better investment yield on those funds, would they
be willing to enter into a contract with the association to repay the sum total
of the reserve assessments they didn’t have to pay to the association with
compound interest at CD rates when they sell their unit in the future.
Because there isn’t a built-in mechanism in the escrow process to cause a
seller to pay for the depreciation that has occurred on all reserve components
(roofs, streets, pools) during their tenure, there will always be people who
sell and manage to avoid paying for those items, while new owners are burdened
with those expenses.
If the foregoing rational discussion does not overcome
objections, it is time to escalate the debate:
Ø
If the objections come from board members, inform them that
California case law (Raven’s Cove
Townhomes vs. Knuppe Development, 1981) has held that board members can be
individually liable for failing to properly fund a maintenance reserve account.
For more on this case, visit:
http://davis-stirling.com/ds/cases/ravenscove.htm
Ø
If the objections come from board members, inform them that their
vote against prudent reserve funding will be documented in the minutes.
Then calmly ask them again if they still want to vote against it.
Ø
If your board is in agreement on the assessment increase, but
several association members vehemently oppose it, inform them that the board
members have been elected to act as fiduciaries on behalf of the association and
they will do what they deem is best for the association.
In other words, members essentially don’t have much say in the matter
in most cases
Depending on the wording of your CC&R’s, association members may have the
right to force the board to call a special meeting of the membership to discuss
the issue. They may even try to
force a membership-wide vote on the assessment increase, but in most
CC&R’s, the board has the ultimate say in whether or not to bring an issue
to the membership for vote, unless, of course, the assessment increase exceeds
the amount that the board is authorized. Consult
with your attorney for further clarification.
If the Board agrees to a vote of the membership on the assessment increase and
the increase is rejected by popular vote, then the membership, rather than the
board, may be seen as complicit in not funding reserves properly.
To protect yourself and your fiscally-prudent allies, keep a tally of
members who voted against and those who voted for the proposed reserve funding
increase and document that in your minutes.
Ø
Strive to get as many members as you can on email and use that
medium to campaign for the assessment increase.
Make sure that you send equivalent copies of those emails to your members
who don’t have email so everyone has equal access to information.
In the end, persistence coupled with logic and reason should prevail.
After some rigorous lobbying for an assessment increase on
your part, some members who had opposed the increase will capitulate and you
will have won more votes. Or
they’ll become even more irrational, at which point you must realize that
you’ll never convince them. Conserve
your energy and focus your efforts on the remaining rational individuals.
Indeed, some of the foregoing suggestions may seem like
playing hardball against the opposition, but you should remind yourself that the
opposition is playing hardball against the association’s fiduciary duty to
maintain its property.
Stone
Mountain Corporation 