Thursday, January 5, 2012

When Community Associations Lose "Critical Mass"

The Consequences to a Community Association of the Loss of Human Energy

By Tyler P. Berding, JD, Ph.D.

(Editor's Note: The following article comes from our historical file. It was first published in 1997. The message is equally applicable today--community associations which ignore proper management, fail to encourage owner involvement, and do not adequately fund for future repairs will deteriorate over time. This and various articles which followed became the basis for "The Uncertain Future of Community Associations" series of essays.)

            "Critical Mass" is a physics concept.  Basically, it is defined as the smallest hunk of matter that will sustain a nuclear reaction.  If the mass of the material is too small, it cannot generate heat or light.  When the mass is adequate, it can support a chain reaction that will continue to produce energy.  While it may be a bit of a stretch, we can also apply the critical mass concept to social phenomena.  A group must have enough people to produce the creative energy necessary to accomplish the goals of the group.  If the group is too small, it will not be sufficiently energized, and will fail to accomplish its purpose.  When this happens, members become disillusioned, and quit the group.

            The "critical mass" concept has parallels in economics.  A business project without sufficient funding or creative energy to sustain it will eventually wither and die unless it gets a periodic influx of new economic and intellectual capital.  Both for profit and non-profit companies and organizations must, therefore, maintain a certain economic "critical mass" to sustain their economic health.  In a manufacturing concern, if sales of its products fall below the level needed to pay the overhead, the organization loses capital until it fails.  If a charity fails to attract sufficient donations to fund its operational costs, it will also fail.  This economic model does not apply, by the way, to those organizations that are funded by outside sources.   Government agencies, for example, are basically on permanent "life support" and have no obligation to sustain their capital, and therefore can operate at a very inefficient level and still survive. 

  Meeting the energy requirements necessary to sustain the life of an organization depends on many factors, including marketing, production, and various forms of human energy.  If any of these factors fall below a certain level, determined by the needs of that particular organization, the enterprise will eventually fail.  The failure may be rapid or gradual, depending on how quickly "energy" is lost, but failure is inevitable unless the means of producing energy is restored.

            Now, apply this concept to community associations.  Factors like funding and human energy affect the long-term stability of those organizations.  Community associations also have certain other unique components that contribute to its "energy mass."  The physical condition of the property, the number of absentee owners, and the business acumen of its boards of directors all impact the association's ability to continue to generate revenue and to continue to attract and utilize good human resources.  A community association is a unique blend of social and physical phenomenon, and they each contribute to its "energy."  A loss of vitality in one of the factors can have long-term detrimental effects on the whole organization.

            Assume, for example, that the association has some building problems which are contributing to a gradual deterioration of the project, say leaks which are causing internal dry rot. Also, assume that several past boards of directors have either ignored the problem or taken only a minimal repair approach.  After a number of years, the deterioration will have progressed to the point where simple waterproofing attempts no longer will make any difference, and major restoration will be required.  No association is normally funded for a major restoration, and depending on the cost of the fix, may not be able to borrow, or raise by assessment, the necessary funds.  The association has lost one of its primary sources of energy-funding.  It can no longer produce enough economic energy to fulfill its maintenance and repair obligations. Property values drop, owner's equity is lost.  Owners find it difficult to sell their property, and rent instead.

            As non-owner occupancy increases, the condition of the project is further compromised. Behavioral problems tend to increase in frequency, more owners move out, and gradually the project turns, in effect, into an apartment complex with numerous owners.  Rents often do not equal mortgage payments.  Owners must dip into savings or other capital to service their mortgages.  If the condition of the project continues to spiral downward, rents decrease, leading to greater equity losses.

            Absentee owners, already substantially impacted by the inability to sell, or to obtain adequate rents, refuse attempts by the board to raise assessments (essentially new capital) to reverse the trend.  No individual owner has a sufficient interest in the project to induce them to contribute the necessary new capital.  Eventually the balances of some of the mortgages will exceed the market value of the unit.  Some owners in that situation will find that ceding the property to the bank is a better alternative than sustaining continued losses.          

            Along with a deteriorating physical and financial condition, we also encounter flagging human energy.  The association may no longer be able to afford proper professional management.  Board members tire of demands upon their time in what is an apparent losing effort to maintain the viability of the project.  The emotional confrontations with owners and tenants over behavioral issues and the condition of the buildings further take a toll on the volunteers.  It becomes hard to attract and hold good board members.

            A quorum at the annual meeting, always difficult becomes impossible to obtain, as owners flee or ignore the project.  Meetings are held infrequently.  Efforts to collect assessments from an ever-lengthening list of delinquent owners falter, and the delinquencies increase as a consequence of this lack of energy.  Funding is further impacted.  The downward trend continues.  This is of course, a hypothetical association.  However all of these problems have each occurred at one time or another in many associations.  That they all could occur in one association is quite within the realm of probability.

            Can this association ever recover its vitality?  Probably not without a heavy influx of outside capital.  It no longer has the "energy" necessary to internally generate sufficient income to cope with the deteriorating conditions.  It probably cannot borrow the necessary funds because banks will normally require a special assessment as collateral.  Human energy is exhausted.  Conventional rescue attempts are probably out of reach.

            How long did the debasement of this project take?  Obviously it depends on many individual factors that would vary with each association.  The problem is that the loss of "energy" may be so gradual that it will not be noticed for many years.  The factors which contribute to a loss of organizational energy, may, individually, be concealed or illusive.  The vital factors of funding, absentee ownership, building condition, and human spirit, interacting over an extended period, can result in a permanent loss of economic and physical viability.  A short-term review may not reveal the severity of the problems, because most require time to become apparent. 
            There are, of course, examples of short-term loss of "energy."  If a project is heavily damaged, say, in an earthquake, it may sustain such a blow to its resources that permanent failure is the only possible result.  When a project sustains a catastrophic loss for which it is inadequately insured, it may lose as much "energy" in one instant as a project that deteriorates slowly over many years.

            If the loss is of human energy, such as owner apathy or complacent or careless boards of directors, the deterioration may occur more slowly, but the process will continue nevertheless. The lack of proper leadership in a community association will cause it to lose its spirit just as surely as dry rot.  The process is not as noticeable but may be more repairable.  Repeated confrontations between different interest groups, for example, can cost an association a great deal of its "energy."  Negative energy is not productive and will contribute to long-term deterioration, both physical and social.

            With so bleak a picture, what can be done?  If the association has made, for example, periodic attempts to raise dues sufficiently to stay ahead, much can be achieved to forestall long-term deterioration.  A proper reserve study, properly followed, is also a good start.  A good reserve study that is ignored by the board is useless.  If the proceeds from a construction defect case are infused into the repair program, it can bring the condition of the project back to a position that is economically manageable by the owners.  If the proceeds are spent foolishly, or not at all, that opportunity to achieve an adequate energy level will be lost.  Behavioral issues can be solved far cheaper than physical ones.  Negative energy in an association must be addressed with sensitivity and accommodation.

            The concept of "energy loss" as applied to a community association requires taking a little poetic license with the laws of physics.  But it provides, at least, a useful analogy with which we can better understand the dynamics of that very unique entity, the community association.  With an adequate understanding of these issues, boards of directors, managers, and owners can act now to avoid the eventual loss of owner equity that results from a loss of energy.  As usual, ignorance of the consequences of neglect over time costs the most.        

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