Survey: Condos Still Short of Funds

          Community Associations are going broke. They are running out of cash. Borrowing from reserves to pay operating expenses has left reserve accounts severely underfunded.  There will not be enough money to do necessary repairs when the time comes.  As a consequence, associations are resorting to bank loans and special assessments to fill the gap. How do we know this? Check the survey below.

In 1996, Berding|Weil published “Latent Liabilities” a treatise which explored the long-term impact of underfunding the reserve accounts of community associations. Some of our data came from our clients, and some from Levy, Erlanger and Company. We suggested that most community associations, and principally condominiums, were severely underfunded for long-term maintenance and repair and predicted that this issue could lead to large-scale deferral of necessary maintenance or re-construction and ultimately a shortened service life for these projects. Subsequent financial surveys by Levy, Erlanger and Company, with our assistance, have shown this problem to be endemic—this year’s survey finds community associations now have only 54% of the funds on hand that their reserve studies say they should have at this point in time. And the problem is obviously getting worse—in 1993 that figure was 60%! The present survey numbers support those earlier predictions.

          Borrowing from reserves for regular and newly discovered maintenance problems has trended upward, and when the reserves run out, borrowing increases. The fundamental cause of this cash shortage is the inability or unwillingness of boards of directors to increase assessments sufficiently to stay ahead of both inflation and the cost of anticipated repairs, often coupled with the discovery of unplanned-for maintenance and repair problems which are not anticipated by the reserve budget at all. 

          These instances of “hidden damage” have pushed many associations to the financial edge. Too many older associations have discovered hidden damage resulting from long-term deferred maintenance which, when discovered, carries a price tag that greatly exceeds the resources of the membership. Dry rot in balconies, entry structures, roof under layment, and wall framing; and deterioration of utilities like electrical lines and plumbing, are becoming common but are rarely included in any reserve budget.[1]

          Long-term underfunding of reserves coupled with the late discovery of unanticipated damage to buildings places a heavy financial burden on the owners of attached housing units.  This financial burden is enough in some cases to raise the question: have many of these projects reached the end of their service lives—are they, in fact, obsolete? It is important to compare the resources and expenses of a community association to other, similar associations, and it is also important to investigate beyond the parameters of a typical reserve study—especially in older associations. Review the data in this survey and compare it to your own.[2]  Then ask yourself, are the components listed in your reserve study the only areas of concern, or could there be others? If your reserves have less than 100% of the funding called for by your reserve study and if your association was built more than 20 years ago, it’s time to undertake a sober review of the association’s financial and physical condition.

The Survey

This survey, while not the first of its kind, is probably one of the largest and most recent. It includes data from more than 2,000 northern California community association financial statements. This survey is the product of many hours of work, and more importantly, the cooperation of almost two hundred management companies and self-managed associations, as well as the assistance of Berding|Weil, the leading California construction defect and homeowner association law firm. The data has been gleaned from the 2011 and 2012 year-end balance sheets and income statements of 2,157 community associations representing 226,297 individual units.  Comparative data was also taken from three prior surveys done by Levy, Erlanger and Company in 1993, and with the assistance of Berding|Weil, in 2006 and 2008.

The Results

Percent Funded

2012

Replacement reserve cash                $    5,558  average per unit  (2,044 surveyed associations)    

Replacement reserve obligation      $ 10,293  average per unit (estimated based on 2006 percent funded)

Deficit                                                    ($  4,735)  average per unit

2012 Percent Funded                                 54% 

1993    

Replacement reserve cash                $ 1,708 average per unit (813 surveyed associations)            

Replacement reserve obligation      $ 2,864 average per unit (813 surveyed associations)

Deficit                                                    ($1,156) average per unit

1993 Percent Funded                                 60%                             

In the roughly 20 years from 1993 to 2012, the percentage that reserves are funded has declined by approximately 10%. 

Average Income and Expenses

2012

Assessment, operations                    $ 367 (75%)  (2,146 surveyed associations)

Assessment, replacement $ 124 (25%)  (1,789 surveyed associations)

2012 Total Assessment                     $ 470[3]  monthly average per unit (2,146 surveyed associations)

Expenses, administration                 $ 148 (27%)  (2,141 surveyed associations)

Expenses, maintenance                     $ 154 (28%)  (2,120 surveyed associations)

Expenses, utilities                              $   91  (16%)  (2,070 surveyed associations)

Expenses, replacement                      $ 164 (29%)  (1,628 surveyed associations) 

2012 Total Expenses                          $ 512[4] monthly average per unit (based on 2,142 surveyed assns.)

2012 Implied Deficit                          ($   42) monthly average per unit, or approximately 9% of revenues

1993 Survey

Assessment, operations                    $ 128 (80%)  (875 surveyed associations)

Assessment, replacement $    33 (20%)  (781 surveyed associations)

1993 Total Assessment                     $ 161 monthly average per unit (875 surveyed assns.)

Expenses, administration                 $   46   (20%)  

Expenses, maintenance                     $   59   (26%)  

Expenses, utilities                              $   31   (15%)  

Expenses, replacement                      $   47   (25%)    

Expenses, other                                   $   10   (14%)      

1993 Total Expenses                          $ 193 monthly average per unit (921 surveyed assns.)

1993 Implied Deficit                          ($   32) monthly average per unit, or approximately 20% of revenues

Comparison of 2012 and 1993 Survey Results

                                                        2012                                    1993                                Percent Increase

Assessments, average            $ 470                                    $ 161                                              192%

Expenses

Administration                            $ 148    27%                        $    46    24%                                 222%

Maintenance                                 $  154   28%                        $    59    31%                                 161%

Utilities                                         $    91   16%                        $     31    16%                                                194%

Replacement                                $ 164    29%                        $     47    24%                                                249%

Other                                                                                             $     10       5%

Total expenses, average            $ 512                                    $  193                                             166%

Implied Monthly Deficit         ($  42)                                   ( $  32)                                                             31%

The annual increase in administrative expenses over the last 19 years has been approximately 12% per year, maintenance expenses 8% per year, utilities 10% per year, and replacement reserve expenses 13% per year. While monthly assessments have increased 10% per year since 1993, total expenses have increased by almost as much at 9% per year during the same period.  

Conclusion

Looking at the actual dollars being expended, the average common interest development had a monthly deficit of $42 per unit per month in 2012 compared to only $32 per unit in 1993 – a 1½% per year increase.  But look at the status of replacement reserve funding.  Since operating expenses must be paid currently, how is this growing monthly deficit being covered?   You will see that funds are being diverted to cover the monthly deficit which should otherwise have gone to reserves and are creating a growing deficit in the replacement reserve account—an average total deficit of $4,735 per unit in 2012 versus only $1,156 per unit in 1993 – an increase of 309% or 16% per year!

This trend, which we also noted in 2006 and 2008 and in various articles and treatises over the past 20 years, continues and is gradually eroding the ability of community associations to adequately maintain their infrastructure. It is now to the point where the average association has only about half of the funds it needs to have on hand for the known long-term repair of the buildings and nothing on hand for any unknown or unexpected repair. 

What is the solution?  Right now it’s special assessments and bank loans. Will owners who see no future in the property agree to pay more?  Probably not. What about mandatory funding of reserves as required in some other states, such as Florida and Hawaii?  Even in those states, however, reserve deficits are routine. The legislature should act, but there is a profound lack of awareness of this problem in all branches of government. Like municipal governments with growing deficits, only time will tell which community associations will survive.

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[1] We have documented this problem in another treatise: “The Perils of Hidden Damage” which describes how these problems lie undetected unless the association initiates more intensive inspections of the property than are now undertaken. All of these articles and publications can be found on our website: www.berding-weil.com.

[2] Levy,  Erlanger & Company, CPAs offers a comparison of your association’s income and expenses with up to five similar associations, based upon the parameters of size, age, geographic location and subdivision type (condominium v. planned unit development) for a modest fee.  They can be contacted at info@hoa-cpa.com for a cost estimate.

[3] The monthly average total assessments number is based on averaging total assessments for each of 2,146 surveyed community associations.  It does not equal the total of the averages of each category of assessments (operating and reserves) because not all surveyed associations reported each category of assessments in computing the average assessments by assessment category.

[4] The total monthly expenses number is based on averaging total expenses for each of 2,142 surveyed community associations.  It does not equal the total of the averages of each category of expense because not all surveyed associations reported each category of expense in computing the average expenses by expense category.