Tuesday, January 13, 2015

Association Reserve Analysis

2014 Community Association Financial Survey

In 1996, Berding|Weil published “Latent Liabilities” a treatise which explored the long-term impact of underfunding of the reserve accounts of community associations. Some of the data came from our clients, and some from Levy, Erlanger & Company. We predicted that most multi-family community associations were severely underfunded for long-term maintenance and repairs and we opined this issue could lead to serious deferral of maintenance obligations and ultimately a shortened service life for these projects. Subsequent financial surveys by Levy, Erlanger & Company, with our assistance, have shown this problem to be systemic—affecting most community associations. This year’s survey finds community associations to have only 57% of the funds on hand they should have. This shows that the problem is not getting better—in 1993 that figure was 60%.
Since “Latent Liabilities” was published, we  further documented this problem in “The Uncertain Future of Community Associations” and similar treatises.   Community associations are slowly running out of cash. Borrowing from reserves for regular, and newly discovered maintenance issues has trended upward, and when the reserves run out, special assessments and borrowing from banks increase. The fundamental cause of this cash shortage is the inability or unwillingness of boards of directors to increase assessments sufficiently to keep up with inflation coupled with the discovery of needed repairs not anticipated by the reserve budget.

Discovery of “hidden damage” has pushed many older associations to the financial edge. Too many older associations suffer from long-term deterioration which, when discovered, carries a price tag that greatly exceeds the resources of the membership. Dry rot in balconies, entry structures, roof underlayment, and wall framing, and deterioration of utilities like electrical lines and plumbing, is becoming more common and are rarely the subject of any reserve budget line item. We have documented this problem in another treatise: “The Perils of Hidden Damage” which describes how these problems lie undetected for years. All publications above can be found on our website: www.berding-weil.com.

Boards of Directors in older associations cannot rely entirely on a reserve study to predict their future funding. By statute in California, as in many other states, reserve studies are required only for those components which are visible and accessible—siding, roofs, streets, etc. The components hidden under the outer skin of a building are not included. This is where most dry rot, corrosion, and other structural deterioration can be found, but not usually computed as part of the study. More intrusive inspections are necessary but almost never done.      

Years of underfunding of reserves coupled with the late discovery of previously hidden damage places a heavy financial burden on the owners of attached housing.  This burden is heavy enough, sometimes, to question whether many have reached the end of their service lives—are they actually obsolete? Compare the resources and expenses of your community association to other, similar associations[1], and 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.  Then ask yourself, are the components now in your reserve study the only areas of concern, or could there be others? If your reserves have less than 100% of the funding required by your reserve study and if your association was built over 20 years ago, it’s time to undertake a sober review of the association’s financial and physical condition.

The 2014 Survey Background
This survey, while not the first of a kind, is probably one of the largest and most recent. It includes data from over 1,500 Northern California community association financial statements. This is the product not only of many hours of work, but the cooperation of nearly two hundred management companies and self-managed associations, and the association of two leading California professional organizations: Berding|Weil, LLP., California’s largest construction and community association law firm, and Levy, Erlanger & Company, CPAs, community association accountants and consultants. The data has been taken from the 2013 and 2014 year-end balance sheets and income statements of 1,569 community associations representing 191,976 individual units.  Comparative data was also taken from three prior surveys done by Levy, Erlanger & Company, CPAs in 1993, and with the assistance of Berding|Weil in 2006, 2008 and 2013.
The 2014 Survey Results
Percent Funded
2014 Survey
Replacement reserve cash             $    3,748    average per unit (1,529 surveyed associations)             
Replacement reserve obligation  $    6,576    average per unit (1,529 surveyed associations)
Replacement Reserve Deficit          $   (2,828) average per unit
2014 Percent Funded                             57%
1993 Survey     
Replacement reserve cash             $ 1,708    average per unit (813 surveyed associations)    
Replacement reserve obligation  $ 2,864    average per unit (813 surveyed associations)
Replacement Reserve Deficit          $ (1,156) average per unit

1993 Percent Funded                             60%                           

In the roughly 20 years from 1993 to 2014, the percentage reserves are funded has declined by approximately 3% and the Replacement Reserve Deficit has more than doubled!

Average Income and Expenses
2014 Survey
Assessments, operations                $ 178 (72%)  (1,565 assns. reported data)
Assessments, replacement            $    71 (28%)  (1,521 assns. reported data)
2014 Average Assessments *        $ 258 monthly average per unit (based on 1,569 surveyed assns.)

Expenses, administration                             $   63 (22%)  (1,566 assns. reported data)
Expenses, maintenance                  $   88 (30%)  (1,561 assns. reported data)
Expenses, utilities                           $   54 (18%)  (1,541 assns. reported data)
Expenses, replacement                   $   93 (30%)  (1,414 assns. reported data) 
2014 Average Total Expenses *    $ 288 monthly average per unit (based on 1,569 surveyed assns.)
2014 Implied Monthly Deficit       $   30 monthly average per unit, or approximately 12% of revenues

1993 Survey
Assessments, operations                $ 128 (80%)  (875 assns. reported data)
Assessments, replacement            $    33 (20%)  (781 assns. reported data)
1993 Average Assessments *        $ 161 monthly average per unit (based on 875 surveyed assns.)

Expenses, administration                             $   46   (20%)  (921 assns. reported data)
Expenses, maintenance                  $   59   (26%)  (921 assns. reported data)
Expenses, utilities                           $   31   (15%)  (921 assns. reported data)
Expenses, replacement                   $   47   (25%)  (921 assns. reported data) 
Expenses, other                                $   10   (14%)  (921 assns. reported data)               
1993 Average Total Expenses *    $ 193 monthly average per unit (based on 921 surveyed assns.)
1993 Implied Monthly Deficit       $   32 monthly average per unit, or approximately 20% of revenues

Comparison of 2014 and 1993 Survey Results (Per Unit per Month - PUPM)
                                                     2014                                  1993                              Percent Increase

Assessments, average           $ 258                                      $ 161                                         60%

Administration                         $    63    22%                         $ 46    20%                                37%
Maintenance                             $    88    30%                         $ 59    26%                                49%
Utilities                                     $    54    18%                         $ 31    15%                               74%
Replacement                             $    93    30%                         $ 47    25%                               98%

Total expenses, average *          $ 288                                    $ 193                                         49%

Implied Monthly (Deficit)        $ (30)                                   $ (32)  

*   Totals may NOT equal positive values in the above detail line items because the detail line items only reflect the average per unit per month (PUPM) for those associations which report the income or expenses. Not all associations had or reported each line of income or expenses.

The annual increase in administrative expenses over the last 20 years has been approximately 2% per year, maintenance expenses 2-1/2% per year, utilities 3-1/2% per year, and replacement reserve expenses 5% per year. While monthly assessments have increased by approximately 3% per year since 1993, total expenses have increased by approximately 2-1/2% per year during the same period.  While this last represents a positive trend, after 20 years the average association is still operating at a loss when reserve expenditures are included. These losses are cumulative and reflect the growing imbalance of the reserve account.

When we look at the actual dollars being expended, the average common interest development has a continuing monthly deficit of $30 per unit in 2014 compared to approximately the same in 1993.  It is troubling to note that association obligations continue to outdistance income. This is due in part to the increasing demands on replacement reserves in aging California community associations. 
Next, look at the status of replacement reserve funding.  Since operating expenses (insurance, water, management, etc.) must be paid, how is the monthly deficit funded?  Funds which should go to reserves are increasingly subsidizing operating expenses: $2,828 per unit in 2014 versus $1,156 per unit in 1993. After adjusting for inflation, the accumulated replacement reserve account deficit increased approximately 22%, or about 1% per year.  Similarly, the accumulated reserve liability increased from $2,864 per unit in 1993 to $6,576 per unit in 2014 – an increase of approximately 230% or about 4% per year before inflation!

This trend, which we noted in 2006, 2008, and 2013 and in various articles and treatises over the past 20 years, continues eroding the ability of community associations to maintain their infrastructure. 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 long-term solution?  Voluntary digging deeper into the pockets of aging owners who do not believe that they will still be here when the next roof goes on?  Mandatory funding of reserves as required in some other states, such as Florida and Hawaii?  The solution is more intense investigation of aging infrastructure coupled with a rational review of the true cost of ownership, and developing the political will to meet that cost with the additional dollars necessary to protect owner equity. That’s a lot to ask and it will fail often. But continued education of Boards of Directors and owners can make inroads. We hope that happens before it’s too late. 
Tyler Berding, J.D.; Ph.D.       
David Levy, MBA, CPA

[1]  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.

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