Tuesday, August 4, 2015

A Community Association's Four Stages of Life

          Community associations, like people, evolve during their lifetimes. Some of it is good and some is bad, but  change is inevitable as projects, and people, age. Whether that evolution leads to a long and healthy life, or an early demise depends a great deal on the decisions made early and the ability to recognize signs of decay--both physical and political. To assist, we have outlined what we consider to be the various "stages" that an association will pass through eventually. You will note that we are not just talking about physical manifestations, but political and economic ones as well, for they each play a role in the long-term health of the project. Read about them and see which apply to your association or your client's associations. Like anything harmful, recognizing the symptoms can help with a cure.
The First Stage
A brand new project enters the first stage. The duration of that stage depends on many of the factors outlined above. Generally, during the first stage, the regular assessments will appear to cover all projected maintenance and repair costs without resort to special assessments or outside sources, and with only modest annual increases. Non-owner occupancy is at the lowest percentage it will ever be, usually 10 percent or less. Board members and professional managers are easy to find, the political climate is benign and the members are generally supportive of the board. The project looks and feels new and exciting. The membership's attitude reflects these qualities. Re-sales are brisk and values stay high with modest appreciation reflecting general market trends.
The Second Stage
In a project's second stage of evolution, regular assessments will be insufficient to satisfy mounting maintenance and repair costs. If a competent board using professional management has identified the true costs of repair, the members will contribute to capital by means of a special assessment on at least one occasion during this stage. If required maintenance and repair has not been identified, the project will appear to be within its budget. There may have been a discovery of defective construction conditions that will demand a remedy. Non owner occupancy has increased beyond 25 percent. The board of directors will begin to face political issues which emanate from the increasing percentage of non-owner occupants. There will be more complaints from residents about the general condition of the project or about the necessity for specific repairs. Recruitment of board member candidates may be necessary. If true repair costs are identified and brought to the members, there will be general resistance to the request for a special assessment, but the members will ultimately support the board's request if the costs for repairs at this stage of the project's evolution remain affordable. This will be true if deferral has not postponed needed repairs for too long. Sales of units are comparable to the market generally. Government backed mortgages and refinancing is still obtainable.
The Third Stage
In the third stage of evolution, those associations (and there are thousands) that have failed to store enough nuts away for the winter, will have to appeal to the membership for emergency funding and/or apply to a bank for a loan. Bank financing of large reconstruction projects is becoming quite commonplace, but most financial managers will argue that borrowed capital is not an adequate substitute for capital that is contributed by the owners. This is especially true if the repayment of the borrowed capital prevents the association from adequately reserving for the next round of reconstruction. Borrowed capital for reconstruction should only be considered as a temporary means of achieving solvency for the association. The assessments for repayment of the loan should be in addition to contributions to reserves adequate to fund future repairs. In this stage, non-owner occupancy has increased beyond 35 percent. Government-backed mortgages become difficult to obtain. Management costs increase due to the additional workload presented by the many complaints from residents about the physical condition of the buildings. Political strife within the association increases as the demands upon the residents for funding, coupled with a decreasing quality of life, increase. Board members resign rather than be subjected to the volume of the owners' demands. Recommendation for current repair now includes several building components that were not anticipated with the requisite reserve accounts. The price of such repairs is beyond the association's financial ability. The economic and political climate of the association begins to be reflected in the sales price and turnover of units. The project begins to show the effects of deferred maintenance. Painting is delayed, landscaping deteriorates, and resident complaints about maintenance and repair issues further increase, putting added stress on the board and management.
The Fourth Stage
Given that many, many associations have failed to anticipate the full extent of eventual reconstruction costs, they will, sooner or later, exhaust both contributed and borrowed capital sources. This includes such one-time influxes of capital as that provided by insurance recoveries or litigation settlements. Once all outside sources of capital are exhausted, the ravages of obsolescence will be hard to forestall. By this Fourth Stage in the project's evolution, the owners have long since refused to provide meaningful contributions of additional funds; lending institutions have refused further advances; and the projection for immediate or future repairs is well beyond any projected accumulations in the reserve accounts. Assessment delinquency begins to climb to the point where the association's ability to pay for essential services, including utilities and management, is fading fast. Repairs are being deferred to the extent that the basic habitability or safety of the buildings is coming into question. Non-owner occupancy has risen beyond 50 percent, and refinancing or mortgage lending by most traditional lenders is precluded. Behavioral problems increase, vandalism to the property becomes more than just occasional, and political problems within the association make recruitment of board members and management very difficult if not impossible. The ship is rudderless and sinking.

And After That?
Beyond the Fourth Stage, a project's fate is hard to predict. Certainly if the deterioration of the physical condition seriously affects habitability, health, and/or safety, local jurisdictions will be forced to intervene and will demand that those conditions be repaired. Given that the lack of ability to reach consensus on funding is the reason that these conditions have been allowed to develop, it is unlikely now that the owners, mostly absentee, will see any point in throwing "good money after bad." Their cash flow and equity may be nonexistent or negative, and the condition of the project makes a sale impossible. They continue to hold their interest in the property only because they receive rental income. The local jurisdiction may condemn some or all of the buildings, accelerating the onset of obsolescence. Absentee owners, deprived of rental income, will simply walk from the project and abandon the property. Resident owners without alternative housing will stay as long as the local jurisdiction will permit occupancy. Criminal activity will make if difficult for anyone to continue to occupy the premises. Redevelopment or other government-backed programs might be called upon in rare cases to rehabilitate the property. However, in most cases, the project will be valueless, uninhabitable and unsalable. Continued ownership will become a clear liability to the remaining investors and wholesale abandonment will ensue. In most cases, legal title to the separate interests will default to various lenders.
An example of such a project was observed in San Bernardino, California many years ago. It consisted of four-plex condominium buildings, approximately 35 years old, now gone beyond a Stage Four. Units were boarded up or burnt out. Whole buildings had been bulldozed and only empty lots remained. There were a few inhabitants, possibly squatters. The surrounding neighborhood was in only slightly better condition, but fully occupied, lessening the chance of a municipal redevelopment project. The varied condition of the units suggested that they remained under separate titles. The complexity of titles, including the interests of lenders, most likely prevented any uniform scheme to convert the property to a better use.
If you found this interesting, read our entire treatise at "The Uncertain Future of Community Associations"


  1. Thanks for posting this blog it is very informative and helpful! Keep it up!

  2. I am currently suing my HOA Board for lying about the percent funded of our reserves. They had a former Board member doing reserve studies, claiming 100% funded every year. I dug into it and concluded it was %. Hired an expert to confirm. They then claim the 100% funded really meant 100€% funded for projects for the current fiscal year. They actually sent out altered CA Civil Code Form 5570 in order to hide the truth. I bought in on the premise of 100% funded. Disaster. Lawsuit.

  3. I suppose my Condo is somewhere between stages 2 and 3. I don't see things getting any better.