Knowing How is the Key to Success
PLANNING YOUR HOA BUDGET without knowing what you’re doing can impact the financial and physical health of the community. Poor planning can also decrease residents’ property values. Key planning knowledge is the first, crucial step if a budget is to restore aged communities. Strategic planning determines the enjoyment residents will derive from their community and how much boards can increase market value.
Too often, board members tend to copy and “tweak” last year’s budget to fit the current year. Technological advances, new practices, and green rebates can help HOAs save money. See other money-saving ideas, below.
More importantly, with increased costs to community associations for materials and services due to COVID-19, HOA budgets are likely overdue for adjustment of budget figures.
BUDGET BASICS EXPLAINED
First, let’s distinguish between the two budgets from which an HOA operates: the HOA’s operating budget and the HOA’s reserve budget. It’s easy to misuse budgets if there’s no clear plan for the issues an association needs to tackle and the accounts that will pay for them.
Consult your association’s documents to determine what each budget covers. In simple terms, the operating budget is like a checking account, and the reserve budget is your savings account. Items can be paid out of the regular operating budget if the Board determines there is no need to pay them from reserves.
The operating budget pays for the services that help carry out the everyday functions in the community, such as landscaping, management costs, security, insurance and taxes, utility expenses, office expenses, and fees for accounting and legal.
The reserve budget is for larger-scale projects that don’t occur on an annual basis, such as roof replacement on common area buildings, replacement of failing mechanical systems, and repair of roads and sidewalks.
The operating budget and the reserve study each contain lists of items. Which items go where? Generally, the answer depends on how much the item costs to replace and whether it’s an annual expense. Higher-ticket items financed over time are usually in the reserve component inventory so they can . Whereas, smaller, relatively inexpensive items should be in the operating budget.
A component listed in both the operating budget and the component inventory of the reserve budget should be placed in the most appropriate area and be removed from the other. Ask a professional adviser (reserve specialist, accountant, manager, or engineer) if it isn’t clear which area is appropriate.
HOA BUDGET | Which One to Spend or Save?
Association boards can take several steps to optimize their operating budget to save money and improve the community. Let’s get started!
1 Set goals
In reviewing the HOA’s budget each year, it’s critical that boards plan for long-term goals and challenges to avoid maintenance and financial issues that could cause unreasonable hardship for residents. As well as addressing prevention, long-term planning is an opportunity to substantially upgrade the community and increase property values, with the added benefit of increasing residents’ quality of life.
The community should answer the following questions:
▮What expenses must the association cover?
▮What other expenses could it cover to improve the community or satisfy residents?
This list will become the line items in the association’s budget. Mandatory expenses such as utilities, taxes, and maintenance are established line items that remain from year to year. Items to improve the community or satisfy the residents will differ annually, so arrange them in rank order for budgeting purposes.
2 Determine assessments
One of the purposes of planning an annual HOA budget is to determine what the annual assessment will be. The governing documents specify how the assessment is allocated to each unit (on an ownership basis or by equal division), as well as payment frequency (monthly, quarterly, or annually).
In some communities, the basic equation for determining association assessments is as simple as totaling your total operating expenses and the annual reserve contribution, then dividing by the percentage of ownership.
An association must estimate costs first and then determine their revenue source. Most of the revenue source will be from assessments. Avoid starting with your income first and then planning for expenses. To start with income first may create a budget shortfall the next year and, ultimately, require levying a special assessment to cover costs.
Once you determine your annual assessment, examine the number. Is it the same or close to the same as what you charged last year? If so, that’s a good sign for your budget. If not, it’s time to revise your assessments or budget.
3 Look for trends in past budgets
In addition to planning the current year’s HOA budget, boards should examine each line item cost in their association’s budget within the past five years. Note any trends. This will help anticipate future costs that may impact the operating budget and reserves beyond the current year.
4 Review collections procedures
Closely examine your collections policies. Reducing bad debt, such as delinquencies, can save your community money. Keep in mind that collection expenses and legal fees to pursue bad debt create a line-item expense in the budget related to estimating bad debt. That is, the less spent on collections, the more delinquencies the association can expect. Watch for a tipping point where collection costs approach the recovery amount.
Ideally, your delinquency rate should not exceed 5%. If it does, consider tightening your collections policies and be sure to charge late fees consistently.
5 Don’t defer maintenance
The community must be well-maintained and aesthetically pleasing in order to realize top market values and improve residents’ quality of life. Plan to allocate a portion of the HOA’s operating budget for regular housekeeping items, such as:
▮Rotating exterior painting to keep the exterior fresh and vibrant
▮Replace dilapidated or broken gates, fencing, and retainer walls
▮Repair damaged stucco or wood throughout the exterior
▮Replace faded, torn, or stained poolside cushions
▮Consistently enforce resident violations that degrade common area and exterior aesthetics of the property
6 Spend money to save money
Many cost-saving measures require an investment in newer or improved systems or materials. Investments spread over several budget cycles require long-term planning.
Always keep residents informed about the decisions behind cost cutting, and cut wisely.
Your community might consider conducting an energy audit to identify inefficiencies and implement energy-saving practices. Many communities, for example, have been converting common-area lighting from incandescent and fluorescent bulbs to LEDs.
Other money-saving ideas include:
Water and landscaping. Gradually change out water-intensive vegetation in favor of water-wise landscapes. These will not only require less water but also require less maintenance, which can significantly reduce landscape maintenance costs.
Smart pool systems. If your community has a pool and spa, consider converting to a smart system to operate systems automatically to reduce cost and manual management time and expense.
Solar. Installing solar panels can reduce the cost of lighting and electrical features, as well as pool and spa operations.
Bundle services. Internet, cable, and waste removal vendors often offer reduced pricing at community bulk rates.
7 Invest in smart projects
In your HOA’s long-range budget plans and goal-setting, you should be thinking about any capital improvements that enhance residents’ lives and boost property values. Capital improvements are typically large, expensive projects, and sometimes members must approve them. A special capital project will require establishing a reserve fund specifically for payment of the project.
Many communities, for example, are installing electric vehicle charging stations. As electric vehicles become more popular, associations will need to accommodate the trend—whether due to owner demand or legislative requirements. Some states and companies offer rebate programs for charging stations. Do your research.
8 Keep an eye on your funds
Strive to maintain three months of budgeted operating expenses. This should include housekeeping tasks like painting, repair, and landscape and lighting conversions. Items addressed in the operating budget do not require an allocation in reserves.
9 Raise assessments or levy a special assessment
Don’t hesitate to raise monthly assessments to set your community on a permanent path to fiscal and physical integrity. Failing to raise assessments to cover actual expenses is a breach of the board’s fiduciary duty. It’s also a breach of contract with owners who expect the board to protect their assets.
You might also consider minimal annual assessment increases, about level with the rate of inflation. Increases spread out over the time of ownership increase assessments at 2 to 5% per year, rather than at 10 to 15% in two to five years. Special assessments should always be a last-resort funding option, not a stopgap for budget shortfalls.
0 Consult the experts
Your community manager, accountant, reserves specialist, attorney, and other business partners can help boards develop and fine tune their budgets. They can help you set affordable goals for the property, bolstered by realistic, comprehensive fiscal and maintenance schedules. Ultimately, however, the board needs to understand what they’re doing, how, and why. The board has the responsibility for the association’s finances. It has a fiduciary duty to review, monitor, and follow the budget.
By ASPM CEO Karen Martinez. Published and reprinted with permission from the November/December 2019 issue of Common Ground TM magazine, the flagship publication of Community Associations Institute (CAI).