HOA/Condo Governance Issues

[grumpy]

I have been living in a community governed by an HOA for 5 years. I was recently appointed chairman of the association's finance committee. I found myself wondering how many of the RE members reside in HOA's/Condo associations and whether a thread on association financial issues (e.g. assessments, replacement reserves, budgeting, etc.) would be of interest.

 

[Brat]

Actually I live in a co-op but we have many of the same issues.

It is important that the building have a reserve study and an inspection of the structure/common areas regularly. What kills a building is deferred/ignored/unknown maintenance issues and failure to save enough money in reserves to replace what will eventually wear out.

 

[Rustic23]

I live in a community with an HOA. Our HOA pays for garbage, security, common area maintenance, and support for the volunteer fire dept. The HOA also pays for most of the street maintenance. While the streets are county roads, the county does not have the money to repair streets. The HOA pays for materials and the county supplies most of the labor. Residence get this for $300 a year and complain the fee is too high.

Generally our financial problems is keeping the board from spending our reserve.

 

[HFWR]

No association in my neighborhood, but do have some interest, as one possibility for the future is getting rid of the [-]albatross[/-] 3BR "ranch", and moving to a condo/townhome, to shed myself of yardwork, and to allow lock-and-leave for extended roadtrips/adventures.

Not sure I like the idea of an "association", nor of having neighbors on the other side of the wall. Still, it's an option.

 

[haha]

I am interested also.

Ha

 

[grumpy]

Well, I'll start off with the basic financial stats for my HOA. We have 800 single family homes, a large clubhouse with 2 pools, fitness center, extensive landscaped common areas (some irrigated, some not) and private roads maintained by the HOA.

Our association dues are $220 per month. The annual budget is approx. $2M. The HOA is 7 years old and we currently have $1.9M in our replacement reserve account. $35,000 of each month's assessment goes into the replacement reserves. This is based on a professional reserve study done in 2009 which inventories approx. $10M in assets that will need to be repaired/replaced over the 30 year period of the study.

One issue I have been dealing with is finding enough banks with decent CD rates to allow for laddering of our reserves without exceeding the FDIC insurance limit at any one bank. We have looked into banks offering CDARS but the rates are much lower than what we can find independently. We are also struggling to insure that our management company keeps our operating account below the FDIC threshold.

We are doing better than many associations in terms of delinquencies with a current total of $52,000. We have collection efforts underway on some of this. There are 12 homes in foreclosure.

This year we reduced the role of the management company (which was originally hired by the developer) from full responsibility to only financial duties (collecting assessments, paying bills, keeping the books, etc.). We have hired an on site manager and administrative staff as employees of the association. This has saved alot of $ and given the board better control.

For 2010 we ended the year with a surplus in the operating account of $191K despite a huge overrun in the costs for snow removal.

My biggest long term concern is with the cost of maintaining the roads. Another older gated community in our area was forced to remove the gate and turn the roads over to the county for maintenance because they could no longer afford to maintain them. With rising oil prices directly affecting asphalt costs, it is going to be difficult to project what the road maintenance costs will be and to budget sufficient reserves to cover those costs.

 

[Ally]

I live in a neighborhood with an HOA. We have a neighborhood pool, party house you can rent for $25, tennis courts and a playground. They try to enforce things like what type of roofing materials you use, that you don't park an RV or boat in the driveway for too long, you keep your outdoor areas maintained, etc. The fees are $125 annually.

 

[Rustic23]

We have about $7.5 mil in our accounts and keep all of in in municipal bonds. The HOA tax rate is 35% and we pay that on all income regardless of expenses. I would have thought that our expenses would off set income as in personal returns, but I have been told by two accountants and tax preparers that it is not the case for HOA's. There is a seperate tax form for HOA's.

http://www.irs.gov/pub/irs-pdf/f1120h.pdf

Notice from the form only expenses that can be deducted are those that correspond to the production of income.

 

[Westernskies]

We live in an HOA-governed community, and have a second home in another. I've been on the the Board of Directors of the vacation home community for several years; it's been interesting, to say the least. PM me with any specific issues; I've probably encountered them before...

 

[Texas Proud]

Generally our financial problems is keeping the board from spending our reserve.

Yea.... our board voted to replace the entry ways to the neighborhood at a high cost... the old ones were better looking IMO...

They just cut up and replaced concrete at the pool across the street... I do not remember the old concrete being bad...

They do find lots of ways to waste money... our cost is close to $600 and we do not have to pay to fix the streets... well, nor does the county as we have a few major cracks and dips in our street...

 

[JOHNNIE36]

I have been living in a community governed by an HOA for 5 years. I was recently appointed chairman of the association's finance committee. I found myself wondering how many of the RE members reside in HOA's/Condo associations and whether a thread on association financial issues (e.g. assessments, replacement reserves, budgeting, etc.) would be of interest.

I have always been interested in Condo law and HOA law. I've served as president of both. Recently I was appointed to serve on the Archetectural Committee of our HOA. I'm in Florida and the state laws governing condos and HOA are really different. I'd love to see the various questions, opinions and problems that a forum like this could provide. However, I caution that there can be a lot of confusion due to the difference in the state laws. Not to throw cold water on this subject but it's almost as if there should be two different threads.

I'm looking forward to the posts but almost every one should be prefaced by whether you are in a condo or HOA.

 

[grumpy]

We have about $7.5 mil in our accounts and keep all of in in municipal bonds.

Rustic,

I assume you have the municipal bonds laddered in some fashion so that you have bonds maturing at regular intervals? What do you do if a major repair/replacement expense occurs between "rungs" on the ladder? You might have to sell one at a loss if interest rates have risen. I am surprised that your association investment policies allow that.

Do you restrict yourselves to bonds issued only by the highest rated municipalities? What expenses are involved - are there brokerage fees to buy and sell the bonds?

Our HOA investment policy provides that investments should seek maximum return with no risk to principal. Therefore, we restrict ourselves to FDIC insured vehicles such as CD's, savings accounts, and bank money market accounts. If a large expenditure occurs between maturity dates of CD's the early withdrawal penalties are only the loss of some of the interest. There is no risk to principal.

 

[Rustic23]

Yes the portfolio is laddered. It is made mostly of Texas municipalities, municipal utility districts, water districts, schools and such. We pay standard brokerage fees. Interestingly, the is a MUD district that overlays our HOA area. We have had their bonds in our portfolio, and will most likely have them in the future. In effect we borrow from ourselves.

We really don have 'emergencies' that require us to sell. Between the money the portfolio throws off, and the dues we have enough cash on hand to handle just about anything that comes up. Our major emergency would be a street repair and we can forecast those. Minor repair we have in the budget.

I understand that several years ago the portfolio was in stocks and for tax reasons it was moved to muni's. We have no investment policies that restrict what we can do with the portfolio.

 

[grumpy]

I am surprised that you have no investment policy that restricts what you can have in the portfolio. The board has a fiduciary duty to the members of the association to protect their funds. If you were to lose association money in a risky investments the board could be sued for breaching that duty. Is the possible higher returns you might earn or the lower taxes worth that risk? Many municipal bond issuers are having serious financial issues. How do you protect yourselves from default by bond issuers?

In Virginia, where I am, the state statutes governing HOA's and condos explicitly enumerate the types of investments the associations are permitted to make. It sounds like Texas laws are much less stringent.

 

[grumpy]

I understand that several years ago the portfolio was in stocks and for tax reasons it was moved to muni's. We have no investment policies that restrict what we can do with the portfolio.

I am surprised that you have no investment policy that restricts what you can have in the portfolio. The board has a fiduciary duty to the members of the association to protect their funds. If you were to lose association money in a risky investments the board could be sued for breaching that duty. Is the possible higher returns you might earn or the lower taxes worth that risk? Many municipal bond issuers are having serious financial issues. How do you protect yourselves from default by bond issuers?

In Virginia, where I am, the state statutes governing HOA's and condos explicitly enumerate the types of investments the associations are permitted to make. It sounds like Texas laws are much less stringent.

 

[Rustic23]

I agree the board has a fiduciary duty, and, no matter how we invest the money there would be risk. The current policy of putting the money in muni's has been in effect for about 10-15 years, and, while we have not had any losses that does not mean there will not be in the future. I think I will bring it up at our next meeting and see what the comments are. As for Texas having less stringent laws, I believe this is so. As far as I am aware, there are not rules governing us in regards to investments. The major push of regulations in Texas has been the foreclosure laws.

 

[jimnjana]

My biggest long term concern is with the cost of maintaining the roads. Another older gated community in our area was forced to remove the gate and turn the roads over to the county for maintenance because they could no longer afford to maintain them. With rising oil prices directly affecting asphalt costs, it is going to be difficult to project what the road maintenance costs will be and to budget sufficient reserves to cover those costs.

Our HOA is reconditioning the asphalt roads vs replacing or repaving. Not exactly sure what it all entails, however I know that the cost is a fraction of replace/repave. While they had the funds in the Reserve to repave, they decided not to in order to save money and the fact that doing what they are planning to do extends the life of the road surface. Our community is about 10 yrs old or so and in Florida our roads are baked by the sun by don't get the winter abuse of Northern states.

 

[Gotadimple]

We have about $7.5 mil in our accounts and keep all of in in municipal bonds. The HOA tax rate is 35% and we pay that on all income regardless of expenses. I would have thought that our expenses would off set income as in personal returns, but I have been told by two accountants and tax preparers that it is not the case for HOA's. There is a seperate tax form for HOA's.

http://www.irs.gov/pub/irs-pdf/f1120h.pdf

Notice from the form only expenses that can be deducted are those that correspond to the production of income.

You pay taxes on the value of Gross income (which are not dues but CD interest, gross rents, royalties) less $100 &/or other deductions.

The association does not exist to make money but to maintain commonly owned areas. I would think it would be difficult to attribute the cost of cutting grass to production of interest income earned from muni bonds. That's why muni bond interest is taxable after the first $100 is earned.

-- Rita

 

[Zoocat]

Grumpy, I have written about my HOA problems before but thought I would again outline them, although last spring I did sell my townhome in that community. Readers may want to skip my story and go directly below to the section "What I learned."

The community where I purchased (50 condos and townhomes) was built in 2003, including about 20% "affordable" units, which were basically subsized housing by the city. The builder cut corners and there were construction defects, some apparent immediately, some only apparent in subsequent years.

Because there were lots of non-homeowner occupants, only a few homeowners attended the HOA meetings and those who did became very interested in keeping the HOA fees low, even though they were set artificially low by the builder to attract buyers. The HOA board members were not knowledgeable enough about running a HOA so they allowed the fees to remain low. Consequently, it was always a hassle to budget funds for necessary maintenance as well as the continuing repairs.

Eventually, those owners who fought to keep the fees low sold their townhomes at a big profit and moved out. The HOA got a new manager who urged the HOA to bring suit against the builder before the 7 year tme limit ran out. Our HOA hired construction engineers and their report indicated that the costs to repair all the defects would run into several million dollars. So, after learning that, I put my home up for sale and eventually sold.

I feel very lucky to have found a buyer because these suits can take 3-5 years to resolve. The suits are always almost settled through arbitration and the HOA does not usually get a settlement that covers all the costs to repair the defects. There are usually a series of assessments that owners have to pay.

What I learned:

1. When you buy into a complex with a HOA, you are voluntarily joining your financial well being with the other owners. If they make bad decisions, you will suffer along with them even though you made your views known.

2. Homeowners in a HOA community often have differing goals in owning the real estate. If there is a large percentage of investors and landlords owning in that community the buyer should be VERY wary. I'd stay far away. FHA rules disallow mortgages for condo communities that have over a certain %(?) of non-homeowner occupants.

3. A HOA should always have a large reserve and a reserve study. No reserve study is a red flag.

4. A potential buyer should always read the last six months of the HOA minutes, more if possible, and study the financials. Also, I'd suggest talking to the HOA manager.

 

[grumpy]

What I learned:
1. When you buy into a complex with a HOA, you are voluntarily joining your financial well being with the other owners. If they make bad decisions, you will suffer along with them even though you made your views known.

That is why I backed a slate of candidates for the first elected board and got myself appointed to the finance committee. With the recent departure of the former chairman of the committee from the community, I now find myself as chairman of the committee. I work closely with the board treasurer, who is not very financially astute. If the HOA's finances do not stay strong I will have no one to blame but myself.

 

[Gotadimple]

That is why I backed a slate of candidates for the first elected board and got myself appointed to the finance committee. With the recent departure of the former chairman of the committee from the community, I now find myself as chairman of the committee. I work closely with the board treasurer, who is not very financially astute. If the HOA's finances do not stay strong I will have no one to blame but myself.

+1

I became the treasurer when the former treasurer sold his unit. I was always worried that we were under-reserved, and it turned out to be true. Luckily, we can make up the shortfall with small annual increases and still do major upgrades without borrowing from the bank.

-- Rita

 

[haha]

Please help me understand this tax aspect. Are all the receipts of the HOA/Condo Assoc considered income, and taxed? Or just the earnings on reserves? Are rates comparable to individual rates, or more a corporate rate? Is the tax rate progressive, such that a large association will pay a greater proportion in taxes, even though the reserve earnings per association member may be no larger?

This thread begins to sound like another argument for renting.

Ha

 

[Brat]

I agree with grumpy's attitude. The best way to assure that an HOA is well managed is to participate, be an officer. If short term thinkers run the show the facility will go to wreck and ruin.

 

[ChrisC]

I agree the board has a fiduciary duty, and, no matter how we invest the money there would be risk. The current policy of putting the money in muni's has been in effect for about 10-15 years, and, while we have not had any losses that does not mean there will not be in the future. I think I will bring it up at our next meeting and see what the comments are. As for Texas having less stringent laws, I believe this is so. As far as I am aware, there are not rules governing us in regards to investments. The major push of regulations in Texas has been the foreclosure laws.

I'm surprised by the absence of Texas law not having restrictions on investments that an HOA may do with homeowners' assessments and reserves. Even if there were not explicit rules, the HOA operates as a nonprofit organization, subject to prudent business rule standards applicable to nonprofits and the board members have to comply with fiduciary duties as well.

I previously served on my HOA board in Virginia, and I wouldn't continue to serve on a board without a sound investment policy, especially if the HOA is investing in Munis, which still have a default risk. I hope you have good D&O insurance!

 

[grumpy]

Please help me understand this tax aspect. Are all the receipts of the HOA/Condo Assoc considered income, and taxed? Or just the earnings on reserves? Are rates comparable to individual rates, or more a corporate rate? Is the tax rate progressive, such that a large association will pay a greater proportion in taxes, even though the reserve earnings per association member may be no larger?

This thread begins to sound like another argument for renting.

Ha

Haha,

Our HOA only pays taxes on the interest earned on our investments of replacement reserve funds. I'm not sure about the tax rate structure as our returns are prepared by our auditor and signed by the treasurer. Based on what I know of our investment income and the amount of tax we pay, the rate appears to be in 25 to 30% range.

If the HOA collects more in assessments that it spends, those surpluses have to be transferred to the reserves, refunded to the members, or applied to next year's expenses with an equivalent reduction of the next year's assessments. Otherwise that excess income is taxable.