Community Associations Institute (CAI) believes it is imperative that all community associations adopt and use a financial planning and budget process to project annual operating costs including: long-term maintenance, repair and replacement costs of common areas, facilities and equipment, and uncollectable assessments or unexpected budget shortfalls in order to create a balanced budget based on generally accepted accounting principles.
CAI believes that all governing boards, whether developer-or-owner-controlled, should prepare and disclose budgets which accurately estimate projected operating costs and reserve requirements. CAI also supports full and open disclosure to owners and the opportunity for participation by owners in the development of budgets on an annual basis or more often as conditions warrant.
Although CAI believes community associations should be encouraged to fund and maintain maintenance, repair and replacement reserves, CAI disfavors laws that would mandate how community associations fund and maintain reserves. In those states requiring an owner vote in connection with the budget or concerning the funding and maintenance of reserves, CAI encourages associations to include owners in the discussion concerning the purposes and benefits of reserves. CAI believes that the funding of reserves through the budget process is one that the association governing body should undertake in consultation with a reserve specialist rather than be mandated by governmental regulation.
Experience has shown that equally important to adopting a specific method of reserve funding is the recommendation that the developer-controlled board prepares a reserve study close to transition to the owner-controlled board.
Community associations are responsible for substantial activities involving administration, management, insurance, maintenance, cleaning, services, repair and replacement of facilities and equipment and rules enforcement. Depending upon the extent of association activities and facilities, the costs of carrying out these activities are annually funded by owners through association assessments. These assessments are determined during the annual budget process. Special services or amenities may be funded through user fees. It is particularly important that developers create an initial budget that adequately provides for operating expenses and reserves, notwithstanding the lack of history related to a particular association. While each community association is unique, reference to similar associations in the same geographic area will typically provide a basis upon which to estimate expenses with reasonable adequacy.
Due to the potential costs of future major repair and replacement, concern exists about the ability of the association and its owners to meet those costs exclusively through assessments, special assessments or loans without creating excessive hardships for owners. When owners fail to pay assessments, it creates a strain on the association’s cash flow and should be accounted for using a line item in the budget, such as an Allowance for Doubtful Accounts or Uncollected Debt [Receivables], with the assistance of an accounting professional.
Use the services of an independent professional to prepare the budget or, at a minimum, review and offer recommendations for changes to the budget to help ensure accuracy. The independent professional should have no financial involvement with the developer and should have prior community association budgeting experience. The budget should be prepared prior to the sales phase so that reliable information is provided to potential buyers, and should also be prepared in accordance with generally accepted accounting principles.
Use the services of an independent professional to prepare a Reserve Study, in order to calculate the annual contribution rate required to provide for the long-term maintenance, repair and replacement of the facilities.
Organize the association as an entity with the authority to borrow.
Ensure that the initial budget, budget presentation and reserves’ analysis reflect not only annual operating considerations, but initial funding of reserves’ accounts established for future maintenance, repair and replacement of facilities and equipment.
Ensure that common elements mean and include any other interests in real estate for the benefit of owners which are subject to the declaration.
Consider and adopt a formal policy for meeting future maintenance, repair and replacement obligations, which would include goals for funding and investing reserve accounts.
Consider use of an independent professional to prepare a Reserve Study, to calculate the annual contribution rate required to provide for the long-term maintenance, repair and replacement of the facilities.
Fund, in whole or in part, reserve accounts based upon replacement cost estimates, so that all or a substantial portion of those funds are available when needed without resorting to special assessments.
Be discouraged from establishing reserves solely as a fixed percentage of the operating budget or of the value of the improvements.
Follow state statute requirements for funding reserves, or, where applicable, waiving of reserve requirements, as well as providing to members an annual report on the status of the reserve account. This may be a summary, presented along with the annual budget, to all owners, with access to review the complete Reserve Study on an individual basis by the management company.
While associations should plan for meeting their substantial future maintenance, repair and replacement obligations, the form of any plan should be tailored to the individual association and its members. Different reserve funding plans may be appropriate for different associations. For example, some associations may be faced with tax liabilities associated with the funding of reserves for certain components. Community associations with substantial limited use areas, whose maintenance is paid for by the owners using those areas, may treat those maintenance costs differently. Additionally, the amount that members of one association are willing and able to pay in assessments to cover unfunded repair and replacement reserves will differ from one association to the next. However, those unfunded items should be clearly identified, at a minimum, in the annual financial statements prepared for the members. The ability of a community to fund reserves may affect the timing and magnitude of each year’s reserve contribution.
The ability or the attractiveness of borrowing for major or long-term capital expenses will also differ. CAI opposes laws that do not allow community associations and their governing boards to determine the appropriate level and method of funding for reserves for long-term maintenance repair and replacement costs. CAI supports laws that provide for disclosure of information to owners and prospective purchasers in communities so that they can make informed decisions about the association and its finances as they relate to funding the long term maintenance, repair and replacement obligations for the community.
CAI shall encourage and educate lenders and regulators toward an understanding of the credit worthiness of associations, adequate instruments for securing a loan and the opportunity to extend credit for the repair, expansion or replacement of common area improvements.
Risk management and insurance is an additional critical component of effective governance for every association because consideration of protecting association assets and amenities is part of the fiduciary duty of governing boards. Costs for providing protection including for self-insurance and for funding deductibles should be included in the annual operating budget as mentioned briefly in Background. For a full discussion on this extensive topic please refer to the Community Association Risk Management and Insurance Policy