Realty Times - Inspecting Condo Communities' Financials

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Inspecting Condo Communities' Financials

by Broderick Perkins

At least three in four home buyers obtain a professional home inspection to determine the physical condition of a home before they close the deal, but most home buyers aren't as likely to pay attention to a home's financial condition when it is necessary.

It is necessary to know your home's financial condition when the home under consideration is a condo, town home or any home in a community with its own operating budget. Why?

Buying a condo or town home is a lot like buying a share in a closely held, publicly-traded, non-profit real estate holding corporation. You don't just buy a home, you effectively enter a partnership and bad business surprises -- just like deferred maintenance surprises -- can cost you.

"It is amazing that people don't spend much more time on a condo purchase when they are becoming "business partners" with strangers in a multi-million dollar real estate development partnership," said Robert M. Nordlund, president of Calabasas, CA-based Association Reserves, Inc.

A growing percentage of home buyers are opting for condos and town homes over single-family homes according to the "Historical Census of Housing Tables Units in Structure", yet many buyers spend more time researching a used car purchase than they do when they are buying a condo.

Without careful attention to financial details, you could overlook the troubled financial status of the one in three homeowners associations (HOAs) that are unable to meet major repair and replacement obligations because of insufficient reserves, according to Association Reserves. The company has completed more than 10,000 financial studies from associations in 43 states to back up its claim.

What's at stake

Condominiums, town homes and even some newer higher-density, single-family home communities are developed as what's called common interest developments (CIDs) -- you own everything in your unit, at least everything on your side of the walls. You are a shareholder in the remainder of the buildings, grounds and other facilities. As a shareholder, you are a mandatory, dues-paying member of the CID's HOA, the organization responsible for the upkeep and care of buildings and grounds.

Under the guidance of a board of directors, one of the association's primary responsibilities is managing the dues and other money collected to fund the operating budget of hundreds of thousands of dollars. Budget monies are dispersed for repairs and the upkeep of common area components -- the condo buildings, other structures, landscaping, lighting, walkways, paving, swimming pools, decks, etc, as well as for other operating expenses.

When an HOA can't financially take care of itself, it looks to members -- you and your fellow home owners -- for additional funds, typically in the form of special assessments at whatever level necessary. The assessments are typically over and above the monthly dues and can be one time fees or short term additions to the monthly dues.

As a buyer, you have the right to examine an HOAs operating budget and other records related to its financial decisions and behavior, but you likely aren't any more qualified to interpret those documents than you are to professionally inspect a property's structure.

"The key is interpretation. You'll get a three- to six-inch stack of association documents and you can wade through it and look at the meeting notes, but will you know if $250,000 in the reserves is is a good thing or a bad thing?" asks Nordlund, also president of Association Reserves' new division, Association In$ights.

In$ights offers a new service designed to take the guesswork out of determining the fiscal condition of an HOA. It's called a "Risk eValuator Report."

For $89, the report scrutinizes an HOA's financial factors to determine the likelihood of the HOA levying a special assessment within the next year.

Percent of Reserves Funded. A portion of an association's budget called the reserve fund reveals how much cash is available for upcoming obligations. The level of reserves can vary from association to association and is based on the size, age and type of the community as well as how it was constructed, how it's been cared for and other factors. The American Institute of Certified Public Accountants recommends associations conduct annual reserve studies to determine how financially fit they are. Only a few states, however, mandate the studies and most law requires studies less frequently than the institute recommends. The study reveals how much cash is available for upcoming obligations, how much an association actually needs to meet those obligations and a financial plan to come up with any shortage.

Generally, if the HOA has less than 30 percent of the reserves a study says it needs, the reserves are in "poor" condition and there's a very good chance that an assessment or other action (deferred maintenance, loan, higher dues) will be necessary to overcome the shortfall. The lower the funding the higher the risk.

When a reserve is 30 to 70 percent funded, the reserves are in "fair" condition and there's less chance of an assessment or other action. When a reserve is more than 70 percent funded the reserves are in "good" condition and special assessments or deferred maintenance aren't likely.

The reserves aren't the sole assessment determining factor.

Percent Owner-Occupied. The more owner-occupied units, the more residents there are on site with a vested interest in the well-being of the community. If 75 to 100 percent of the development is owner-occupied, conditions are "good," at 60 to 75 percent owner-occupied, "fair" and at 60 percent and below, "poor".

Percent of 60-Day Delinquencies. If 5 percent or fewer of the HOA's members are 60-days or more late paying their dues, that's a "good" sign of a steady flow of cash and a well-managed budget. If 5 to 10 percent are late conditions are "fair". If more than 10 percent are 60-days or more late, that's "poor" and a red flag that warns of poor cash-flow management and the possibility of an under funded association.

Each eValuator report also provides location and community facilities information and the status of legal filings, assessments, tax filings, insurance coverage and management.

Finally, the report grades the HOA with a mark of A for excellent to F for being a financial failure.

As well as being an informative tool often otherwise unavailable, eValuator reports also can serve as a negotiating tool for both buyers and sellers depending upon which way the wind is blowing.

"This is not a shot in the dark. We make it as simple as when you drive into a national park and you see Smokey the Bear's risk sign of fire. Is it low, is it medium or is it high?" said Nordlund.

Published: June 5, 2002

Use of this article without permission is a violation of federal copyright laws.

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Broderick Perkins parlayed a career in old-school journalism into a contemporary digital news service that really hits home.

The award-winning consumer journalist, originally from Wilmington, DE, is founder, publisher and executive editor of the bootstrap DeadlineNews Group, a Silicon Valley-based editorial content and consulting service specializing in residential real estate, consumer news and related editorial consulting services.

The DeadlineNews Group includes the website, DeadlineNews.com, offering real estate editorial content and consulting services, and its back shop, the Deadline Newsroom, an open house on news that really hits home.

Perkins obtained his formal journalism education from University of Delaware and a journalism boot camp, the Institute of Journalism Education at the University of California-Berkeley. He went on to 20 years of service as a daily newspaper journalist at the Wilmington, DE News Journal and San Jose, CA Mercury News.

Perkins covered housing on the San Jose Mercury News reporting team which earned a General News Reporting Pulitzer Prize in 1989 for coverage of the Loma Prieta earthquake.

He has also produced real estate, consumer and small business content for the Wall Street Journal, Los Angeles Times, RealtyTimes.com, Nolo.com, Better Homes and Gardens, the National Association of Realtors, Homestore/Move and Intuit/Quicken among more than three dozen publications.

In addition to managing the DeadlineNews Group, Perkins most recently served as chief editorial consultant for Nolo's Essential Guide To Buying Your First Home, Nolo, and writes real estate television scripts for RealtyTimes.com.

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