HOA Budget Basics

Written by Richard Thompson Posted On Thursday, 17 June 2021 00:00

Many prospective homeowner association buyers are attracted to their maintenance-free aspect. Fixed income buyers expect maintenance fees to relatively remain stable, possibly adjusted by inflation and little more. Unfortunately, this is rarely the case due to the tendency of many boards to keep fees and reserves unrealistically low. This budget "starvation" results in deferred maintenance and special assessments. What can be done to prevent this?

The accuracy of the budget directly affects future year budgets and maintenance fees. Under budgeting creates shortfalls which are often covered by reserve funds earmarked for future replacement and repairs. This in turn causes a shortage in reserves. If these shortages are not corrected in the year they happen, a domino effect results year after year until the community finds itself in a precarious financial situation.

Webster's defines budget as: "A financial statement of estimated income and expenses for a specific period of time." In an individual's personal budget, income is determined and then assigned to various expenses. For a community association budget, the process is reversed. Expenses are estimated and then the source of revenue determined. Maintenance fee levels are the end product of the budget process, not the starting point. Deciding what maintenance fees will be and then, producing a budget will usually produce disastrous results.

So how can your community avoid the trap? There are four basic steps to budgeting:

Step One: Operating Budget Expenses     

To budget for the upcoming fiscal year, examine the previous three year history of each line item...the actual disbursements, not the budgeted. This information will show spending trends that may otherwise be missed. Then, consider future changes that will effect disbursements. For example: utilities, what rate increases are expected for the next year? Call the utility companies and ask. Are there any operational changes that will increase or decrease utility consumption? For example, if additional security lights are to be installed, an increase in the electricity budget may be called for; if existing light fixtures are being replaced with energy efficient ones, a decrease may be in order.

Step Two: Reserve Contributions     

Reserves are the funds you put away to fund future repair and replacement projects. For this purpose, a Reserve Study is necessary. The Reserve Study identifies the common area components (like roofs, painting, siding, paving, etc.) for which the association has maintenance responsibility, assigns a useful life and replacement or repair cost to each component, and a long range funding plan so that future maintenance can happen without the need for special assessments. It is the single most important piece of the budget because it provides a long term plan for all boards to follow. It also helps relieve the board from political pressure to not raise fees since "The Reserve Plan" dictates a prudent course of action that defends all owners' interests, not a particular individual's. More importantly, associations that fund a sound Reserve Plan consistently better maintain the property which produces higher resale values. Reserve Study computer software and workbook manuals are available for self help. Or, a professional consultant can perform the Reserve Study.

Step Three: Compute the Homeowner Fees    

It's simple mathematics:

Total Operating Expenses + Annual Reserve Contribution = Homeowner Fees

This figure is then divided equally or by percentage of ownership, depending on your community's governing documents, to determine the annual maintenance fee for each owner.

If the budget maintenance fee is close to last year's, your community has probably been budgeting well. More than likely, the comparison may show that a significant increase is in order. If so, this is the board's opportunity to revise the budget to reflect an "acceptable" maintenance fee increase. An "acceptable" fee doesn't change reality, however. To move towards a reality budget the board might propose a transition period of, say, three years where the gap between "acceptable" and "reality" is closed by 1/3 each year.

During the transition period, cosmetic reserve repairs like painting and carpeting can be deferred as long as the underlying structure is not threatened. Lower priority disbursement items like window washing may also be eliminated to help hold the line. On the revenue side, consider raising things like parking fees when possible. Since the budget reductions reflect an austerity program, the board should carefully explain the long term plan to the members. The message to all homeowners, real estate agents, buyers, lenders, and other interest parties should be that the plan will make the association financially sound.

Step Four: The Year-End Financial Statement     

This step compares the current year actual to the budget. It will show whether the association spent or collected more money than planned in order to include the changes to account balances in the next year's budget. If disbursements were higher than budgeted and/or income lower, the shortage was probably made up by using reserve funds. If this was the case, the association's reserves are lower than expected and additional funds will have to be collected to bring the reserve accounts up to their proper level.

The year-end budget review is important because it reminds the board that each year's budget affects and is affected by other years' budgets. Overages and shortages will increase or decrease funding requirements in future years.

While a homeowner association's past budgeting errors are water under the bridge, its future financial stability can be secured by a commitment to thoughtful budget planning that reflects the true needs of the community. The successful HOA plans for the future instead of reacting to it.

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