By Bryan Farley, Association Reserves - Colorado
Inflation increasing, bank instability, rising insurance costs, material shortages...
With news like this, it seems the sky is falling, or at least a roof is failing due to a lack of proper funding in a reserve account. Why would that happen? It is because the board has been unable to increase or collect the money necessary to take care of the assets of their property due to homeowners being significantly impacted by the rising cost of everyday items and the rising cost to insure their homes.
Consider the following email we received from a concerned board member: “Our bylaws require us to get majority approval for any increase above 5%, as well as for any special assessment amount. Right now it seems residents, if given the option, vote any increase down, even if it will be to their eventual detriment.”
How can a community association operate if there is no capital to maintain the community’s assets?
Based on data analyzed by CPR News, the average Colorado home increased 37 percent in value over just two years. That means even a small, 5-unit condo community is now collectively valued over seven figures. A condominium with over a million dollars worth of real estate should be run like a well oiled machine. Monies are needed to repair, replace, and enhance the common area assets in a community. Boards need to make sure that monies are collected in a timely manner to maintain the assets of the community association that the Board is tasked to oversee.
There are few issues that board members may face in the next year that could make their collection process a top priority.
- Rising Insurance Premiums.
- Legislated Payment Plans
- Increase in Costs and Labor
Rising Insurance Premiums
Based on conversations with board members and community managers, there have been insurance premium increases from 25% all the way up to 500%. One board member mentioned that the annual premium for his 100-unit condominium increased from $75,000 to $460,000 this year.
The problem with these premiums is that many of the insurance contracts renewed in Q3 of 2023, but the budget that will now pay for these premiums will not be implemented until Q1 2024. That means many boards had to borrow money from the reserve account in order to cover the gap until the monies could be collected from the homeowners.
That means there is a ‘due to, due from’ in the books for many properties across Colorado. If the monies are not collected, then the reserve account will be short of the necessary funds needed to adequately fund the repair and maintenance of the property assets. This shortfall will either lead to increased contributions, special assessments, or loans. All of these options will cost the homeowner much more money.
This puts the board in a hard place since the HOA must be insured in order to secure mortgages and be compliant with the Colorado Division of Real Estate. Therefore, the board is obligated to have insurance and pay the large increases. The costs are now going to be shared by all homeowners moving as part of the budget and increased dues.
However, what if a homeowner cannot pay the increased dues?
Legislated Payment Plans
In 2022, Colorado legislature passed HB22-1137, which became effective on August 9, 2022. One of the outcomes of the legislation was the extension of the payment plan offered to delinquent homeowners. In the past, associations were required to offer homeowners a 6-month payment plan before sending the matter to an attorney or collection agency. HB22-1137 required that associations now offer an 18-month payment plan.
The minimum payment allowed as part of this payment plan is $25 a month. After this 18-month period, the payment will balloon to the final balance with interest accrued capped at 8%.
When a roofing replacement project needs to occur, the monies will be needed immediately to cover the cost, not in 18 months. The intermediary period could require some creative solutions if a majority of the owners are unable to pay the increased assessments in a timely manner. However, if the board cannot come up with a payment plan that works for everyone, owners could fall into delinquency.
However, homeowners that live in a property that has multiple owners delinquent could face home resale obstacles.
Freddie Mac now requires that any condominium, housing cooperative, or any multi-family common interest ownership association with more than five attached units have no more than 15% of owners more than 60 days delinquent in paying their assessments. If 15% or more of the owners are delinquent, then this could cause issues with mortgages being underwritten on the property, which could put homeowners that are selling in that property in a difficult situation.
If the board of directors is unable to complete a project on-time due to the lack of funds available, then the board may need to defer the project. Yet, there is a risk of seeing the price of the project increase.
Increasing Labor and Material Costs
In 2021 and 2022 a common response from clients regarding completing a project on time was that the board decided to defer the project until inflation normalizes. The problem with this line of thinking is that inflation will at some point indeed ‘normalize’ to historical averages, but that does not mean that the prices will deflate to pre-2020 costs. Inflation is perpetual and compounding.
For example, per The Mortenson Cost Index, indexed construction costs have increased ~40% since 2019. Within the last year, when national CPI inflation was tracked at 3.2%, construction costs in Denver increased by 3.8%, and Denver construction labor costs increased by 5.2% during the same period.
Internally, Association Reserves has tracked the following increases on typical Colorado association assets:
- 400k BTU Boiler = ~ 70% increase since 2020
- Asphalt Overlay = ~ 60% increase since 2020
- Asphalt Seal = ~ 60% increase since 2020
- Comp Shingle Roof = ~ 30% increase since 2020
- Exterior Paint = ~ 50% increase since 2020
- Wood Fencing = ~ 25% increase since 2020
- Traction Elevators = ~ 25% increase since 2020
The board of directors has the obligation to run the association in a fiscally responsible manner. Increased costs on the life safety systems of the association (such as the roof and elevators) require adequate funding. Adequate funding requires that owners pay their fair share of the deterioration of these expenses, and not just defer the projects until something potentially dangerous could occur.
What Can be Done?
It is never easy to raise dues. It is tough to tell your neighbor that the fees will be more than last year. However, based on the increasing costs and external pressure on HOAs that boards may see in the near future, the risk of not having adequate funding could cause much greater problems for the owners that live in an association.
During this volatile time, the board and the owners need to be proactive to protect the interests of their community. The board needs to remember that they have a a fiduciary responsibility to maintain, repair, and enhance the common area assets. The owners will also need to remember that the board was elected in order to protect the community’s interest.
It is recommended to have a Reserve Study completed and updated to provide a non-biased opinion on how much should be collected and contributed into the reserve account. Having an updated Reserve Study will help both the board and the owners realize that there are important projects in the community that need to be taken care of.
Therefore, plan to have a Reserve Study completed. Use the Reserve Study like a map for the financial future of the community. If the community runs into a detour (like a large hail deductible), then update the Reserve Study and to find out how to stay on the correct course.
The future is not predictable, however, a professional Reserve Study will provide the board with the information to decide what the best course of action is given what we know today.
Bryan Farley is the President of Association Reserves – Colorado. A Reserve Specialist, Bryan has completed ~3,000 Reserve Studies and has been a frequent speaker on the topic of Reserve Studies.
