Approving the annual community association operating budget is one of the most important obligations of the board of directors. It is also the duty of the board treasurer to take the lead in this endeavor and ensure that a budget is approved in a timely fashion i.e. before the end of 2018 and in accordance with applicable laws. The approved budget should be realistic while considering short, medium and long-term maintenance requirements of the common elements while also adequately funding the association’s capital reserves account. That said, what are some of the best budget planning practices board members should follow? Let’s look at the best of class:
- Approve the budget in a timely fashion.
By now all managed associations should have received a proposed budget by the management company. At that point, the treasurer should make any adjustments to the 2019 proposed budget. This involves a careful line by line item review of the proposed budget on the income and expense side and by considering a reserve study and/or capital plan along with an operations plan for the upcoming year. Once the board agrees on a proposed budget, the management company distributes the proposed budget to all the homeowners in advance of the budget approval board meeting to ensure compliance with applicable state and local laws and the association’s governing documents.Bottom line: Pass a realistic budget in a timely manner and experience a peace of mind in 2019. - Include a contingency line item. This might seem like common sense to some, but unfortunately it seems that many board members are quick to remove this line item. This is probably one of the most important line items to include in a budget as it is nearly impossible to accurately predict with a high degree of certainly the income and expenses of a community association over a 12-month fiscal period. Snow removal expense is one of the best examples of why an association needs a contingency expense line item. The contingency line item should be in the range of 5% of the total operating expense budget. So, if your expenses are $100,000, there should be a contingency expense line item of $5,000.Bottom line: Include a contingency line item in your 2019 budget and don’t stress out if you encounter an unexpected expense.
- Integrate a capital plan/reserve study.
How can you properly determine the correct assessments levels? It is certainly not a simple answer because there are many factors that should be taken into consideration. One factor that undoubtedly needs to be taken into consideration is a capital plan and/or a reserve study. This will determine with a high degree of accuracy how much assessments should be to properly fund the reserves and avoid a special assessment. Without considering a capital plan, there is no way of knowing how much there should be in the reserves when it comes time to address capital improvements or repairs. The worst-case scenario is to ignore long term capital planning and then pass an emergency special assessment to fund the project. If the project(s) are larger in size, this might require bank loans which will further increase the cost of the projects.Bottom line: integrate a reserve study and/or capital plan and start saving now for those future large-scale projects. The homeowners will thank you. - Include realistic expense category line items.It is tempting to cut expense line items to keep the assessment “low”. But sooner or later, this practice will haunt the board of directors. For example, it is typical for associations to have a 2.5% to 5% delinquency rate of assessment payments. So inevitably this issue translates to legal collection bills. Even if your association is fortunate enough to not have any uncollected assessments, sooner or later this will become an issue. If you have been excluding a legal expense line item because you have been “lucky”, that doesn’t mean it is a good idea to exclude a legal expense line item. You should still include an expense and use it to further fund your reserves if you end up not using an entire expense line item.Bottom line: Take a more conservative budgeting approach and watch your reserves grow to a healthy stress reducing amount.
- Raise assessments every year.
Have you ever wondered why utility expenses always go up? Your answer is probably, “No, I just take it for granted”. That is why you should raise your assessments every year. It is much better to raise assessments 3-5% per year than waiting 5 years and then having to raise assessments 15%. It is easier on the homeowners to pay slightly higher assessments and it ensures that the association is keeping up with rising expenses. Bottom line: Raise assessments every year to keep up with rising costs and sleep more comfortably at night. - Avoid bank loans and special assessments.
Even if you raise assessments annually, there is a good possibility that you will not have enough funds to cover capital expenses. So that is why I mentioned in Recommendation #3 to incorporate a capital plan and/or reserve study when setting the assessment levels. An even more methodical approach is to create separate reserve accounts for each large-scale capital project or at least have a way to segregate the funds in a single reserve account. This will help plan each capital repair/replacement item with an even more detailed approach and ensure that proper funding is in place.Bottom line: A more detailed and methodical approach to budgeting and capital planning will only lead to happier and healthier community living. - Incorporate a 1-year operations plan.
This plan which breaks out in detail the day to day building maintenance and operations activities of the association will help the board see the entire fiscal year in a snapshot view and will allow them to see the big picture. It will also encourage the board to include money in the budget for general association upkeep and other items that might otherwise get lost in the drudgery of the budgeting process.
Bottom line: Seeing is believing. - Properly Communicate.
Not only is it important to include the right levels of income and expense categories in the budget and pass the budget in a timely manner, but it is equally important to property communicate this information to the homeowners. Professionally managed associations should not have to worry about this, but the self-managed associations should make sure that the proper notices are given to all the homeowners. Another important aspect in the approval process is making sure there is a reasonable open discussion during the board meeting allowing the homeowners to voice any concerns for or against the details of the proposed budget.Bottom line: A compliant and transparent approach is always best. - More Details are Better.
How many budget categories should your association budget have? It really depends on the type of association and the size of the budget. If you have an HOA with 100 single family homes with just a security gate and common area landscaping, there really is no need for a very detailed line item budget. On the other hand, if you have a 300-unit high rise building with onsite staff, a swimming pool and a parking garage, it certainly should have a significantly higher number of income and expense categories. For example, for the simple HOA example above, it would be okay if you have an expense category called “general maintenance” with only a few subcategories such as snow removal, gate repair and landscaping to capture the types of maintenance expenses. In the case of a larger scale community, it would make more sense to have many more General Maintenance subcategories like: carpet cleaning, fence repairs, electrical repairs, fire suppression equipment, drywall, power washing, painting etc. A rough rule of thumb is more is always better as it is easier to manage any budget overages with greater details in the expense categories.Bottom line: More is better when monitoring and controlling income and expenses. - Adequately fund the reserves.
How much should be in the reserves? One common rule of thumb is to fund the reserves by AT LEAST 10%. This would mean making sure your budget includes a reserve contribution of at least 10% of the total projected annual income. This also ensures your association is FHA compliant (if applicable). Adequately funding the reserves properly is critical when it’s time to take on large scale capital projects and when prospective buyers are looking at the financial picture of the association.Bottom line: A healthy and adequately funded reserve leads to a more peaceful community living environment.
Approving the association’s annual operating budget is by far the most critical annual task that the board of directors must complete. Not only is it important but it is a fiduciary duty. The good news is that these duties and obligations are vested to the board of directors by the governing documents of their association. This means simply that they need to approve a budget that is fair, realistic and takes into consideration real life conditions and long-term capital requirements. Taking any other course of action is simply a dereliction of duties that will only cause the homeowners undue stress and frustrations. The better approach is to property plan the future of the association, so you can create the most ideal and enjoyable community association living environment for you and all the other homeowner