Funding for the Future: Why Financial Forecasting is Essential for HOAs

Dan Stondin
CEO, homey.io

On June 24, 2021, at approximately 1:22 in the morning, Champlain Towers South, a 12-story beachfront condominium in the Miami suburb of Surfside, Florida, collapsed. Ninety-eight people lost their lives. Only six years earlier, in Berkley, California, a balcony collapsed and killed six students celebrating a 21st birthday shortly after midnight. While many factors contributed to these tragedies, deferred maintenance and inadequate inspections of community-owned property played a significant role. Bills and new laws like California SB 326 / CA Civil Code 5551 and SB 4-D in Florida aim to bring more physical checks and financial oversight to HOAs and their management teams following these events. And it’s not just the government becoming more aware of the dangers of poorly maintained physical and financial HOA assets. This year, Fannie Mae & Freddie Mac, two of the most prominent players in the mortgage market, added a new questionnaire to condo loan applications. This addition will likely protect them from purchasing loans in potentially dangerous buildings. A positive side effect for homeowners may be that it generates demand for a higher standard of condo care and management across the country.

Board members have an invaluable role to play alongside these new laws to assure their communities are desirable and safe places to live. Building maintenance is complex and expensive, and saving for longer while deferring replacements is a recipe for disaster.

More often than not, HOAs inherit mistakes and many start life at a disadvantage. The initial “plan” prepared by developers and submitted to the Department of Real Estate isn’t always as thorough or accurate as the one often required by law three years later. Assessments are unfortunately kept artificially low in the first year to encourage property sales and are rarely corrected until it's too late to get back on track quickly. Another contributing factor to high-risk HOAs is continuing to operate against a once-accurate plan. California law requires that HOAs conduct a visual study of the entirety of an association's components every three years and produce a financial update every twelve months in an attempt to stay on track. These reserve studies are a snapshot of the health of an association and include a plan for collecting and spending association funds over 30 years. Unfortunately, we all know life rarely goes to plan; things break before their anticipated replacement date, materials and labor cost more than expected, and out of left field, inflation skyrockets because of an unimaginable global pandemic. Forgetting, or simply not conducting, these essential revisions to an association's long-term savings plan leads to dramatic assessment increases and significant special assessments.

A common goal among HOAs is to be “100% funded”. While this is a fantastic ambition, it is unrealistic for many associations. A more attainable goal might be to have a strong reserve, where the likelihood of large special assessments is low. There’s a shared opinion in the reserve analyst community that funding above 70% can be considered strong, while anything below 30% should be regarded as weak. 100% percent funded is often mistakenly interpreted as the amount required to replace all commonly-owned components at once. In fact, all components begin to deteriorate after they are installed, each with a life expectancy and associated replacement cost. For example, an analyst might estimate a condominium roof to cost $250,000 to replace and last 25 years. An HOA must save $10,000 each year in preparation for its replacement. In reality, it’s not exactly $10,000 a year because inflation has to be accounted for, but for simplicity’s sake, it’s ignored in this example. If applied to all components in the community, this same saving principle would result in the association being 100% funded each year even though the total replacement costs for the components haven’t yet been collected! Instead, associations tend to ensure they have enough money saved each year to cover the replacements in that year while saving as much as is socially acceptable for the future. It’s a literal l balancing act and equanimity is difficult to attain without financial forecasting tools or expertise. While this method works for years with few or inexpensive replacements, it quickly breaks down when multiple or significant expenses are due.

Do HOAs need financial forecasting software? Absolutely. For-profit companies use tools like these and rely on them to ensure their business can continue to pay salaries, keep up with operating costs, and save for the future. Sound familiar? Running “what if” scenarios is a fantastic way to avoid surprises and present options to a broader audience, reducing the responsibility of decision-making burden for individual board members. Humans are innately visual. Competing tables of financial information can be complicated to glean meaning from unless you know what you are looking for. Many financial forecasting tools communicate the same information through data visualizations or derived insights.

All the data needed to generate financial models and forecasts are locked up but available in an association's reserve study. These studies and their suggested plans are incredibly valuable but often challenging to implement. Board members are not experts and, by law, volunteers; even reviewing upcoming replacements and kicking off projects can be difficult. Simple calendar reminders can go a long way. Why not try “Alexa… remind me to review ongoing and future HOA replacement projects each month.” Simple project management software by design typically requires someone to be assigned to or lead projects. While this sounds obvious, without being explicit, HOA Board members can quickly lose track of who is supposed to be doing what, and replacements can fall through the cracks.

Considering that 53% of the US population live in homeowner associations, and 60% of condos in the US are now over 30 years old and haven’t been adequately funding their reserves, a storm may be on the horizon. When a community reserve is underfunded, one of the only tangible ways to get back on track is to levy a special assessment tax on its homeowners. While the term ‘special assessment’ carries many negative connotations, it can be a very effective tool to improve an association's financial health quickly. The problem most people have with special assessments is usually less about the finances and more about the homeowner's shock that an assessment is necessary in the first place. Why now? Why didn’t we know about this sooner? Who came up with this assessment figure? Using software can reduce shock factors and answer such questions by presenting the effects of inaction to improve an association’s financial situation.

Transparency, regular monitoring, and effective communication methods engage and inform homeowners, making them much more likely to appreciate and empathize with the HOA board in challenging times. While effectively getting out of a financial hole is essential, avoiding getting into one is a much more effective way to operate. Responsible board members often have to make difficult and unpopular decisions, but the consequences of not making these decisions can be devastating.

This article is published in the ECHO Journal Issue Three 2022