Reserve Funds, Assessment, or Loan: 3 Ways to Pay for Capital Improvements
If your HOA doesn’t have basic maintenance plans or sufficient reserve funds in place, your capital improvement options will be limited.
Of course, it’s what’s on the inside that counts. But what’s on the outside matters to current and potential homeowners. A beautiful, well-functioning community leads to improved property values, and the opposite is also true: An outdated community means property values will likely suffer. That’s why capital improvements matter.
Whether a Scottsdale community association decides to add a new spa, or a Phoenix high-rise needs a new roof, your HOA’s capital improvements have a big impact on your reputation among neighboring communities. It’s crucial to prevent standard maintenance from turning into a capital improvement. To learn how to avoid this roadblock, read our article, “Maintenance, Capital Improvements, Useful Life: Is Your HOA Prepared?”
Read on to see the three ways to pay for capital improvements, and the pros and cons for each option.
1. Use your reserve fund
Pros: Your HOA reserve fund can be used for capital improvements. When part of your community’s capital assets reaches the end of its useful life, you should use your reserve fund to pay for it.
Cons: Reserve funds typically have restrictions around what they are used for. The laws in Arizona don’t specifically address how to use a reserve fund, but your governing documents should provide clear guidelines on when and where it can be spent. It's important not only for major expenses such as roofing or pavement repair, but also for smaller projects that need extra attention like painting fences around the property!
What Can HOA Reserve Funds Be Used For?
HOA reserve funds can be used to cover future repair costs as facilities and equipment reach the end of their useful life and should not be used for maintenance. In other words, the money in this account is earmarked only to cover expenses that arise from time-to-time because of natural wear and tear on equipment or parts as they age past their prime, such as roof replacements. Reserve funds exist so you can protect yourself against these unpredictable future expenditures without fear your community will suddenly find itself shorthanded.
You may not have enough reserves to cover the costs of your capital improvement projects. That’s why it’s especially important to ensure your reserves are properly funded. If your assets are not taken care of because of underfunded reserves, your association can even be sued for breach of contract, negligence, or injuries caused by improper maintenance.
2. Collect a special assessment
Pros: One way to fund a capital improvement is by using assessments. The community will not have any debt and it won't burden homeowners’ association members with monthly fees. Many HOAs opt for this route instead of assuming responsibility themselves or asking for homeowner’s association dues from everyone involved (which often include monthly fees). Make sure to consult with your on-site management company attorney as well as a lawyer knowledgeable about governing documents before taking this step!
Cons: Special assessments are not the most popular choice with residents. They can be a great way to improve your community, but they often face pushback and disagreements from homeowners - especially if you decide to use this tool for improvement projects! To help avoid any negative feedback or resentment towards you as well as gain support in future discussions about capital improvements (like new amenities), make sure that all parties involved know what is going on before we get started. Partner with your management company and they can help you prepare for a communication plan, coordinate payment schedules with residents (if necessary), and make sure that everything goes smoothly.
If you do decide to take a special assessment, you’ll need to communicate to homeowners about the benefits.
3. Get a loan
Pros: It turns out a loan may be your best (and safest) bet when it comes to paying for a capital improvement. For starters, HOAs typically do not receive prepayment penalties for making additional principal payments to pay down a loan. Often, a prepayment penalty only applies if the loan is refinanced with another lender. Additionally, while most banks will lend up to 10 years, many banks extend amortization to 15 or 20 years depending on the capital improvement. This reduces the monthly payment and makes financing more affordable for HOAs. Finally, association loans typically have minimal closing costs. Since no physical collateral is involved, the title and attorney fees are generally much lower.
Cons: There aren’t many downsides to getting a loan to fund your capital improvement; however, it is important that you follow best practices when getting a loan for your capital improvement. Make sure to consult with your governing documents and association attorney before making such an investment to ensure it complies with all association bylaws. Additionally, make sure to work with your HOA management company’s financial partners to ensure that you get the most competitive interest rates.
In the case of one master-planned community in Mesa, FirstService Residential’s affiliate, FirstService Financial, was brought on board to shop around for competitive loan rates after they decided to make a major investment and purchase the nearby golf course. Community manager Kamin Havens worked with Karla Chung, vice president of FirstService Financial, to help them secure a significant loan. Havens said, “The truth is, very few banks want to approve a loan for a golf course. But after partnering with Karla from FirstService Financial, we were quickly approved for a 15-year loan for $2.2 million. ”
“Which option is best for my Arizona HOA?”
Make no mistake, if you don’t have a solid maintenance plan, your options for capital improvements will be limited. Find out where your HOA falls.
Want to learn more? Contact us today!
Disclaimer: This article is provided for information purposes only and does not constitute legal advice.