Reserve Funds, Assessment or Loan: 3 Ways to Pay for Capital Improvements
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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 A beautiful, well-functioning community leads to improved property values, and the opposite is also true: An outdated community means property values will likely suffer.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. (Of course, 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.
Pros: Reserve funds are designed to pay for capital improvements. When part of your facilities or a piece of equipment reaches the end of its useful life or your HOA decides to make an addition to your community, you should use your reserve fund to pay for it.
1. Use your reserve fund
Cons: Reserve funds typically have restrictions around what they are used for. While Arizona law doesn’t specifically address reserve funds, your governing documents should clearly outline how the reserve fund should be spent. Ultimately, it should be used for major expenses like roofing, paving and capital improvements.
Secondly, you may not have enough reserves to cover the costs of your capital improvement projects. It turns out that many boards do not have the funds needed for capital improvements. In fact, a 2013 study by Association Reserves estimated that 72 percent of associations have “under-funded reserves.” That’s why it’s especially important to ensure your reserves are properly funded. If your assets are not taken care of because of under-funded reserves, your association can even be sued for breach of contract, negligence or injuries caused by improper maintenance.
Pros: Collecting a special assessment from HOA members is certainly an option when it comes to paying for a capital improvement. This is especially the case if you don’t have enough in your reserves to cover the cost. And the good news is that with special assessments, your Arizona homeowners association will not assume any debt. Because of that, many HOAs choose to take a special assessment to cover the cost of a capital improvement. Of course, remember to consult with your HOA community management company, attorney and governing documents before taking this step.
2. Collect a special assessment
Cons: Well, we don’t need to tell you that special assessments are not the most popular choice with residents. They are often met with backlash and disagreements, at the very least. If you do decide to take a special assessment, you’ll need to communicate to homeowners about the benefits of the capital improvement. Partner with your management company to help you develop a strategic communication plan. You may also need to coordinate a payment plan for some owners who are not able to pay the assessment up-front.
If you do decide to take a special assessment, you’ll need to communicate to homeowners about the benefits.
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 or paying the loan off. 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. 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.
3. Get a loan
While most banks will lend up to 10 years, many banks extend amortization to 15 or 20 years. This reduces the monthly payment and makes financing more affordable for HOAs.
Cons: There aren’t many downsides to getting a loan to fund your capital improvement. However, there are some best practices for ensuring that it’s a positive experience for you and your fellow board members. When obtaining a loan, always consult with your governing documents and association attorney to make sure you are abiding by association bylaws. Last but not least, 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.”
“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?”
So how should your HOA pay for a major capital improvement? There are many details to consider when making that choice. It’s up to you and your management company to ensure that your decision is in the best interest of your community and ultimately protects your HOA’s financial health and vision. To do this, work with an experienced management company that has access to a team of financial experts and a national and local network of HOA professionals.
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.