Every year about the same time, your community association board is most likely creating its budget for the following year. Even if you have experience developing your association’s budget, many factors can change year to year, so it’s easy to overlook important items.
Missing a relatively small expense probably isn’t too consequential, since you can probably make up the deficit from another area of your budget. However, if you’ve forgotten to include a necessary big-ticket item, you may have to take out a loan or impose a special assessment to pay for it. Neither of these actions will be good news to residents.
As some associations in California, Texas and Florida have discovered recently, insurance deductibles can take a big bite out of your budget if your community is hit by an unexpected event like a natural disaster. Although you’re not likely to forget to budget for insurance premiums, you probably haven’t given much thought to the deductibles, especially if you haven’t filed any claims in a long time (or ever!).
“It’s out of sight, out of mind for most associations,” says Raymond Weber, executive director of client accounting at FirstService Residential. “But a claim can happen at any time.” He recommends budgeting for a single event – even though he acknowledges that it’s possible to have more than one claim event in a year or none at all. “Of course, if you know that something more is likely, you may want to build that in,” he says.
Reviewing your prior-year budget often will enable you to anticipate legal fees for recurring services or for a claim that hasn’t yet been resolved. However, it won’t account for fees that may result from unforeseen claims, for example, if the community association or a board member is sued.
“We see a lot of associations that budget little or nothing for attorneys’ fees because they, perhaps, did not have any significant litigation costs in the past or are not anticipating any litigation,” says Ben Solomon, managing partner at real estate law firm ALG. “However, litigation can – and often does – arise unexpectedly where associations don’t have budgeted funds for it.”
Solomon points out that this can create problems in other areas of an association’s budget. “[The association] may need to use funds from other important budget line items to cover such legal expenses,” he explains, “which may leave them short on cash.”
If you didn’t need to pay any taxes in prior years, you probably don’t need to budget for them next year, right? Don’t be so sure. Consider carefully whether the association expects to add any new revenue-generating activities. These could result in your owing taxes for the coming year. Consult with your accountant about budgeting for taxes if you expect your revenues to be significantly higher next year.
Reserve Funds/Reserve Study
Funding your reserves
is crucial for the financial health of your association, yet for many associations, it’s one of the most poorly addressed budget items. In fact, the percentage of associations with underfunded reserves may be as high as 72 percent. In some cases, associations don’t even include reserve contributions in their budget. Instead, they depend on the budget surplus – if there is a surplus – to fund their reserves. Why?
According to the Community Associations Institute (CAI), contributions to a reserve fund are often seen as an extra expense. However, the repairs and capital improvements that are funded with reserves will need to be made regardless of whether you adequately budget for them or not. You’ll just have to find other funding sources, like a special assessment or a loan, which will probably cost homeowners more.
Although some states specify how much of your annual fee must go toward your reserve fund, you shouldn’t depend on this figure to determine your actual needs. The amount that you budget for your reserve fund should be based on your most current reserve study, according to Terry Bascher, vice president, onsite management at FirstService Residential. “You need to understand the reserve study and how to use it in budgeting,” she says. And since the study should be updated at least every two to three years, you may need to budget for that, too, if you haven’t had an update done in a while.
Another area that Weber says is often overlooked is delinquent association fees, which he attributes to excessive optimism. “Board members have to be honest with themselves,” he says. “They can’t assume they live in a perfect world.”
Weber recommends looking over the past few years to determine how much of your assessed fees generally aren’t paid. “It’s a good idea to put that into your budget by building in the percentage you frequently don’t collect,” he says. “Look at your trend. Are you usually collecting 80, 90 or 95 percent of your fees?”
Snow removal, landscape cleanup, tree removal and other weather-related expenses can be challenging budget items. “Weather isn’t a trend,” explains Weber, so looking at prior years won’t provide the information you need. “One of the biggest unknowns in many areas will be snow removal.” In other areas, hurricane damage can vary significantly year to year. Nevertheless, you need to budget for these potentially costly items, even if that means basing the amount on your best estimate.
Although not a specific line item, Bascher notes that too many boards are reluctant to increase fees and then find that they have to “hit the homeowners up with either a special assessment or large increase in one year.” She favors raising fees consistently and gradually. “Historically, we have seen it is better to have slight ‘cost of living’ increases each year or every other year.”
Weber agrees. “One of the biggest issues we see is under budgeting to keep association fees low,” he says. For example, board members may start off allocating a realistic $10,000 for a particular line item. Then in order to keep fees at current levels, they will decide to arbitrarily trim $5,000 from that item, an approach that can only lead to budget deficits. “Budgeting does tend to become very emotional because, remember, board members are homeowners, too. If they have to raise fees, it also impacts them.”
To avoid such issues, read below to learn about seven commonly neglected items in community association budgets that you may be missing.
Chances are, your budget won’t be 100 percent to the penny. You will probably over budget for some items and under budget for others. Weber recommends paying for any deficits with one or more line-item surpluses. “The most important thing is to be transparent about it with the members of your association. It’s a question of trust,” he says. If you have a substantial surplus or deficit, he recommends building it into your next year’s budget.
Bascher has another suggestion. “If you do not have to spend those dollars, great! Move that money to your reserve fund – as long as you keep enough working capital in your operating account to cover costs for the next three months.”
A good property management company can be a tremendous asset as you create your budget. You’ll have the assistance of a management team with decades of experience developing association budgets and an understanding of how to apply best practices to help you reach your association’s goals. In addition, the right company will have in-house professionals with specialized expertise to support your management team and will be able to provide you with opportunities to lower your costs on utilities, products and services.
Get more tips on how to create a budget that will keep your community association on track. Fill out the form below to download our Budgeting Checklist infographic.