3 Ways your Homeowners Association Can Fund Capital Improvements
All Homeowners Associations Face Having to Fund Capital Improvement Projects
Sooner or later, every homeowners association has to invest in capital improvements. It could be anything from needing to install a new heating and cooling system in your high-rise building, to replacing the roof on your clubhouse or upgrading the equipment in your fitness center. These long-term, big tickets items are not something you can overlook, so what’s the best way for your association to pay for them?
That depends on how urgently you need to do the work and whether it is something you had planned to do. Based on these factors, you have three options for funding your capital projects.
1. Rely on Your Homeowners Association’s Reserve Fund
Having the money to pay for these types of projects is the purpose of having a reserve fund. In Minnesota, the Common Interest Ownership Act only defines a vague requirement to maintain “adequate reserve funds to cover the replacement of those parts of the common interest community which the association is obligated to replace.”
At FirstService Residential we recommend following best practice which is to have at least 10% of your association’s income transferred to your reserve fund. The Federal Housing Authority requires it if you want to be an FHA-qualified property, meaning that prospective buyers can use FHA-backed mortgages to purchase their home.
In reality, more than 70 percent of associations have under-funded reserves. As a result, most don’t have enough money when they need to undertake necessary work. This is why it’s imperative that your homeowners association re-evaluate the adequacy of the reserve fund at least every third year as stated in the Minnesota statutes through a reserve study.
A reserve study identifies predictable capital improvement projects and recommends a plan for funding those projects over a number of years. Appropriate funding of your reserves depends on the accuracy of your study. If you are working with a good property management company, they can help guide your board through the reserve study process and ensure you are working with a reputable and qualified vendor who will come onsite to perform a thorough inspection of your equipment.
Even if you do fund your reserves based on a well-conducted study, it’s important to remember that unexpected projects can arise. Regulatory requirements for things such as elevators and fire systems can change with little notice that you won’t have considered when it comes to your reserve funds.
2. Levy a Special Assessment
If you don’t have enough in your reserve fund for your capital improvement project, you’ll need to find additional financing sources. This often means levying a one-time special assessment to cover the shortfall. Homeowners rarely welcome a special assessment. For one thing, they may see it as an investment that benefits future homeowners more than them. An unexpected payment can also create a significant financial hardship for many residents. You can reduce this burden by offering the option to make monthly payments rather than pay a lump sum. Keep in mind, though, that this could delay your ability to start the project.
In Minnesota, there are no set rules around special assessments within the statutes and a board can impose a special assessment without needing the approval of the residents unless stated in their own governing documents. Therefore, it’s important check your governing documents ahead of choosing to move forward with a special assessment for guidance on how to properly do so. You can also seek additional guidance from your property manager and association legal counsel.
3. Take Out a Loan
With a loan, your homeowners association can access a lump sum of money quickly without requiring that residents make a large payment themselves. The long repayment period – typically 5, 7 or 10 years – creates less of a financial burden for homeowners, especially if your community management company can leverage its buying power to negotiate a low interest rate. Usually, loans can’t be overruled by homeowners, so there is more certainty when your board decides to use one. However, you should check your governing documents to verify this.
One option is to connect with a brokerage firm that can combine the capital markets and treasury management expertise of a bank with a rare in-depth understanding of homeowners association insurance fundamentals. Not every bank understands how to structure a loan for these kinds of communities. “I have personally helped many of our lenders develop and implement lending programs to our boards where the bank did not lend before,” says Jordan Muchnick, vice president of lending and cash management at FirstService Financial. FirstService Financial provides financial services for condominiums and homeowners associations managed by FirstService Residential and can often broker a better loan rate than if your board or other community management company approached a bank on their own. “Our clients get the advantage of our expertise, market knowledge, credibility, and our leverage over our depository banking partners that yield lower rates, lower costs, and expedited closing time frame.”
Combine Options to Fund Your Homeowners Association’s Capital Improvement Projects
Typically, loans are the first step, but you need collateral, and your special assessment can act as collateral. That’s why FirstService Residential recommends combining a loan with a special assessment to fund your association’s capital improvement projects. Many banks will also provide an initial interest-only period, which the association will usually cover from its own funds first. The special assessment kicks in after that.
When it comes to planning for capital improvements, it’s extremely important to be open with homeowners. You want all the members of your community to understand the importance of completing these projects and why you need to move forward with a special assessment and loan as this impacts them firsthand.
If your board hasn’t updated your association’s reserve study in a while, plan to get that done soon. Then do your best to follow the recommendations in it. If you need help growing your reserves or identifying the best sources of funding for an imminent capital improvement project, seek out an experienced community management company with robust in-house expertise.