Reserve Fund, Assessment or Loan: How to Pay for Capital Improvements
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We all know that it’s what’s on the inside that counts. But the truth is, it’s what’s on the outside that matters to current residents and potential homeowners. A beautiful, updated community leads to better property values, and an outdated one often causes property values to suffer.
Whether your Henderson community association decides to add a new playground or your Las Vegas high-rise is in need of a new roof, your HOA’s capital improvements have a major influence on your reputation in the greater community. (Remember that it’s critical to prevent maintenance from turning into a full-blown capital improvement. To learn how to avoid this roadblock, Read our article, “How to Prepare for HOA Maintenance, Capital Improvements and Useful Life” to see how to avoid this common roadblock.)
Read below to see the three methods of paying for capital improvements and the pros and cons for each one.
Option 1: Your reserve fund
Pros: Reserve funds are supposed to be used for capital improvements. When elements of your community or facilities reach the end of their useful life or your association decides to add a new piece of equipment to your community, your reserve fund can be used to pay for it.
Cons: In most states, reserve funds have restrictions regarding what they are used for. Nevada law states that reserves may only be used for “repairing, replacing and restoring roofs, roads and sidewalks, and must not be used for daily maintenance.” Always consult with your association attorney and management company to make sure that the project you are taking on falls under a capital improvement and not simply “daily maintenance.”
Additionally, 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. A 2013 Association Reserves study estimated that 72 percent of associations have “under-funded reserves.” And if your assets are not taken care of because you don’t have enough reserves, your HOA may even be sued for breach of contract, negligence or injuries caused by improper maintenance.
Option 2: Special assessment
Pros: Of course, taking a special assessment is a viable way to fund a capital improvement. When you’re dealing with under-funded reserves, collecting a special assessment from homeowners may be the way to go. The biggest positive is that it ensure your HOA will not take on any debt. For that reason alone, many associations choose to collect a special assessment to pay for a capital improvement. As with all of these choices, consult with your HOA property management company, attorney and governing documents before going through with this step.
Cons: To put it mildly, special assessments are not well received. HOAs that call for a special assessment typically face homeowner backlash and disagreements, at a minimum. To help mitigate the negative impact that comes from special assessments, work with your community management company to develop a strategic communication plan. You’ll need to outline how the capital improvement will benefit residents and why you need to take a special assessment. Lastly, you may need to coordinate a payment plan for owners who cannot pay the assessment up-front.
You’ll need to outline how the capital improvement will benefit residents and why you need to take a special assessment.
Option 3: Loan
Pros: It turns out a loan may be your smartest choice for funding a capital improvement. There are many positives that come from using a loan. First, HOAs generally do not receive prepayment penalties for making additional principal payments or paying the loan off altogether. Prepayment penalties typically only apply if your loan is refinanced with another lender. Second, many banks extend amortization to 15 or 20 years (versus 10 years), which reduces the monthly payment and makes financing more affordable for your association. Third, HOA loans typically have marginal closing costs. Since no physical collateral is involved, title and attorney fees are often much lower.
Many banks extend amortization to 15 or 20 years (versus 10 years), which reduces the monthly payment and makes financing more affordable for your association.
Cons: The truth is, there aren’t many cons to using a loan to pay for capital improvements. But there are some best practices to keep in mind to avoid common roadblocks. For starters, consult with your governing documents and association attorney to make sure you are abiding by association bylaws. Lastly (and perhaps most importantly), make sure to work with your HOA management company’s financial partners to ensure that you get the most competitive interest rates.
For instance, one master-planned homeowners association partnered with FirstService Residential’s affiliate FirstService Financial when they made the decision to purchase a nearby golf course. With such a major investment, it was critical to find the most competitive loan rates. Karla Chung, vice president of FirstService Financial worked with community manager Kamin Havens to help the HOA secure a substantial 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.”
“What option is best for my Nevada homeowners association?”
There are many details to consider when deciding how to pay for a capital improvement. At the end of the day, you should partner with your management company and HOA financial experts to ensure that the decision lines up with your community’s vision and helps protect your association’s financial health.