Superstorm HOA: Tight Budgets, Fiscal Cliffs, and Foreclosures

The devastation caused by Super Storm Sandy will be felt for years to come and our hearts go out to the tens of millions of people affected by this powerful act of nature. While discussions of HOA’s and their specific challenges pale in comparison to the aforementioned devastation, it is nevertheless important to discuss the circumstances and trends which are right now endangering the value of our communities. Although these circumstances appear much less ominous and dramatic than the storm which devastated the East Coast recently, their potential for destruction is significant and should not be underestimated.

It is arguably one of the most challenging times to be a property manager, and all indications are that it will remain that way for some time to come. A recent bulletin by the DRE warned of the looming foreclosure crisis and the strain it will continue to put on HOA’s. Even when the economy rights itself, the lingering fallout from the recession will leave many HOA’s in a less than stellar position…even in crisis. Diminishing HOA dues, deferred maintenance, and less than aggressive fiscal management can create the perfect HOA storm. However, with a proactive and aggressive strategy to managing through crisis, weathering the storm to smoother sailing is possible. One main component of this strategy is the full and proper utilization of the reserve study

There are three key points to remember about getting the full benefit of reserve studies:

  1. Get the right preparer.
  2. Actively participate in the process with the preparer.
  3. Keep it current.

Contract With The Right Reserve Preparer

First, a quick review…according to 1365.5(e) of the Davis-Stirling Act: “at least once every three years the board of directors shall cause to be conducted a reasonably competent and diligent visual inspection of the major components which the association is obligated to repair, replace, restore, or maintain”… and “the board shall review this study annually and shall consider and implement necessary adjustments”.

In a nutshell, to be in compliance the board must ensure a reserve study with visual inspection is performed every three years and review it during the two in between years. But is that really all there is to it? Take away the fact that often the visual inspection will slip a year or two here or there, there is clearly a great deal of maneuvering room for a board to follow the letter of the law and be in compliance without actually doing much to help long term viability and health of the community.

For example, following the letter of the law could mean that a board member performs the visual inspection and prepares the reserve study. This is not uncommon given that 1365.5(e) does not require reserve studies to be prepared by independent, outside consultants. However, most boards recognize the potential pitfalls in utilizing reserve studies that have been prepared in house. The most obvious ones being the inherent conflict of interest, the lack of currency on costs and component useful lives, and an overall lack of knowledge related to construction and systems

Furthermore, selecting a professional reserve preparer that is experienced and credentialed will ensure your reserve studies are formed from an objective point of view, providing the requisite accuracy for financial management. Vetting out a reserve study provider should be done by reviewing sample work and interviewing past clients to understand fully if a particular preparer will provide the most useful and accurate information possible in a format that is easy to read and understand.

Actively Participate in the Process with the Reserve Preparer

It’s a better idea to look at your reserve preparer as part of your team rather than a necessary evil. Clearly the intent of 1365.5(e) is to provide for the long term success of an association through the proper care and maintenance of the project. This can be achieved through effective collaboration between association manager and reserve preparer via exchange of information, clear communication, and responsiveness to each other’s needs. The more the reserve preparer understands about the project, in terms of replacement history and costs, the more accurate the report he/she provides will be. This in turn allows the association manager to utilize the information provided in the reserve study to manage with optimal effectiveness.

Another recommendation would be to not over utilize reports based on a previous reserve studies to fulfill the 3 year visual inspection requirement. Again, while it does fulfill the letter of the law, it’s not always in the best interest of the community. When in doubt, or simply because it’s been several years…get a brand new study from scratch with a new component inventory just to ensure that it is up to date and accurate. The additional dollars spent can provide for smoother sailing along the way and possibly save thousands in the long run.

Keep Current

While skipping years is common when it comes to reserve studies, it’s not recommended for three main reasons: legality, longevity, and liability.

Legally speaking if an association does not perform reserve studies according to 1365.5(e) and is unable to fund necessary repairs/replacements while property values decline, the HOA is on less stable footing if homeowners decide to sue because they are unable to attain financing or sell their properties.

The longevity and protection of the association’s assets can be compromised by deferring accurate and timely reserve study reports. This can and often does lead to lawsuits, special assessments and/or spikes in HOA dues. When homeowners are unable to afford such cost increases the vicious cycle compromises the integrity of the project as a whole.

The liability of not staying current with 1365.5(e) lies in the fact that it can affect the ability of the HOA to attain or maintain insurability. In the best case rates can skyrocket beyond budget limitations and in the worst case the association can find itself uninsurable due to the harm deferments have caused to the project.

While managing in these difficult times is indeed challenging, it can be effectively done by utilizing the tools that are already in place to the peak of their efficiency and utility. The reserve study requirement is much more than a requirement, it is a valuable tool which when utilized fully and properly can be a major part of navigating through the stormy waters of economic uncertainty.

Checklist for Maximizing the Value of your Reserve Studies:

For the 3 Year Requirement:

-Consider a Level 1 Study instead of a Level 2 update.

-Ensure the Field Inspector is Experienced and credentialed.

-Provide detailed information to inspector of work performed/replacements made (with costs).

-Provide information to inspector of bids received for intended upcoming projects.

-If areas of concern are identified by reserve preparer, consider immediate further investigation by a’s better to know sooner rather than later.

-Work together with your reserve study preparer on multiple drafts when necessary to ensure accuracy.

-Don’t skip a year.

For the Annual Review Requirement:

-Ensure the Field Inspector is Experienced and credentialed.

-Provide an accurate, up to date prior reserve study.

-Provide clear and detailed information to inspector of work performed/replacements made (with costs).

-When possible, reference the previous reserve studies component names to clearly identify areas of work

-Provide information to inspector of bids received for intended upcoming projects.

-Work together with your reserve study preparer on multiple drafts when necessary to ensure accuracy.

-Don’t skip a year.