The Hidden Dangers of Low Assessments

woman filling out paperwork after assessment

There is an old saying that goes “penny wise and pound foolish” which is perfectly apt when one discusses homeowner association finances. In other words, in an attempt to save money, associations might fall victim to unwise decisions in the short-term in an attempt to keep assessments low but ultimately regret the decision later when issues culminate into one large project list that ends up costing far more in the long run.

While it is perfectly natural for owners to desire low assessments, it is important to remember that homeowner associations are businesses. Associations need to apply sound business principles to have a positive impact on assessment levels. Trying to simply cut costs arbitrarily to reduce assessment levels without acknowledging the full impact on the association is not going to bode well for the association in the future. The better approach is to look at the operating side of the budget and analyze trends in expense categories that might be contributing to rising costs. Once the analysis is complete then a wise decision can be made on items that can be cut that won’t harm the community. For example, if a property simply looks at a high labor cost on the budget and simply decides to decrease the labor force without considering the impact, then there could be unintended consequences. The property might not be as clean as it once was, there could be an increase in turnaround time for the completion of repair work, workers could get burned out faster having to take on a larger workload and subsequently quit, the work that employees performed in-house might disappear from a reduction in staff, or there could be gaps in shift coverage for sick days and vacation days taken from the remaining staff. So while the assessments might remain lower as a result of a staff reduction, it is an illusion that the change has provided the association with adequate coverage. A proper analysis would eliminate these risks and provide a true picture of what the association needs. This is practicing fiscal responsibility and making sound business decisions as a result.

Fiscal responsibility and sound business practices include maintaining the property to protect the asset not only in the short-term but in the long-term. In order to do this, an association should have a reserve study as their guide and actually follow and implement that plan. If the reserve study calls for a 3% increase in assessments each year over the next ten years to adequately fund the reserve account and maintain the property then that is what needs to be done. Failure to follow the plan will result in deferred maintenance that ultimately will cost the owners more money in the future and lead to special assessments. Think of some of the projects in your association that led to a special assessment. Did that roof replacement project suddenly appear? No, it was known for some time that the roof would likely last 20 years and would have to be replaced around the end of that time span. Building components have a useful life that is often spelled out in the reserve study. If money isn’t being set aside now for the end of the useful life for those components then that too is projecting an illusion to the owners that current assessment levels are adequate.

Some associations believe if they keep assessments low then the property will be more marketable. This is an illusion if there is deferred maintenance and a special assessment is looming on the horizon. For example, if a budget only called for a 1% increase in assessments during the last five years, with minimal contribution to reserves, it is highly probable a special assessment will become necessary for that roof replacement project. The overall effect of the regular assessment plus the special assessment could very easily average well over the contribution rate of those past few years. If the average of those years with the special assessment turns out to be 9%, then the annual 1% increase really wasn’t the true rate. This will be noticeable to lenders who obtain the financials and other association disclosure documents prior to closing and it will raise a red flag. It will also be a red flag to Realtors and that will cause the property to actually become less marketable. Buyers want a property that is well funded and has a plan in place to tackle future projects. Disclosing to a buyer that in five years the property is going to have their roof replaced shows that a plan has been put in place and the Board is practicing their fiduciary duty to maintain the property.

The best course of action for an association is to maintain transparency. If the association does choose to operate with a bare-bones budget with the knowledge there isn’t adequate reserve funding for a future project, then it should be disclosed that there is special assessment likely in the foreseeable future. If it is necessary to replace the windows in three years, then let the owners know so they are not misled into thinking what they are contributing in assessments now is matching the needs of the property later. While owners might not like the news that a large expense is coming in three years, they will take it far better than having it thrust upon them all of a sudden. Owners want to know there is a plan in place and that the board and management have a plan to address it. That plan should include constant and abundant communication to the owners about the project and what to expect. Town hall meetings, email alerts, text alerts, phone alerts, etc. all make for a great resource of communication. This advance notice allows owners to adjust their own financial plan to ensure they will be able to meet their financial obligation. This, in turn, will reduce the risk of delinquencies rising that will in turn place an undue burden on the association.

Lifting the veil of illusion of low assessments through transparency can only strengthen an association overall. When boards communicate the realistic needs of the association and implement a true rate of assessment contribution they are fulfilling their fiduciary duty by making sound business decisions and that will ensure the association is well prepared for the future. Owners will be pleased with the results and that will lead to a harmonious community that has “found the magic.”