In a community association, the most dreaded phrase you can hear is “special assessment.” A special assessment is a real property tax proportionately levied on homeowners and landowners to cover the costs of improvements that will be for the benefit of all upon whom it is imposed. Special assessments come in all shapes and sizes. Common examples of special assessments are failures or deteriorations of elevators, roofing, sidewalks, roads, water systems, sewer systems, or recreational facilities. They can come from poor long-term planning from a community, poor short-term planning, a decaying structure that people don’t even realize is a problem, or just a freak accident. Here are five ways to avoid them.
1. Get a professional reserve study done and update it every few years
A reserve study is a planning tool that involves compiling a list of a community’s physical assets, determining each asset’s remaining life and life when new, current cost, future cost, and then properly funding each item over a thirty year span. A small association with only minor physical assets may be able to get away with their own calculations, but it is still risky. A large association likely won’t have access to all of the cost data, construction bids, and other contact information or sources that a professional reserve specialist (RS) has. Additionally, there are many nuances and intricacies when preparing a reserve study that the reserve specialist has to consider on a larger community.
2. Fully fund your reserve items
Partially funding reserve items is a risky practice, especially in a tough economy. It is possible to only partially fund reserves with a voting option, but this is something that should never be considered. Partially funding reserves will leave you with very few contingencies and will likely lead your community to the brink of a special assessment. Conversely, by fully funding reserve items, you are paying now to alleviate future reserve shortfalls and limiting your risk.
3. Keep 1-2 months’ worth of operating expenses cash on hand for a cushion
Keeping a cushion for unexpected expenses is always a good idea. Financial experts say that 1-2 months of operating expenses is sufficient to cover unforeseen events.
4. Have access to a line of credit from a bank or financial institution
If your association is well-managed, but does not have much extra money on hand, a line of credit is a reasonable and responsible back-up plan. This option could also cover a number of other problems such as HVAC repair or replacement, elevator repair or replacement, or to buy temporary building supplies like tarps or plywood for boarding windows due to a disaster such as a tornado, flood, or hurricane. It can also be applied to others items like landscaping, roofing, painting and even legal fees. A line of credit will cost approximately 1% of the credit available per year. In this case, the association (as a corporation) is the official borrower (not the president, or board members) and accounts receivable can be used as collateral.
5. Get a loan from a bank or financial institution
This may be the least desirable option of the list, but it is still better than a special assessment. Rather than having all of the money collected in a large lump sum assessment, a bank loan will let the item be repaid over time. Common loan terms would be in the neighborhood of 5 years for painting, and as many as 10 years for roofing. To qualify for this loan a community should have less than 6% (and certainly no more than 10%) delinquencies (30 days late) of association dues. It also helps if a community is owner-occupied or used for second homes. Developers in control of an association would likely not qualify for a loan. A community association would currently expect to pay between 5% – 7.5% interest for this loan.