Condo Reserve Empty - Assessment vs. Condo Association Loans

The solution for the funding of major projects and required condo reserve maintenance items seems to be to have the Condo Association take out an Condo Association Loan or HOA Loan and include the principle and interest payments as part of the condo fees.

Is this the best solution? What are the alternatives?

We can and do continue to beg condo associations to fully fund condo reserves so special assessments and the resulting trauma do not fractionalize the condo association owners. Most of our clients do fully fund condo reserves, but some hear the song of the siren and do not want to raise the maintenance fees to a level felt might be uncompetitive in the resale marketplace. Alternatively, they assume many of the condo owners will no longer live there or even be alive when something needs replacing. Let's look at the real cost of this alternative.

Even the best planning can result in a shortage of condo association funds and if this occurs Condo Board members often, erroneously, take on a personal feeling of responsibility for those shortages. As if they should have known oil prices would double the cost of roofing materials, or workers comp rates would go up precipitously, or condo association insurance rates would quadruple and cause a condo budget shortfall. However, more often than not the reason for shortage of condo funds is condo budget and maintenance fees being determined politically and not realistically. Therefore, with this guilt the condo Board feels a responsibility to rescue the condo association from the insult of a special assessment and looks for alternative funding. We will look at the different forms of borrowing.

Maintenance fees are, according to Chapter 718 Florida Statutes, the Condominium Act (Act) are assessments. The "S" word we now run into is "Special" Assessment. Special assessment means any condo assessment levied against a condo unit owner other than the assessment required by a budget adopted annually. Special assessments are levied to meet budget shortfalls, under funding of condo reserves, funding for special projects, material alterations, improvements, modernizations and unexpected expenses. This is the most common and easiest form of raising the necessary money for the needs of the condo association. Traditional waiver or under funding of condo reserves is the precursor of condo special assessments.

For the sake of this discussion, we will suppose the needed condo funds are for replacement of a reserve item (painting, paving, roofing, etc.). For whatever reason, the condo association is short $100,000 for an item that had a ten-year life and was not covered by any condo reserve funding.

Before we cover the costs associated with paying for this item it must be mentioned that the Division of Florida Land Sales, Condominiums and Mobile Homes (the Division) amended the Administrative Code (the rules of the game) last year to allow pooling of reserves. See http://fac.dos.state.fl.us/ and look in Chapter 61B 22.005. Many modern condo associations have been using this tremendous tool for years. It allows full funding of condo reserves at a contribution rate well below that required for straight-line reserve contribution. Ergo, fully funded condo reserves may be possible when previously only partially funded. It may be possible to pay for that huge condo association insurance increase and still fully fund the condo reserves without a maintenance fees increase.

Now we can look at the costs involved in the raising of the $100,000 needed.

If out condo association were reserving $10,000 per year for 10 years, we would have $100,000. We will assume the interest rate earned is equal to the inflation factor and the amount of interest earned was less than would be required to pay income tax. For a 100-unit condo association it is $100 per year or $8.33 per unit per month.

If we take out an HOA loan or Condo Association Loan, the $100,000 for a ten-year period at the current commercial rate of around 7%, we will be paying $1,161.08 per month for a total of $139,330. On top of that, there will be closing costs, attorney fees, UCC filing fees and Doc stamps for about another $3000. Now we are at $142.33 per year or $11.86 per unit per month. Then the item will need replacing; again we will not have any money to do it and will have just finished paying for the old one.

If we special assess the membership, the cost to the condo association is zero and it has $100,000 available to do the job now. It can then institute good business practices, adopt pooling of condo reserves and probably end up having the $100,000 available in ten years without increasing the maintenance fees.

What about the condo association's presumed responsibility to minimize the trauma to the membership with having to come up with $1,000 each on short notice? Let us look at the availability of condo funds from the membership.

If they use savings, they are currently probably only getting 1% on their money. It does not make sense to have the association pay 7% and have money in the bank only earning 1%. They are 6% ahead by paying from savings.

If they have stock the cost of margin funds should also be much less than 7%.

However, there is an even easier way to borrow money, a Home Equity line of credit. This is where the condo association can be of immeasurable assistance.

The interest rate for a Home Equity line is currently around 5% and that interest is supposed to be deductible on federal income tax. This could (in the 30% bracket) result in a real rate of less than 3% on the money borrowed or based on the 10 year term we are at $114.77 per year or $9.56 per unit per month. There is also no prepayment penalty and no up-front cost. Additionally Home Equity lines of credit usually are for a larger amount than the $1,000 used in this example. However, there is no requirement to use the money on any set schedule or to make principle payments on a fixed schedule.

The relationship the condo association has with the bank should facilitate the conclusion of whatever scenario you want to attempt. The HOA lenders we talked to were more anxious to get 100 new equity line customers than in loaning the condo association the money. Your manager should be able to set up the whole program for the condo association. The bank will provide all the paperwork and the condo association will disburse it with the explanation as to the benefits to the members and to the condo association. No one is obligated to set up the home equity line and has the option of paying the special assessment any way they want as long as it meets the schedule required by the condo association. The condo association does not even have to know or care who is taking out the condo line of credit with the bank.

These examples are reflective of today's interest rates and can be extrapolated for any set of circumstances.

In conclusion where do we stand?

Full Funding of condo reserves as soon as possible is the least expensive and now with pooling available provides flexibility and insurance for unexpected requirements. ($100 per year)

The condo association borrowing the money is the most expensive and provides no tax benefit to the members ($142 per year). Additionally if an individual condo owner doesn't pay his share the Condo Association members have to pick it up and pay it as part of the common expense.

A Home Equity line of credit provides the membership the flexibility of paying the condo assessment as needed could provide tax benefits and allows individual determination and privacy concerning personal business ($115 per year).

It may now be possible to hire that professional you always wanted, but didn't think you could afford, to provide the higher level of services the condo association members deserve

In the case of condo association needing repair to their property or general improvements, apply for an HOA Loan.