Underfunded reserves is a chronic problem for community associations. The seeds of financial crisis often begin with developers’ budgets, since their focus is on selling condominiums and townhomes as quickly as they can, and a low assessment is viewed as a marketing tool. Volunteer Boards often harbor the mistaken belief that their mission is to keep assessments low, and they also know that assessment increases do not engender love and admiration from their friends and neighbors in the association. Owners also play their part by loudly protesting assessment increases, particularly when they exceed the inflation rate, which they perhaps should because of the need to play "catch up.”
Somewhere between 20 and 30 years (and often much sooner for rental conversion properties), some hapless Board is finally forced to face the reality that their association is woefully unprepared to pay for much-needed replacements: roofs, siding, streets, elevators, a major redecorating project, etc. The Board will probably consider the following options:
Postpone the work – this is the worst option, as the cost to do the work will only increase each year, maintenance costs will likely increase, and property values will be adversely impacted. Doing nothing is actually the most costly option.
Increase the annual assessment – simply increasing the annual assessments is usually not a viable option. The money will come in over a period of years rather than being available upfront, so the work must also be spread out over many years. Meanwhile, inflation will erode the buying power of those future dollars, requiring an even greater increase in the monthly assessments. Many associations are struggling with collection issues and bad debt write-offs, and a $50 or $100 monthly assessment increase may lead to more abandonments. Your documents may also require owner approval for a large assessment increase.
Levy a special assessment – many owners simply do not have $10,000 or $20,000 in spare cash lying around. Some could borrow the money, but there are others for whom that is not an option. Again, this could lead to more abandonments, leaving the remaining owners to pick up the tab for the vacant foreclosed units. Owner approval may be required.
Borrow the funds from a bank – many associations have exercised this option, and it requires less paperwork and is quicker than obtaining the funds from the government. However, the payment term is usually fairly short, from five to seven years, and will carry an interest rate several percent higher than a first mortgage on a principal residence. Since your association probably has no fixed assets to pledge as collateral, the bank is relying on future revenue to repay the loan. If you are experiencing serious collection issues, it will be difficult to persuade a bank to give you what is essentially an unsecured loan.
That brings us to our fifth and final option: create a Housing Improvement Area (HIA). In 1996 the Legislature granted to cities the authority to create Housing Improvement Areas by enacting Minnesota Statutes 428A.11 thru 428A.21. This allows cities to provide funds to a community association for specified purposes, and to then levy a fee against the benefitted property owners which can either be paid upfront in a lump sum or added as a special assessment to their property tax bill for up to 20 years. (To read the Statute, go to www.revisor.mn.gov/statutes.)
Compared to the four options described above, an HIA offers a number of advantages:
- The interest rate will be lower than what the association would pay to a bank, roughly comparable to a first mortgage.
- Individual owners do not need to credit qualify.
- Repayment can be over a period of as long as 20 years, although most associations opt for a shorter time.
- The interest may be deductible by those owners who itemize their personal deductions.
- Owners have the option to pay in one upfront payment to avoid the interest charges, or over the term that is agreed upon with the city.
- The agreement can also be structured to allow owners to pay off the balance at any time during the term without a prepayment penalty (this can be helpful for resales).
- The association gets the money now which means that it can make the needed replacements/improvements now, rather than having the work drag on for years.
Creating an HIA can be a daunting process that can take from one to two years before the funds are available. A brief list of the steps required are as follows:
- Have a 30-year Reserve Plan prepared by an independent third party. That will not only be a requirement by the city, but you need that information before you can determine how much funding to request.
- Communicate with your members! Although you may not have all of the answers yet, no one likes surprises, and you will find that obtaining the required owner approval will be much easier when there has been an early and ongoing communication program. Let them know now the direction you are going.
- Prepare a documented plan to present to the city, explaining how you will use the funds that you are requesting.
- Meet with city officials (the department which handles these requests will vary from one city to another) to present your plan.
- Also prepare background information, briefly explaining your association’s history and the problems you now face, the options you have considered but rejected, and your plan for keeping out of financial trouble in the future. Include letters from banks turning down your request for a loan on the terms you are requesting from the city.
- Once you have gained the support of city officials and you have a projected interest rate and term, send a mailing to the owners giving notification of an informational meeting to discuss the HIA. Include in the mailing the approximate dollar amounts for both the proposed levy against each unit and the amount of the annual tax assessment. Also include the project scope and costs and your plan for funding reserves so your association does not again find itself in dire financial straits. Be sure to include a petition form and a postage-paid return envelope.
- Hold the informational meeting at which time you will explain the need (photos are a real help), present the funding plan, and discover if there is any serious opposition. Have extra petitions on hand so you can obtain signatures from those attending.
- Assuming the meeting went well and no changes are needed, prepare a follow-up mailing within a few days to those who have not yet signed a petition, letting them know that you are making good progress towards your goal of creating an HIA and ask for their support by signing and returning the enclosed petition (be sure to include another postage-paid return envelope).
- When you have received the necessary number of signed petitions (the statute mandates a minimum of 25 percent but many cities require 50 percent), present those to your city officials so they can start the process of holding public hearings and sending formal notices to each affected owner.
- The City Council must then vote to approve an ordinance creating the HIA. If 35 percent of the owners object to the HIA, the ordinance cannot be approved. The City Council also has the discretion to not approve the HIA if they are swayed by even a few vocal opponents. That is why you want your supporters to show up in force at the Council meetings when the hearings are held.
- The final step is to enter into a Development Agreement with the city which will address a wide range of issues and should be reviewed by your attorney. Depending on the funding source used by the city, the funds could be available within just a few weeks of signing the agreement.
Creating an HIA has proved to be a successful option for many community associations in Minnesota. If you are professionally managed, your management firm may be willing to undertake the process, but please remember this is a time-consuming project that is almost certainly not included in their contracted duties, so don’t be surprised to be asked to compensate them for their time. A second option is to hire an experienced third party to provide assistance. The third option is for the board to do it themselves, provided you have the volunteers willing and able to invest the time to see the project through to a successful conclusion.