Significant changes lie ahead for Minnesota’s condominium, townhome and co-op associations for their fiscal years beginning on or after January 1, 2012. Perhaps most noteworthy, associations are now prohibited from using or borrowing from replacement reserves to fund operating expenses. Otherwise, reserve funding rules for Minnesota CICs have been altered considerably, becoming extremely flexible – and somewhat more complex. Effective next year the focus shifts more toward due diligence and disclosure than actually saving funds sufficient to pay for all future major expenses. It is a dramatic shift from the past mandate to annually budget adequate reserves for everything the association is obligated to replace. Yet these statutory changes are not meant to supersede or invalidate your association’s existing declaration. Since funding is now optional for many items, and disclosure of both funded and unfunded components is required, associations must identify and disclose all the components for which they are responsible and decide how the needed funds will be collected—whether by reserves or by other means. For many associations, it is back to the drawing board with governing documents in one hand and the new statutory revisions in the other. This task can be confusing, intimidating and overwhelming. So we offer you an outline of steps you might take to help ensure your association is in compliance for 2012, and beyond. Uncertainties? Don’t guess. Your association attorney, manager or professional reserve planner can help.
1) Identify everything that the association is responsible to maintain, repair or replace.
Review your declaration and inventory your facilities and infrastructure. List everything, be specific and avoid generalizations like "common areas” or "building exterior surfaces.” A typical townhome association might be responsible for components such as (but certainly not limited to) roofs, siding, brick trim, soffit and fascia, gutters and downspouts, sidewalks, stoops, driveways, exterior lighting, trim paint, decks, patios, sidewalks, streets, curbs, mailboxes, monument signs, irrigation systems, storm & sanitary sewers, lateral sewer lines, retaining walls, fences and so forth. Multi-story condominiums typically have much longer lists, including windows and doors, mechanical and HVAC systems, elevators and various interior items and amenities like pools and spas, fitness centers or community rooms—all with a litany of furnishings, fixtures, finishes and equipment. Note items that are the unit owner’s sole and individual responsibility. Also check to see if your declaration authorizes special assessments and loans as these may be alternative funding mechanisms you want to consider as part of your overall reserve planning.
2) Categorize each component: Common Element, Limited Common Element, Unit Element, or Common Element of Limited Benefit.
Review your declaration (CC&Rs) for assistance in the classification. The category assignment will help you determine which components must be reserved for, which are optional and whether approval of both the Board and 51 percent of the association votes is required to forgo reserve funding.
3) Determine whether the declaration (CC&Rs) requires you reserve for Limited Common Elements (LCEs).
You might want to reserve for some LCEs and not reserve for others, if you have this option. Unless your declaration provides otherwise, the statute now stipulates your annual budget need not include reserves for Limited Common Elements or components with a remaining useful life greater than 30 years. (Those long-lived components would later be added to your reserve fund assessments once their remaining life falls to 30 years or less.)
4) Identify any portion of the Common Elements that provide an exclusive benefit to "fewer than all” units.
Some components, though not classified as Limited Common Elements, may exclusively benefit fewer than all units. You are permitted, unless otherwise required by the declaration, to forgo reserve funding and instead simply assess the benefited units at the time the expense is incurred. This approach requires approval of both the board of directors and 51 percent of the association votes. Approval is effective for three years, then subject to modification or renewal by the same standards. Should such a vote fail in the future, a separate reserve schedule will be needed for the component.
5) Identify components you plan to fund by Special Assessments rather than by reserves.
Unless otherwise required by the declaration (if the declaration authorizes special assessments) you are permitted to forgo reserve funding and instead simply assess the cost among all units at the time the expense is incurred. As with benefit assessments, this approach requires approval of both the board of directors and 51 percent of the association votes. Approval is effective for three years, then subject to modification or renewal by the same standards. Any component that the board and unit owners have voted to fund by means of a planned future special assessment, rather than by reserves, should be disclosed in the resale disclosure certificate (item #13) because it significantly affects the owner’s obligations regarding the unit. Should such a vote fail in the future, a separate reserve schedule will be needed for the component.
6) Make separate lists for funded and unfunded components (LCEs and LBCs).
Your annual report and resale disclosures must identify those components whose expenses are budgeted in your replacement reserves and the amount of reserve savings accrued to date. In addition, the resale disclosure certificate requires you identify LCEs and any Limited Benefit Components (LBCs) whose expenses are assessed solely against the benefited unit(s); regardless whether they are reserved over time or will simply be assessed to the benefited unit(s) at the time the expense is incurred. A written funding plan must be attached to the resale disclosure certificate for any expenses that are assessed against fewer than all units.
7) Adequately fund your replacement reserve budget each year.
While the statute retains the basic standard for "adequate” replacement reserves, it stops short of requiring a professional or formal "Reserve Study.” However, it requires that each annual budget must include reserve funding "projected by the board of directors to be adequate” (at least barely sufficient) to fund your reserve components. Further, it stipulates the basis on which the reserve budget must be determined: "The amount annually budgeted for replacement reserves shall be adequate, together with past and future contributions to replacement reserves, to replace the components as determined based upon the estimated remaining useful life of each component; provided that portions of replacement reserves need not be segregated for the replacement of specific components.” Clearly, it is not sufficient to simply pull a number out of thin air or survey some other associations to see what they are budgeting. Someone has to identify and compile an inventory of your reserve components, determine replacement costs, estimate their remaining useful lives, and do some math.
8) Reevaluate the adequacy of the reserve budget at least every three years.
The statute now requires the association to reevaluate the adequacy of its budgeted reserves at least every three years. We understand this to mean that every three years the association must reassess the estimated remaining lives and replacement costs of the reserve components, recalculate the funding needs, and update the reserve budget to ensure adequate funds will be available when each component is projected to require replacement.
9) Expand your maintenance matrix to indicate the means by which each component’s expense is funded.
You will find it very beneficial to prepare and distribute a Responsibility and Funding Matrix based upon your specific components and funding policies. It will also help manage owner expectations and satisfy disclosure requirements.
10) Confirm your due diligence and validate your policies with a certification.
Remember, your reserve funding policies must satisfy both statutory and governing document requirements. Your declaration is a legal document; any interpretations should be made, or validated, by a professional legal practitioner. To ensure the validity of your policies, where any uncertainty exists, we recommend you obtain verification from a real estate attorney specializing in community association law prior to implementing the policy. A written legal opinion is preferred. You should then draft and adopt a formal reserve funding policy resolution. Preserve your policy resolution document, together with the written legal opinion, as part of the association’s permanent records.
Yes, it will take some effort, but the payoff is huge:
- Healthy reserves increase property values and improve sales.
- Owners with a clear understanding of their financial obligations do not start riots.
- New buyers will not arrive with inaccurate or unreasonable expectations.
- Documented policies provide a clear reserve budgeting guide for future boards.
On May 27, 2011 Minnesota Statutes 2010, section 515B.3-1141 was amended to read:
515B.3-1141 REPLACEMENT RESERVES
(a) The association shall include in its annual budgets replacement reserves projected by the board to be adequate, together with past and future contributions to replacement reserves, to fund the replacement of those components of the common interest community which the association is obligated to replace, by reason of ordinary wear and tear or obsolescence, subject to the following:
(1) The amount annually budgeted for replacement reserves shall be adequate, together with past and future contributions to replacement reserves, to replace the components as determined based upon the estimated remaining useful life of each component; provided that portions of replacement reserves need not be segregated for the replacement of specific components.
(2) Unless otherwise required by the declaration, annual budgets need not include reserves for the replacement of
(i) components that [have] a remaining useful life of more than 30 years, or
(ii) components whose replacement will be funded by assessments authorized under section 515B.3-1151(e)(1), or approved in compliance with clause (5).(3) The association shall keep the replacement reserves in an account or accounts separate from the association’s operating funds, and shall not use or borrow from the replacement reserves to fund the association’s operating expenses, provided that this restriction shall not affect the association’s authority to pledge the replacement reserves as security for a loan to the association.
(4) The association shall reevaluate the adequacy of its budgeted replacement reserves at least every third year after the recording of the declaration creating the common interest community.
(5) Unless otherwise required by the declaration, after the termination of the period of declarant control, and subject to approval
(i) by the board and
(ii) by unit owners, other than declarant or its affiliates, of units to which 51 percent of the votes in the association are allocated, the association need not annually assess for replacement reserves to replace those components whose replacement is planned to be paid for by special assessments, if the declaration authorizes special assessments, or by assessments levied under section 515B.3-1151(e)(2).
The approval provided for in the preceding sentence shall be effective for no more than the association’s current and three following fiscal years, subject to modification or renewal by the same approval standards.
(6) Unless otherwise required by the declaration, subsection (a) shall not apply to a common interest community which is restricted to nonresidential use.
(b) Unless the declaration provides otherwise, any surplus funds that the association has remaining after payment of or provision for common expenses and reserves shall be
(i) credited to the unit owners to reduce their future common expense assessments or
(ii) credited to reserves, or any combination thereof, as determined by the board of directors.
(c) This section applies to common interest communities only for their fiscal years commencing on or after January 1, 2012.