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Qualifying for a Community Association Loan – September/October 2012
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Minnesota Community Living September/October 2012

Qualifying for a Community Association Loan

By Frank Coleman & Peter Santangelo

According to the recent IBOPE Zogby International 2012 survey on Community Associations:

62 million Americans live in an estimated 315,000 association governed communities.
Seven out of ten residents are satisfied with their association living experience.
Residents rated their community experience as positive where they believed:
? Association board members strive to serve the best interest of their communities;
? The association rules protect property values and they value the return received on their association assessment payments.

Elected association board members have the fiduciary responsibility to protect and enhance the association common elements and unit owners' investments by maintaining and preserving the property values of the community. In order for the Board to maintain the Association's property value, they may contract to have a Reserve/Engineering Study completed to define to the Board/Unit Owners the nature, timing, and cost of future capital replacement projects and assessment dollars needed for each project.

In current difficult economic times, boards and unit owners are reluctant to raise assessments for future replacement projects and frequently delay projects in order to raise the necessary funds. This increases the probability that repair costs for the later "fix” will be greater due to the problem becoming broader and deeper (or as our grandmothers always told us: "An ounce of prevention is worth a pound of cure.”)

In a capital replacement project, boards and unit owners have the following options:

  • Pay for the project from the accumulated reserve dollars;
  • Implement a special assessment;
  • Obtain a commercial bank loan;
  • Or a combination of any of the above options.

Paying for the capital replacement project from accumulated reserves dollars based on the reserve study is the best option, as dollars are set aside over time. The yearly reserve assessment increases are smaller and less of a burden on the unit owners to pay for the replacement projects.

Special Assessments are usually implemented when there is a shortage of reserve dollars to pay for a capital replacement project and unit owners are given a limited period of time to pay their portion of the project cost. If the Special Assessment is large, this may place a burden on unit owners who are unable to pay the one-time assessment charge and default on their payments, which places additional stress on the Association in trying to complete and pay for the project.

With a commercial bank loan, the capital replacement project is completed in a short period of time and the unit owners are not burdened with a one-time large assessment payment but are able to spread their portion of the project cost over time. There will be an increase cost to the project due to interest payments; however, this still may be more palatable to the unit owners then a one-time large Special Assessment payment.

If the board decides to borrow dollars to complete a capital replacement project, a Community Association Lender will look most favorably (the best loan terms) to boards and unit owners that are proactive, well prepared and meet all the bank guidelines. Community Association Lenders may require the following information:

  • Average unit market value;
  • Number of units;
  • Delinquent payment of assessments;
  • Contingencies for bad debt;
  • Assessment levels;
  • Owner occupancy ratio;
  • Insurance;
  • Present and pending lawsuits;
  • Repayment plan;
  • Reserve funding.

An Association should surround itself with qualified professionals to ensure the project goes smoothly and is completed correctly.

The lender will need to understand how the scope of work was identified, the duration of the planned repairs, and the process for selecting the professionals to complete the projects. Prior to loan approval, the lender will require copies of the executed contracts for the work to be performed. Depending on the size of the project, an independent engineer or architect may be required to supervise the project and approve all advances on the loan and payouts to contractors.

Average unit value and number of units are taken into consideration to determine if the size of the loan requested meets the bank’s guidelines. For example: 
A 50-unit building requests a $1,000,000 loan.
The units are valued at $100,000 each.
The assessment per unit would be $20,000 (20% of its value), which the bank might consider too high.

Assuming a 5-year repayment, the amount due per unit would be about $333 per month – which does not include interest, regular assessment or mortgage payments. Such an expense has the potential to monetarily stress unit owners, which may increase delinquencies and cause the association to default on the association loan. To prevent this, it is imperative that associations reserve funds for future capital expenses to reduce or eliminate the need for a loan. If an association has reserves and is able to fund 50% of the project, this reduces the financial impact to owners and increases the probability of acquiring a loan.

Collateral for a community association loan is the assignment of future assessments of the association. Most lenders have internal guidelines regarding delinquent assessments that Associations must meet, to both qualify for a loan and maintain while the loan is in place. Typically no more than:

  • 5% - 10% of the total number of units can be delinquent on assessment payments;
  • 5% - 10% of the annual assessment income.

Prior to obtaining a loan, an association should establish a delinquency collection policy and adhere to it. The Association’s assessment income is the Bank’s source of repayment, so the Association must be diligent about collecting all assessments. Delinquent accounts should be turned over to the Association’s attorney as the Association’s delinquency collection policy allows.  Associations with high delinquency rates may not be able to secure a loan.

Associations considering whether or not to take out a loan should incorporate a reserve for bad debt into their operating budgets. In the event of non-payment or late assessment payments, this reserve will help to ensure the association has sufficient cash flow to meet debt and operation obligations.

The Board should determine the number of non-owner occupied units and what is currently allowed by Association policy. Lenders' guidelines for non-owner occupied units range from 20% to 30% of the total number of units.

Community associations are also required to carry adequate insurance per Minnesota Statutes governing Common Interest Communities. The lender will require proof of adequate insurance as a condition of the loan. Insurance will be required to be maintained while the loan is in place and the lender will require that they are added to the policy as an additional insured or loss payee. Boards should review their insurance levels annually with a qualified association insurance professional.

Litigation against the association is also reviewed by the bank. As plaintiff or defendant, an association that is a party to a lawsuit complicates matters for owners trying to buy or sell units and can inhibit an association’s ability to obtain a loan. Lawsuits against the association may impact the ability to repay its loan due to increased or unbudgeted legal fees and the potential for a monetary settlement payout not covered by insurance or reserves. Association boards should act to resolve lawsuits in order to focus on day-to-day operations of the association.

Community Association Lenders vary in documentation they require, their evaluation processes, and loan terms. Lenders with dedicated association staff, broad experiences, and strong portfolios are generally the easiest to work with and can guide you through the process. Associations considering a capital replacement project should contact a Community Association Lender early in the process, to acquire guidance and options in financing. This will aid in ensuring the loan is acquired in an expedient manner.

Community Association Lenders know that Association Boards with strong leadership, that are well managed and proactively plan, demonstrate to the unit owners that the Board members are exercising their fiduciary duty to ensure the financial integrity of the Association and property values.

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