Why a Healthy Reserve is Important (To the Board & the Community)

As director on the board, you have a fiduciary responsibility to stay objective, unselfish, responsible, honest, trustworthy, and efficient. Board members, as stewards of public trust, must always act for the good of the organization, rather than for the benefit of themselves. One of the most important ways this manifests itself is how the board decides to fund their reserves.  You do not operate in a vacuum because how much money is in reserve, and the percent of the fully funded reserve is shared with owners, lenders, buyers and any interested party.  If a director willingly disregards the reserve study recommendations without concrete reasons why, and the community remains underfunded, you may expose the board to some legal issues.  Here are a few reasons why a healthy reserve is important:

• Lenders Care – When a buyer needs financing on a property, they may hold title to the property, but until the loan is paid off, the lender has a vested interest in the property.  If they have to foreclose on the property because of non-payment, the condition of the community will impact the value of the property, and they may not recoup the loan still on the books and the cost to foreclose.  Lenders will review the budget and reserve study and decide if the property and the association are worth the risk.
• Buyers Care – As part of a buyer’s due diligence on the purchase of a property in an HOA, the seller is required to provide disclosures on the subject property including all documentation related to the HOA including the budget, minutes, CC&Rs, rules and regulations and whatever else requested by the buyer.  If they discover the reserves are 10% of full funding and there is not enough money on hand for imminent repairs, they may be inclined to pass on purchasing the property.  If the seller does not disclose to the buyer because the board did not record in the minutes a plan for shoring up the reserves such as a significant dues increase, a special assessment or a bank loan, the buyer may have legal recourse against the seller or board for non-disclosure.
• Emergencies & the Unexpected – Even if your reserve level seems adequate for expected repairs and replacements, you need sufficient reserves for the unexpected.  We managed an association whose entire gas line infrastructure had to replaced immediately because it was red tagged by the gas company.  The board had to immediately come up with $250,000 for this repair and because there was not enough money on hand in reserves, had to implement a special assessment to fund an emergency loan.  With the new balcony inspection requirement, I suspect many associations must fund repairs to balconies that were not anticipated.
• One Way or Another, You Need the Money – The money in the reserve belongs to every owner and is a savings account to fund necessary repairs.  If an owner did not live in an association, they would have to come up with the funds to repair their roof or paint the exterior, but the money probably would not be sitting in a dedicated reserve account, but still would have to be available from some account.  The community needs the reserve funds to pay for repairs that an expert has called out in the Reserve Study that must be addressed by the board.  Whether it is a special assessment, a bank loan or money readily available in the reserves, the board will need these funds to pay for these repairs.
• Tell the World Why You Are Fine – If your reserve funds are not at the level recommended by the reserve study, the board may have valid reasons to maintain a lower level of funds.  Perhaps the remaining life of the roof is longer than that estimated by the study or the cost to repair or replace the roof is lower than that in the study.  A prudent board should obtain valid, detailed quotes from a vendor and use that to justify a lower balance.  The key is to communicate to your community, and anyone interested in buying or lending that your reserve balance is adequate.

Work with a management company with the expertise and ability to assist you in the complexities of leading your community.

 

How to Increase Dues (Without Alienating Owners)

It is a fact of life as a board member that you will have to raise the monthly assessment.  You are not only raising dues on other owners, ironically you are also raising the dues on yourself.  Nothing grabs the attention of owners in your community more than raising the monthly assessment.  It creates tension at meetings and has led to board recalls and acrimonious community meetings.  But if you don’t increase your dues to pay for escalating operating costs, to better fund your reserve account, or to address an imminent repair or system replacement, you may risk violating your fiduciary duty or force a board member in the near future to handle the increase. Although a touchy subject and certain to irritate some owners no matter how you justify the increase, here are a few ways to handle communicating a dues increase:

• Explain the Current Situation – Many owners are just oblivious to the financial position of the community.  They don’t read the annual budget, attend meetings or pay attention to the dynamics of your community.  You need to educate them.  Whether at the annual meeting, in a newsletter or an email to every owner, provide detailed information on the current financial status of your community.  Review the reserve study, current bank balances and operating expenses.  
• Explain the Future Need – Many owners simply don’t understand the future needs of the community.  A portion of dues paid today, pay for repairs required in the future.  This is done so there is money on had to pay for those repairs without having to impose a special assessment.  If the roof for a community needs to be replaced and there are not sufficient reserves on hand, each owner will have to pay for the cost of their roof, and their portion of common areas to be re-roofed and that assessment may be thousands of dollars.  By increasing dues today, you are funding that future expense.
• Show That You are a Good Steward – Just don’t accept the reserve study estimates as gospel divined by a third party, obtain quotes for your major systems and replacement projects from trusted vendors.  If the reserve study estimated the useful life of your roofs is 3 years and the cost to replace them is $500,000, have a roofing contractor provide their own assessment.  They may estimate a roof life of 7 years and a cost to replace of $400,000.  They may also recommend a maintenance program that may extend the life of the roofs and save the association money.  Either way, the board can show they are a good steward of the association’s money, providing good due diligence, and any increase is completely justified.
• At Least Keep Up with Inflation – One tactic some associations use is to adjust the dues annually with the rate of inflation.  If your dues are $300 and the annual rate of inflation is 3%, you would increase your dues by $9 a month.  This not only keeps your dues in line with the cost to provide services, but owners will become acclimated and expect an annual dues increase.  Just as their property tax bill increase each year by 2%, they understand the cost to do business increases annually and this increase is completely justifiable and fair.

Work with a management company with the expertise and ability to assist you in the complexities of leading your community.

 

How to Adopt a Budget (Without Breaking the Bank)
Adopting the annual budget is perhaps the most important duty of a director.  Owners in your community may be oblivious to much of what you do, but they will notice when their monthly dues are increased which typically occurs when the new budget is adopted at the end of the fiscal year unless the board has approved a special assessment for some unforeseen expense during the year.  The board will be exposed to a lot of information for this exercise and it is critical that the board spend time and energy digesting this information and crafting a budget for the next year.  Here the information that should be reviewed:

• What Were the Expected Expenses? – In last year’s budget you estimated expenses for this year.  How accurate were you?  Why were you off?  Typically, you can estimate with a high level of certainty for contractual expenses such as insurance, landscaping and pool maintenance.  Other expenses are more variable, such as utilities, and more difficult to get right.  If there has been a consistent anomaly in the expenses, you may need to reconsider the amount of your operating costs.
• What Were the Actual Expenses? – You will compare your budgeted expenses with your actual expenses.  What caused the variance?  Certain items such as emergency repairs can’t be anticipated.  But if every year you are paying for the same “unexpected” expenses, you may want to consider them an expected expense.  One association we manage has a problem with people outside the community dumping trash in their community and they must pay to remove it.  It is not a one-time occurrence, but happens like clockwork every month so they should consider this an ongoing expense and budget for it.
• What are the Future Expenses? – Are you aware of projects the community must undertake in the coming year included in the budget?  If there are insufficient reserve funds on hand, should the board charge a special assessment or increase dues substantially?  If you know you have a substantial expense in the coming year you must budget for it, have funds on hand to pay the vendor, or exhaust the funds set aside in the reserve account for this project.
• What does the Reserve Study Say? – This is the critical part of the budget process.  Just because your monthly dues pay for current operating expenses, are you putting enough money away monthly into your reserve account?  If the reserve study estimates that your roofs must be replaced in 2 years at an expense of $200,000, will you have those funds on hand in 2 years?  If not, you may need to increase dues for the next 2 years to pay for that, otherwise, you may be voting a large special assessment in 2 years.  Perhaps you can have a vendor provide a bid now which is lower than the $200,000 or they can do maintenance work which extends the life of the roof until you have sufficient funds in the roof reserve account. 
• What Can be Saved? – It is usually at budgeting time that the board analyzes expenses, particularly your big-ticket items such as landscaping, insurance and perhaps your management fee.  Can you get comparable services for less money?  Perhaps your community does not need to be painted every 20 years and this expense can wait.  Put some of these services out to bid and see if you can save some money for your community. In some extreme cases, boards have changed their CC&Rs so that expenses borne by the community are now paid by the owners.  An HOA we managed changed their CC&Rs so the garage door maintenance and replacement became the responsibility of the owner and not the association, saving them substantial money.
• Don’t Forget about Inflation – Even if you nailed your budget and spent the appropriate amount for operating expenses and funded your reserves to a healthy level, you still need to consider inflation.  If the consumer price index reflects an inflation rate of 3% and your monthly dues are $300, you would have to increase dues $9 just to keep pace with inflation.  Not only will your operating costs keep pace with inflation, but the costs for which your reserve accounts are dedicated will also increase.   We have yet to find a community that has too much money in their reserve account but we are aware of many associations who are underfunded and ill prepared for the unexpected.

Work with a management company with the expertise and ability to assist you in the complexities of leading your community.

 

How to Change Your Rules (And Keep the Peace)
One of the most important duties of the board and the management company is to enforce the community rules.  Rules not only apply to owners who live in the community, but to renters who occupy the property.  The enforcement of rules is perhaps the most tangible evidence that living in an association is very different from living in a property that is not an HOA because everyone is held accountable for their behavior to the same set of rules, and the board has the power to modify those rules without a vote of the members.  How do you change your rules without antagonizing your members?  Here are a few pointers:

• Make them Reasonable – California law dictates that association rules must be reasonable and lawful.  Obviously, the board cannot institute a new rule that is contrary to federal and state law. A board can’t ban all pets because comfort animals are protected by fair housing and the courts have already ruled that anyone should be entitled to at least one pet.  But it is reasonable that the owner of a pet must clean up after their animal and if they don’t, they can be fined.   We had an HOA that wanted to ban all above ground pool coverings because they were unsightly.  But they could not ban child barriers because that is not only unreasonable because state law already has laws encouraging preventative measures at pools to protect children, but this rule may expose the board to litigation if a child were injured because of this rule.
• Get Buy In – Any rule should be vetted by the community.  If most owners want to be able to park in the streets at night, rather than banning all parking in the streets, the board may want to consider putting time limits on parking in community areas.  This stops residents from using community areas for their own permanent personal use, but allows this space to be used by all.  Imposing a rule that the majority of the community does not want will only result in severe backlash to the board.  But if 80% of the community is for a rule change, the remaining 20% may not like it, but they will have to abide by it.
• Give Proper Notice – Over communicate a change in your rules and give the community ample notice.  The law says you must give 30-day notice before implementing a rule change, but the board should give much more time for the change to be in effect: at least 60 days.  Once the rule is in effect, the board may want to have a grace period, where rather than finding the transgressor, the board issues a warning.  As every board knows, many owners don’t pay attention to the actions of the board (unless you raise the dues), so a gentle transition to a new rule, particularly if there is a monetary fine included or a vehicle is to be towed for violating that rule, is recommended.
• Abide by Them – Once you make a rule change, enforce them.  Many associations have rules that are simply not enforced, or enforced intermittently.  If you have hired a management company, this is a key role they play for you: acting as the “bad cop”.  A director should not be the one fining residents and noting violations, it will not make for a pleasant relationship with your members.  Let the management company note the violations, levy the fines and set up the process to tow cars.  If the rules are uniformly enforced, members will take notice and commit to the new rules.

Work with a management company with the expertise and ability to assist you in the complexities of leading your community.

 

New Laws Impacting Your Community

The legislature passes some laws that impact all residential real estate to protect owners and tenants and other laws to modify the statutes that only apply to Common Interest Developments (HOAs) through the Davis-Stirling Act to address member or board rights.  Either way, these new laws or modifications to existing law, impact the decision making of the board and every year should be reviewed by the board to see how it changes their policies.

• Balcony Inspections – Senate Bill (SB) 721 was signed by Governor Brown in response to the 2015 Berkeley balcony collapse. The balcony collapsed due to decayed wooden joists; six young adults on the balcony were killed and seven others were injured, mostly Irish citizens, visiting California as part of UC Berkeley’s summer exchange program. While some local governments already impose a local inspection program, this California law requires inspection of specific balconies throughout California. All buildings with 3 or more units that have: (1) balconies, decks, porches, stairways, walkways, and entry structures that extend beyond exterior walls of the building and that rely in whole or in substantial part on wood or wood-based products for structural support or stability; (2) a walking surface that is elevated more than 6 feet above the ground level; (3) Balconies designed for human occupancy or use; and (4) buildings that are proposed for conversion to condominiums to be sold to the public after January 1, 2019, must be inspected prior to the first close of escrow. 
  Inspections of the balconies, decks, porches, stairways, walkways, and entries as described above must be inspected by January 1, 2025, with certain exceptions, and requires subsequent inspections every 6 years. The inspection must be conducted by a certified and qualified inspector. The inspector conducting the inspection shall produce an initial report and a final report indicating that any required repairs have been completed. A written report of the evaluation stamped or signed by the inspector presented to the association or management company within 45 days of completion of the inspection. 
  If there is an “immediate threat” to the safety of the occupants, the owner of the building (or the association) must perform required preventive measures immediately. If there is no immediate threat, but corrective work must take place, the association must apply for a permit within 120 days of receipt of the inspection report. Once the permit is approved, there is only another 120 days to make the repairs unless an extension of time is granted by the local enforcement agency. If the association does not comply with the repair requirements within 180 days, the inspector then notifies the local enforcement agency. If within 30 days of the date of the notice the repairs are not completed, the association may be assessed a civil penalty based on a fee of not less than $100 or more than $500 per day until the repairs are completed, unless an extension of time is granted by the local enforcement agency. If a civil penalty is assessed, a building safety lien may be recorded against the property. 
  The message here: don’t wait.  Many associations will delay their inspections and then there may be a backlog of qualified inspectors to comply with this law, or if repairs are needed, a backlog of qualified contractors to do the necessary work.
• Minimum Rentals – Civil Code 4741, adopted in September of 2020 and passed as Assembly Bill (AB) 3182 is the new Civil Code that has the maximum of 25% of the total units as tenant occupied and 75% owner occupied. Now an association may not unreasonably restrict the rental or leasing of the owner’s unit.  While there is uncertainty and disagreement over the impact of this language on minimum rental terms, the law specifically allows associations to prohibit short term and transient rentals, defined as rentals of 30 days or less, and also allows associations to place a rental cap of twenty-five percent (25%) of the separate interests (or greater) in the association.  Any association that willfully violates the new law is subject to a civil penalty to the applicant or other party in an amount not to exceed one thousand dollars ($1,000).  This change was instituted because some associations were limiting rentals to less than 25% and the legislature felt this was restricting available rentals.  Nevertheless, in order to restrict total rentals to 25%, the community must amend the CC&Rs to reflect that percentage and it cannot be retroactive.

• Election – Senate Bill (SB) 323 passed in 2020 and makes several substantive modifications to the Civil Code’s provisions governing association elections including (1) no changes to the election rules within 90 days of an election; (2) any member is entitled to vote, even if delinquent on their assessments; (3) a nominee may be disqualified from running if delinquent on their regular or special assessments but not for nonpayment of fines or late fees; and (4) the inspector of the elections must be a volunteer association member or a third-party inspector but no longer someone on the board or an employee of the management company.
• Insurance – One impact of the Surfside disaster and collapse of that building, may be to increase insurance amounts.  Currently an association only needs a minimum liability policy of $2 million if 100 units or fewer and $3 million for associations with over 100 units.  This total cost for insurance companies may exceed $500 million and this may trigger insurance companies to request higher limits.

 

How to Mitigate Risk (and insure adequately)

Your owners depend on you to both protect their real estate investment and personal assets by having the proper insurance in place for the association.  Even a small community needs to have millions of dollars of protection for both personal liability and potential property damage.  There are a few different coverages and limits to consider, and annually the board should review these policies.  Here are some coverages which are mandatory to have in California:

• Property – This covers the replacement of a building should it be damaged or destroyed.  If there is fire and a building consisting of 6 units is destroyed, the property is rebuilt to current building standards by the insurance company.  The board needs to make sure the policy states that the replacement cost of the structure is covered and not just a ballpark cost to rebuild.  Remember don’t over-insure and have the insurance cover “market value”, because the replacement cost may be less than the market value of the property.
• Commercial General Liability – This protects individual owners from damages sustained in common areas.  If someone is injured in the pool area, the entire association may be sued.  This coverage is required in California with the following minimum limits:  $2 million for 100 or fewer units or $3 million for 101 or more units.  These are the minimum limits and the board may want to consider higher limits.
• Directors and Officers Liability – This coverage protects all directors and officers from individual liability related to decisions legally made, as well as the occurrences that happen during their terms in office.  But if a director or officer is compensated or receives a benefit serving on the board, such as health insurance, this coverage may be void. 
• Fidelity – This indemnifies the employee, managing agent and independent contractors in the event of theft of misappropriation of the HOA’s assets.  Some, but not all, insurance companies will add the HOA’s management company to the policy in order to cover the HOA’s funds under this policy.

These coverages are usually “optional”:

• Worker’s Compensation – You should require any vendor working on your association to have their own worker’s compensation.  But if their coverage has lapsed or they even lied to you, this provides exclusive remedy for work-related injuries.  Since California is a “no-fault” state. This precludes a worker from entering into a civil suit.  An injured worker’s damages generally are limited to the workers’ compensation benefit.  This is options coverage, but provides an added level of protection.
• Earthquake – In the event of an earthquake, this covers repair or replacement costs resulting from earthquake damage.  But review the policy.  The deductibles are usually very high (for an individual unit, it can be $50,000) and expensive.  Unfortunately, this coverage must be obtained if required in the governing documents.
• Flood – If your association is in a flood zone, it provides coverage on residential structures from water damage caused by a flood.  Lenders require HOAs in flood plains to obtain this insurance through the National Flood Insurance Program (NFIP) or other sources.

 

Conducting an Association Election in 2022

The laws relating to association elections changed January 1, 2020 and many associations are still struggling to stay in compliance with this new law.  In effect, it required associations to amend their election rules to conform to new statutory requirements, limit the types of candidate qualifications an association may adopt, address the only circumstances for elections by acclamation, place limitations on who may serve as an inspector of elections, and bolster the ability of members to overturn an election that is not conducted in accordance with proper procedures.  Here are the changes in more detail:

• New Election Rule Requirement – Any changes to an association’s election rules may not be made within 90 days prior to an election.  An association is prohibited from denying a ballot to a member for any reason other than not being a member when ballots are distributed so a member can be in arrears on their assessment and still vote.  Lastly, an association must retain all election materials including both the candidate and voter lists.
• Candidate Qualifications – A candidate for the board may require a nominee to current in their payment of regular and special assessments but not for being in arrears for fines, late charges, interest and collection costs.  A nominee can be required to be a member for a minimum of one year in the association and be free of criminal convictions that would prevent the association from securing fidelity bond coverage.
• Inspectors of Elections – Neither an agent of the management company or anyone employed by the management company can act as the inspector of elections, and the actual inspector must be a volunteer or a third-party inspector of an election company.
• Enforcement of Election Requirements – If a member files an election challenge and establishes that the election procedures were not followed, the court is required to invalidate the results of the election.
• Timing – It is critical that the board be aware of the election deadlines:
  • At Least 90 Days Before an Election – If the election rules are being amended, general notice of the proposed election rules have been provided.
  • At Least 30 Days Before Nomination Deadline – Notice of the procedure and deadline for nomination.
  • At Least 30 Days Before Sending Ballot Materials – Notice of meeting and candidate list sent to owners.
  • At Least 30 Days Before Voting Deadline – Ballot materials mailed or delivered to each member on the Voter List with ballots, pre-addressed envelopes, instructions on how to return ballots and copy of the election rules.
  • Within 15 Days After the Election – Notice of election results communicated to owners.

If you add up these dates, it could take up to 120 days to conduct a valid election.  There are independent third party association election companies to help facilitate this process, but the board needs to be aware of this lengthy timeline and convoluted process or risk having the results becoming invalid.