Funding Reserves & What Happens When You Don’t!

Robert Nordlund 00:07

Well, thank you, Kali. Looks like we have another great audience with us today from all over the country. Thank you for coming into my office for a chat with me on funding reserves. Now you’ve all heard the saying you can lead a horse to water, but you can’t make a drink, and as Coley said a moment ago, for years, managers, attorneys, accountants, bankers and reserve state professionals have been telling boards to get a reserve study and adequately fund their reserves. But looking across the country, the majority of boards don’t fund reserves adequately. They continue to nod their heads and convince themselves that the future is not their problem or it’s just too expensive to do that, then why are they missing this opportunity to take care of their association? Why are they missing this responsibility? How come these same people change the oil in their cars to keep the cars running well and they also take the time to get cleaned up and dressed up when they have an event to attend. Both of these require planning in advance. They both require seeing a successful outcome and preparing. But magically, these same people think that their association can last for an extended period of time without providing funding for the care it needs. So that’s the good question I’ll address in today’s webinar. Funding reserves, and what happens when you don’t the future of your association is based on the decisions or indecisions you make today and at budget time. And there are consequences either way. This is the outline we’ll follow in today’s program. An important starting question is, can we see the future with enough clarity to care to do something about it? It’s a matter of vision or understanding, or is it shirking the responsibility feeling at someone else’s problem? Well, this is important to start with, because it’s usually the first excuse to not funding reserves. We don’t know what’s going to happen. So why should we plan so in this section of the program, I’ll share that I believe we can see the future, and it starts with the idea that you know yourself and your situation. You believe in yourself and your situation. Now for me, I know that I need to leave my house three hours and 15 minutes before my flight at LAX is scheduled to leave, so if I’m in my driveway, if at only two and a half hours before my flight, I know it’s going to be a stressful drive and I could be late. I can see that future while I’m still in my driveway. So follow along as I guide you through today’s material, helping you clearly see the future and how your choices today and at budget time shape the future of your association. Now, I think it starts with perspective. It’s pretty easy to see the things that are right in front of us, and that’s our reality. You can reach out and touch the tree in your backyard, you can touch the trunk and you can enjoy seeing the leaves flutter in the wind, but that same backyard tree looks different compared to a forest at the edge of town, that same big tree starts to look small and insignificant compared to an entire forest of trees. Now that’s perspective, and while your backyard tree seems very real, you know in your head now that there’s a whole lot more trees out there beyond touching distance, you know that they’re real. And if you back away even further, you realize that the forest ends at the base of a mountain range. Now you may not see the rocks or feel the snow or maybe the cool mountain breeze, but that range is huge, and it’s as real as that single tree in your backyard. The point is that those distant things are there. They’re real, and they don’t go away. If you focus only on the things up close, they’re still there. So if you’re focusing only on your tree in your backyard, that doesn’t mean that the mountains and the forest have gone away. They’re still there. Now let’s talk about perspective and point of view with respect to Community Association properties. You can see a condo on the left hand side. And let’s start now with someone with an untrained eye. All right, for a person with an untrained eye, it’s pretty easy to see the near term conditions. You can see that the trim looks good or bad. You can see that the carpet is new or worn. Maybe you can even smell a new carpet, and you can see pretty obviously that the asphalt is either smooth or deteriorated with a lot of cracks and potholes. Those things are patently obvious, even to the person with an untrained eye looking only at and they have a good understanding of the near term things, the things right now. Know and that same Unturned, untrained person may not see so clearly or know so clearly. If the fence is in good shape or poor shape, or if the entry system is new or aged, that untrained person is not skilled in seeing those events a few years away, that kind of mid range area, you could say their mid range opinions get a little bit gray or a little bit fuzzy. That’s just not their strength, and the untrained eye is likely not even going to have an opinion about things further in the future, some long range projects like elevator modernization, other major mechanical issues, maybe some roof system things like that. It’s just not in their skill set. So their reaction is pretty reasonably. How should I know? It’s not my problem. I’m not going to deal with that, and I wonder if that’s a reason that we don’t have boards and managers funding reserves. Because they’re thinking, How can I know? How should I know? But I want to turn the corner a little bit on this discussion and expose you to someone with a experienced eye, kind of a trained eye. This for this person, they’ve got the near term stuff in the bank, they understand that, and the mid range stuff, they know what to expect. They’ve seen it enough that they have a grasp on these things. They know what a good fence looks like. They know what a good entry system looks like, or the one that you have. Maybe they know that’s a 10 year old model, and it’s pretty old. So they have the point of view, and they have the experience base with those mid range components that they know what to expect and being in that position, they also know that there’s some other things out there, a little bit beyond grasp, but they know enough to know someone who can tell them what condition those things are in. So they know enough to know let me get some help. I I know where I can go to get some information about that. And then you go from the experienced eye to the expert eye. And for that person, someone like a reserves, a professional someone who looks at building elements on almost a daily basis, even the long range items are clear to them. They understand it, they see it, they get it. And they think, hey, that’s no problem. I got this. I understand this. And so there’s a difference in perspective between the untrained eye, who only grasps effectively and realistically the near term things, and this expert eye who’s able to see even long range things. So same fact set, just different perspective, just different amount of training and experience. So if we put these things together, the role of the untrained eye is often played by the board or the homeowner. They get it, they see it, they understand these things, and they can make observations about the here and now, but

Robert Nordlund 08:07

moving further into the future is not their strength. Those mid range observations are commonly influenced by the manager, the person that they see regularly. That manager sees properties on a regular basis. Maybe they’re a portfolio manager, so they see other things, or they hear stories from other managers in the office, and then the role of the Long Range person with long range vision, the expert eye, is played by the reserve study professional. It’s our job to make observations and help clients begin preparing now for things far away. So that’s the idea that all those assets are there, and just because you may not know what the condition is and what the reality is, someone else can and that’s the value of having someone on your team who can help you see that. And maybe that’s why I find it so frustrating that board members are missing what I consider obvious. All right, well, let’s change things up here in this first section, again, the board responsibilities. What is the board’s job? And it’s pretty much three things, enforce the rules, make sure there’s law and order and things happening in orderly manner, maintain the property, keep the physical plant going, and handle the finances. That means setting the budget, collecting the income and paying money to the service providers who keep the place going. And that’s pretty much what their job is, in a nutshell. And the interesting thing is that a reserve study helps with two of these three basic functions of a board member. We help a board member see distant into the future, because we can reveal that truth is very clear to us, and we can help them see that you’ve got 16 years for that. Seven years for another thing, 22 years for yet a third thing, and you need to be setting aside this much money to prepare for them. It’s very simple. And so it’s up to the board to again, enforce the rules. What’s said in the governing documents, the bylaws, how many board members are there? How they get elected, how to handle special assessments, the voting percentage, all those kinds of things. Maintaining the property is getting things done, seeing with clarity when projects need to be done. But in order to do that, oftentimes, need to have prepared years in advance and reserve study helps preparing years in advance for those big things. Why is this the way it is? Well, it boils down to three things governing documents, the documents supporting the association that could be governing documents that could be the rules, again, the bylaws, things like that, articles of incorporation. There’s the principles of being a fiduciary, where you as a board member are responsible to care for the assets of others. And there could be state law, sometimes very specific, sometimes in general terms, what a board member is or does. And so you have as a responsibility of a board member that those responsibilities to maintain the association, enforce the rules and handle the finances. So it’s it’s your job to do that kind of thing. And there’s another layer, and that other layer is insurance. Can you get insurance coverage? How much control or how much influence does the insurance company have about making sure you correct unsafe conditions, making sure that you follow the governing documents, otherwise, you’re out on the limb, and they’re not going to ensure that kind of behavior. So there’s that extra layer on top, and in this all, I want to make sure you understand that mother nature and Father Time that are causing all this deterioration, the natural deterioration that exists here on planet Earth, Mother Nature and Father Time, don’t take a break. It’s like you’re in a race. And they’re always running around the racetrack. They never stop and go into pit lane having to refresh themselves, having to get more fuel. And so the question is, are you in pit lane while Mother Nature and Father Time are whizzing around the track continuing to deteriorate things. Or are you going at a slower speed in pit lane, and then you get out on the racetrack, and you’re not getting up to speed with every lap. You’re falling behind and behind and behind. So understand where you’re fitting in this, and understand that there really is a race going on, and Mother Nature and Father Time aren’t stopping or slowing down. It’s pretty hard hustle that you have to be going on to keep up with all that deterioration, and it is a closed loop, as if you’re not funding reserves, you’re going to have deterioration there. It’s that’s just the consequence of reality. You can see this real estate agent here having a hard time explaining in polite or nice terms, attractive terms, what this couple is looking at here. Well, you know, it’s affordable, it’s rustic, and they aren’t wasting your potential HOA dues on funding reserves, because there is a result, either pay more money and get a nicer looking place, or you pay less money and allows your looking place, and that’s going to affect home values. So that’s a little bit of what the situation is, and I want to make sure you’re aware that that is what’s in your ability to see the future these things are going to happen. Okay, so question is, what’s in your future? What is controlling the future of your association? Well, number one, you have to appreciate that. Like I said, the cars are running around the racetrack. Owning real estate is expensive. It just is. There’s a lot of cost of deterioration. The cost to buy in is only the start of what it costs to own a home of the association. Your mortgage is not an ongoing cost. It’s part of your initial cost, ongoing cost taking care of deterioration. That’s a portion of your monthly assessments. So you have to face the fact and feel it in your gut that oh boy, oh darn,

Robert Nordlund 14:32

owning this home is going to come with its expenses and the choices you make create the future of your association. It’s what you do today and at budget time, do create the future. And another cartoon along the same lines of what I showed a moment ago. This is Aspen Creek condos. They are what they are. They are what their decisions have made them. We’re just we’re disorganized, sloppy and mismanaged. We don’t take care of our things. The entry sign. Is chipped and peeling. It’s cracked. Hasn’t been repaired so long the birds are making a nest in it, and I bet the units and the buildings back behind look like we saw in that other cartoon. This is the future, if you ignore the responsibilities of taking care of and keeping up with ongoing deterioration. So along that theme, what does it look like with underfunding? And that was one of the first parts of what colleagues started the program here today. What really are the consequences? Well, if you are underfunding, if you’re not keeping up with deterioration, the first thing you see is deteriorating conditions. This is asphalt that at one point in time was shiny and black and smooth, and now you can see it’s all cracked and deteriorated, holes filled with water. This is a repair that the repair has failed, and it just allows you look in place. And because it’s a lousy look in place, you have lagging property values, and that really hurts, because that’s going to hit you with 1000s of dollars of lost opportunity, because curb appeal is real, and when the homes aren’t selling at what you’d like them to sell because a place just plain doesn’t look nice, there is a growing distrust of the board and their ability to lead well, because remember, in the governing documents, the board has the responsibility to maintain the assets of the corporation, to set and collect the funds to be able to spend the money to do that kind of stuff. So there’s a beginning of distrust. And with the beginning of distrust, there’s increased liability exposure, and when the board isn’t doing its job, when the board is going off on on its own, it’s not following the requirements of the governing documents or the rules, or these basic three principles to enforce the rules, maintain the property and manage the finances, then, yeah, you’ve got a problem here. You may have DNO insurance, but DNO insurance may say you’ve gone off the rails. That is not authorized, behavior that we cover as part of normal business. You have done something unusual, and that is on you, so be careful about that. And then with lower property values, less trust for the board, liability concerns, things going off the rails. There’s, of course, a declining community spirit, and that’s people who are upset. And this can look like long or contentious board meetings. Board overthrows, people doing a recall for board members, people insisting that the special assessment fail when you as a board member or manager, know special assessment has to pass. We’ve got a leaky roof going. We can’t just pull money out of the air here. So there’s problems with the community, and because people don’t like it, they say, you know, I’m out of here. And they leave, and they put someone in who’s just a renter, and so the whole idea of community spirit goes away for people who are just using their home as a rental. Now I’m stereotyping here, but it’s indeed a real stereotype. When there’s increased rentals, there’s less pride of ownership, and there’s only a concern for keeping the monthly assessments down so the home owner who’s renting, the landlord, can maximize their cash flow. And that leads to safety concerns because projects aren’t getting done. There’s just not enough cash to fix the stairs. You can see a couple more stairs and in a rain or snow, these are going to be pretty treacherous stairs. And it’s not just this kind of stuff. It could be balconies, it could be some facade issues. It could be a lot of different things at the association. And that all leads to the death spiral where you don’t have people who care, the owners aren’t willing to support higher assessment structure, and there’s declining community spirit. It’s a lousy looking place. People think it’s a lousy place. And you know why I’m not going to pass a special assessment for a lousy place. And that’s a very real thing we call the death spiral. So be careful. We can see associations and nosing up to that, and bad things happen when you begin to approach the end of the death spiral. Okay, I want to talk about the opposite strategy, where you are funding reserves responsibly. And typically, what we see, after preparing 1000s of reserve studies all across the country, there is a sweet spot, and that sweet spot is funding reserves 15 to 40% of your total budget. You know, that’s a that’s a freebie, I can tell you right now, it’s not 10% it’s not 50% it’s usually somewhere in the 25% range. And that’s, again, something that’s just E. Easy to remember something that I want you to leave this webinar learning that that needs to put you in the ballpark where your association is specifically you’re going to it’s going to cost you some money to do a reserve study, but free webinar. The answer is, you got to think in the 25% range. That’s what it’s going to take to fund reserves responsibly. Remember, I told you that owning real estate is expensive. This is typically what it costs to be able to offset ongoing deterioration. But when you do that, you can get maintenance done in a timely manner. You can get a roof repaired before it starts to leak and before it starts to make a lot of costly interior damage, all these kinds of things. And it can be not just the timely maintenance that saves additional funds. It can be making sure that you have the money so that you can avoid special assessments and loans. And I’ve got asterisks there, because special assessments give the owners a lot of pain, and loans give the association members a lot of cost, because now, in addition to the loan principle, you are paying significant interest to the bank. So instead of earning it from the bank, offsetting your reserve funding requirements. Now you’re paying it to the bank, and that gets real expensive. So you avoid this whole problem. You can relax and know that the board has things under control, and because the board has things under control, you enjoy living there. It’s a great place. The pool is clean, the spa is warm, the entry gate works. The lobby furniture is attractive. There’s just so many minutia type things that all add together and you realize, I like living here. It’s a good place. And yes, it’s going to cost you another 10 or 20 or $50 a month, but really, that’s the difference right there. And when you do that, you have increased home values, maximized home values, homes that will appreciate in the 1000s of dollars, and that’s much more than the 10s or 50s or $100 type numbers that it costs in the higher funding that it takes to fund reserves responsibly. So when I was growing up, they call it the brass ring, the prize is increased home values and the cost effective way to get there is funding reserves responsibly. It’s very doable. So on that note, the question is, well, what do we do? What are the paths forward? How do we get there? Well, I want to make sure you understand this, not just me. In 2021 the CAI Research Foundation prepared this report called breaking point. You can Google it, Cai Research Foundation, and actually, I’ll probably put a link to this in the in the show notes, another reason to stay and fill out the end of session survey. But they concluded in this big, significant and exhaustive survey, how do associations make it to successfully into a long life? And it’s pretty much just four things. Number one, fund reserves as recommended. You need that income going towards being ready to pay the bills. Spend the reserves as recommended. So when it’s time to replace the roof, you replace the roof. When it’s time to seal the asphalt, you seal the asphalt. You’re maintaining it. That just helps things the asphalt work and serve the association a longer time. Update your reserve study regularly, so we have fresh information based on fresh data, and listen to your trusted advisors that’s commonly getting your structural evaluation or your balcony inspection or elevator load test or listening to your HVAC expert, whatever it is, that’s how you prepare. Again, that’s the idea of perspective. As a board member or manager, you’re not expected to know everything. Rely on your trusted advisors. They’re going to be able to give you the give you the perspective to know what’s out there, how much is it going to cost, when is it going to happen? And then, why is this all necessary? Because deterioration is real. It’s like gravity. When I’m doing a live presentation, pull my keys out of my pocket, hold them in my hand, turn my hand over, and I’ll drop them on the table. Deterioration is as real as gravity. It is happening. There’s nothing you can do to get in the way of it

Robert Nordlund 24:30

and appreciate that. Ignoring deterioration is going to be a train wreck. It’s going to happen. It’s going to be ugly, and it’s not going to be nice if you wait until you can see it right in front of your eyeballs, you’ve waited too long. Basically, you have a freight train bearing down on you without time to jump. So what do we do? Remember this just free advice here, free counsel. Your reserves need to. Be in the range of 25% of total budget. You may be an association that’s very simple, and that may be 15 or 16% for you, your association may have a lot of amenities or complex wood surfaces that are expensive to maintain, beautiful but expensive, and your association may need to fund reserves more close to the 40% end of the range, but what you need to do is set your assessment structure appropriately so you can fund reserves. Special assessments and loans are just band aids. You need to make sure you’re driving the income into the association so you can get ready for these big projects. And I don’t want you to think, well, we could never do that. First thing is, about 30% of associations are well funded. They are doing it. They have been doing it. They are ready to pay their expenses. And I want you to look around and think of all the daily use businesses that are out there, and they collect enough money from their daily use fees to maintain and replace all the components of their entire business entity. I’ve never gone to a hotel and been special assessed for a new carpet in the hallway. I’ve never turned a rental car in. They say, Mr. Nordland, I’m sorry, but that’s going to be an extra couple 100 bucks for a tune up, or 1000 bucks for new tires. Sorry, you’re just the wrong person at the wrong time. And hey, 95% of the time, it’s really the daily rate, but 5% of time, yeah, you’re gonna get hit with a special assessment. That’s not the way to do it. I’m gonna, if that happens, I’m gonna stop going to that hotel chain or renting from that rental car company. Hey, folks, treat me like a grown up. Tell me what it’s gonna cost so I can understand and appreciate how to move forward, and that’s what I want to do here in a callback, talk to you about perspective. Just because you can’t see it well doesn’t mean that others can’t see it well. So in the near term, I give it to you, board members, a lot of managers, you can see the commonly, obvious type things are easy to see. You can see them with high confidence, no special skills required, but as you move to the middle range, maybe 10 years out, it requires some skill to look ahead. Experience is helpful, and you can be pretty sure what’s going on, and maybe even pretty sure about what’s going on downstream long range. But there are people who do that all the time, reserved a providers are number one among them. It requires experience, but we are very comfortable. We see this all the time when you see associations that go from new to mid range to poor, it’s just so patently obvious. And I want to give you confidence that just because you can’t see it doesn’t mean that it is unknowable. There’s a lot of things that are easy to understand, if you just know the right questions to ask are the right people? And in this situation, the answer is, it’s found in a reserve study. So let me turn the corner to the last section of our presentation today and wrap it up in a summary. What I want to be able to tell you with and leave you with is that projects are approaching with unnerving pace. Think about that race where the cars are zipping around the course, zipping around the oval, at a high rate of speed. They are not stopping for a pit stop. Mother Nature and Father Time are moving forward fast those future reserve projects will happen. Now, you may not know exactly when it’s going to happen or exactly what the cost is, but you know that is going to happen. And as they draw closer, as you age, those projects get clearer, and you can refine the cost estimate. You can refine the timing estimate. Maybe five years ago, you thought the roof was going to be going to serve 15 years more after five years, instead of it dropping to 10, maybe you think it’s more down in the eight or nine range. You can refine your estimates as you get closer, but still, the roof is going to fail if you wait until it’s right in front of you. That obvious range to the untrained eye, you’ve lost your opportunity to prepare, and you’re now in special assessment or loan land. You’re I think, as Warren Buffett likes to say, when the tide goes out, that’s when you can see who’s wearing a bathing suit or not. So when the time comes to do your actual projects, that. When you find out who is prepared or not. Now, there are early warning systems, like you’ve heard the idea of a canary in a coal mine. They’re sensitive to carbon monoxide with community associations. The early warning system is a reserve study. It tells you where you are. Now, what you need to be doing? Do you need to be running for the exit? Meaning, do you need to significantly increase your reserve funding? Do you need to be pumping oxygen in with a special assessment or a loan you’re going to find this out in a reserve study. Or do you just need to move to a different section of the tunnel where there’s better ventilation? All you find in that reserve study is going to be helpful for you as you guide your association to the future, because it’s your choices. They’re going to determine the future of your association. All those little choices you make on a daily basis, on a monthly basis, on an annual basis, with a budget, they add up, and they have very real consequences downstream in years, the choices you’re making today are going to determine if you look like Aspen creek or not. There’s so many board members that just throw their hands up and say, Well, I don’t know, or let’s keep the assessments the same as last year. Or that roof can’t cost $500,000 we’ll find a way to get it done for 300,000 and you know it is what it is. And when you keep pushing things off, you get yourself painted into a corner, and you end up in a real jam. And that’s what I want to leave you with for the end of our prepared content. There’s plenty of more material on our website, reserves, a.com We’ve compiled a large body, a large library of written and video resources, all organized into different categories. We have a lot of a significant amount of video content on YouTube. If you search for a reserve study, most likely it’s going to be our content. Sign up for our channel, and then you’ll be alerted when we produce something new. It may be an entire new webinar, maybe portions of a webinar, like the different sections we’ve had in this webinar, so you can search for something particular to your question or your interest. Could be, how do we fund reserves? How do we choose components? Why did our reserve stake provider choose that component? How can anyone determine if you have enough money or not? Those are all questions we answer in the different webinars that we’ve done. And one thing special we have here at Association reserves is an online reserve calculator called you plan it, so when you get your completed reserve study. You also get access to you planet, so you can poke around and try some different numbers. Do some What if testing. Try a different interest rate. See if it’s worth going to a different bank where you’re getting more interest. Try splitting the roof project into two phases rather than one phase, lots of different things like that. Seeing how much is going to hurt if you upgrade to two coats of paint instead of one coat of paint, and it costs 20% more all that good stuff. You can see that online, on your own, and all those calculations are done per National Reserve, say standard. So it’s a great tool to help you in your decision making process. Basic principles that we’ve covered here today are all in our book, Understanding reserves available on Amazon, and I will put a link to free chapter one in our outline, so you can get a taste of how that book reads. And if it’s going to be valuable to you, we want to set you up for success at your association. And another tool we have for you is our weekly 30 minute podcast. It’s designed for board members to encourage, equip and inspire you, and that’s HOA insights, common sense, for common areas. You can subscribe from all the major podcast platforms. You can listen to it from our website, Hoa insights.org, or it’s actually on our YouTube channel also, so you can see the episodes we have that are current events that have subject matter experts, different attorneys on different subjects, how to read your financials, how how to take good Meeting Minutes, how to do Robert’s Rules of Order, all

Robert Nordlund 34:23

those kinds of things. And then once a month, one episode, every four or so, we feature a board member hero, just plain fun to sit back and hear how they’re facing the same problems you are, how they’re succeeding. They typically share some helpful tips that have gotten them through three years or five years or eight years, whatever it is, great stuff, great resource. And with that, I’ll turn the microphone over to Collie, who will coordinate our Q and A time together. You.