Recovering from Underfunded Reserves: Strategies for Associations

Robert Nordlund 00:07

Well, thank you, Paige, and welcome everyone. Thank you for joining us for this webinar today, and thank you for taking time out of your day to dive into learning Well, I greatly appreciate that there’s a number of board members here. Wow. What do we have 60% 66% board members, and so many of you are concerned about your underfunded reserve, so I appreciate that, and I welcome you. We’re going to work on that problem today because we want to lead you to an improve the future, and that starts with understanding what the problem is and how to get out of it. For today, we’re going to walk through today’s program in with this agenda. First all, very having a better understanding of Do we have a problem? So let’s dive right into that few things I want to share, and some basic principles. And one of them is that owning real estate is expensive in the community association industry, we’ve heard so many times that owning a condominium can be a carefree way to live, and that may be true, but it is certainly not free. There are major common area components, projects that need to happen on a regular basis throughout the association, and that needs to be paid somehow. So owning real estate is expensive, and owning in a community association is no different. The second thing is that the board is responsible to sustain the association. They set the budget. The homeowners provide the cash. It’s a symbiotic relationship where they work together. And I enjoy this cartoon here because it’s two gentlemen speaking to each other, and they’re saying this fiduciary thingy really complicates pillaging a corporation. And it’s a joke at the situation, and it’s just a reminder that board members are fiduciaries. They are responsible to look after the best interests of the Corporation and its members. So we have to be very careful that you board members and the managers who support you are making wise, informed decisions. And the third is that mother nature and Father Time are very real and very powerful, and as of today, undefeated. Every day the sun comes up, there’s weather events, and the properties that we live in and work in are wearing down, and we have to appreciate that they are the enemy. The enemy is not state law. The enemy is not the governing documents a governing or the enemy is not the board of directors. The enemy is mother nature and Father Time. We need to fight up against them, put up a good defense, or they’re going to get the upper hand and turn our properties into with enough years dirt. So the question is, do we have a problem, and how big is it? And for everyone here, listening to the program, joining us here, that’s your question today. Do we have a problem? How big is it? What am I going to do about it? We start out with this idea. When I was thinking about the webinar today, I was thinking about how we are carried downstream into the future. We have this current that’s drawing us forward. And so I started thinking about this idea of river rafting, river rafting on a current, and we start out with no problem, and no problem is it’s a sunny day, we’re on some inner tube type things. We’re in the shallow water, and no problems. We are here just to have fun. We have no concerns. And so that’s a starting point. Then we start to think, Okay, well, how fast is the water flowing? And for your association, that means, how fast is everything deteriorating? How fast do we need to move just to keep up, because Mother Nature and Father Time are in control. They’re driving us downstream. So what’s that number at your association? And that is the very specific number, and we get to that by looking at your component list. We’ve done this in a prior webinar where we show the component list here. Something similar to this, and see pool furniture, roofing, asphalt, repainting hallways, things like that. And we take it one step further, and we do a calculation on this. We put another column on the right, and we call it the cost of deterioration, and it is literally the cost of the project divided by it useful life. You can see it very easily here in the second line item, $1,000 divided by 10 years. It’s $1,000 per year, if you can do the math, $8,000 a year for the roof divided $8,000 for the roof project. Divided by 20 years, is $4,000 a year for all your components, to add them up. And everything at the association here is deteriorating at 20,170 per year. If you are setting reserves aside at 20,170 per year, your deterioration rate, you’re really not getting anywhere. All you’re doing is keeping from falling farther behind. So if you’re in a catch up mode, you need to be setting reserves aside. More than that. If you’re in a surplus situation, like some associations are, it’s okay to dial it back a little bit and slow down your reserve funding to get back to a good safe place, which is the 100% level. So that’s your deterioration rate. That’s how it’s calculated. It’s all based on your reserve components, and should be custom to each and every Association. Now that you know how fast the basically, the water is flowing, then you need to ask, what is our starting point? Are we starting at a good place? Are we starting in trouble? You can see these people are looks like they’re either taking a break or starting their river rafting trip at a very peaceful place where it’s nice and shallow. They’re just smiling for the camera. No worries. But we know many associations are in a troubled position, so let’s talk about that for a moment. We know that you can’t get things done if you can’t pay for it, if you have a leaky roof, if you have deteriorated asphalt, if you have spalling concrete on the outside of your building, if your iron work is rusting, if your elevator is breaking down more often than you’d like it, you can’t get things done and fixed and replaced if you can’t pay for it. So money is critical. So that’s what I’m going to address when we’re talking about your starting point. And it’s not just the cash here in the reserves world. We talk about your starting position with in terms of percent funded. It’s your comparison between the amount of deterioration at the Association and the cash that you have. The cash is on the numerator and the deterioration is the denominator. It’d be nice if they’re balanced and you’re at 100% funded, but so often this is a situation that we see at negotiations where the deterioration gets the upper hand. There’s more deterioration than there is cash, and that’s why we have this curve in the chart. Now this is a chart of special assessment risk on the vertical scale and pretend funded on the horizontal scale. So on the left is

Robert Nordlund 07:51

low percent funded, three to 1010, to 20, and 20 to 30. You can see that there’s a relatively high risk with special assessment. No surprise, really, for associations that have, relatively speaking, very little cash compared to how much facilitation exists around the association. At the end of the mid range, 30 to 70% where there’s a fair amount of special assessment risk, we call them infrequent. Call them frequent. Here, infrequent in the fair range, and rare in the long range for all the negotiations that are above 70% funded. So this tells you, are you in a heap of trouble now, and I want to specifically talk to the associations that are in the weak range, zero to 30% funded. That’s a high risk of special assessment. You need to be concerned about that. And for those of you who the 45% of you who said you for sure are in an underfunded situation, most likely you’re in this range. I don’t know if you know it or you just feel it, but we’ll call you the underfunded one. And you may ask, okay, 45% of us in this webinar today, but is that Representative across the country? Well, fortunately, we have the statistics on that, and this is the population of associations in each risk range across the country, you can see that about 34% of associations are in the poor range, or weak range, where they have a high risk of special assessment. These are the ones making all the news. So it’s not like everyone is there and then the fair range is in the middle, and actually that’s the largest population of associations in the middle, where they have infrequent special assessments here and there, maybe a big, unsettling event, maybe a surprise. They don’t have a lot of margin. They have special assessments periodically. And then there’s 26% of associations are in the store. Long Range, where they just don’t even think about special assessments because they have the cash set aside they’ve been responsible over the years. Now that’s a national profile, and some of you are thinking, well, that’s not my reality. And if that what you’re saying, maybe that’s because you’re in Florida. Florida is one of the two states in the country that give homeowners the opportunity for a line item veto for reserve funding. Now, about two years ago, that was partially taken away, and so in the last couple years, more Florida associations are responsible to address their reserve needs. But still, there’s so many community associations in Florida that have gotten themselves behind. 49% of associations in Florida are in the weak range, and that’s why, if you’re going to ask, what state in the union would we have a Champlain tower South tragedy, I would guess Florida. And then you add, not only is it the association with a very disproportionate amount of poorly funded associations, it’s also a state with warm temperatures, moist ocean air, moist ocean air, things like that. Now the other state is Ohio. It doesn’t have quite as many associations, and so it doesn’t make the news as much. But this may be your reality if you live in Florida or Ohio. So at this point, we know how fast the river is flowing, that dollars per year of deterioration. We know where to find it. It’s in your reserve study. It’s a calculation. It’s a number. Now you know that your reserve funding needs to be in that kind of range, and you also know how well equipped we are or aren’t. What where are we starting? Where’s our starting point? And that’s what we measure with percent funded. But still, the question is, how big is our problem? We know how fast things are deteriorating at our association. We know what our starting point is, fair, weak or strong. But how big is a problem at our association? So let’s spend a moment talking about that, and that’s important, because you need to identify what’s our first step. What are we going to do now that we maybe have learned something about our association? Do I go this way? Do I go that way? You know how I how am I going to solve this problem as a board member, as a manager, what’s my move? And you need to start screwing up your courage, because you need to know that you got to do something. Now we look at this in the review study industry with your what we call the expense map. It’s your chart of annual reserve expenses. It’s a nice, easy way to see what’s going on in front of you in the future. This is how you can see the future and prepare for it. Now, I’ve got a number of these charts. I want to talk you through them and help you see them the way I see them, so that you can see how big your problem is. Now, a disassociation,

Robert Nordlund 13:17

pretty much, not much going on in the first year, but they’ve got a medium sized set of reserve expenses in the next year. Then they have a lot of recovery years until they have to get ready for another big expense year, and they have a long time until they have their biggest expense here. So in addition to preparing for these expensive years, on the side, they know they got inquinified some extra money to get ready to climb this mountain. But in other words, they don’t have crisis right now. They’ve got climb before their biggest expense. And presuming they’ve got enough money for the next couple years, they really have better part of 10 years. You tell that their reserve fund is really trapped, and that’s different from this profile. You can see they have basically a Mount Everest of reserve expenses in just under 10 years. And everything they’re need to be doing in these years on the left is preparing for that big ear you start acting with a short term lens and looking, I think it’s myopically at the near term, you’re going to walk right into this brick wall of a big effect. So you need to see things in a multi year perspective, and that’s why I want to make it clear that seeing the problems ahead of you is very important. And let me go to this next chart where this association had a big problem next year, hopefully they’re prepared. Hopefully this association has had board members that have done their job to prepare the association to set fund aside, because there’s a lot of years that kids require. Five. Expenses. But there’s going to be some years that are just plain big. Okay, another one nice gather of expenses through the years. A couple well, all the numbers are very big in the chart, couple million dollars in reserve expenses in the first year. But they’re pretty much spread out. They’ve got four big years out 20 years past. So they got 20 years to prepare for these huge events. Another different profile. A lot of scatter looks almost random through the years, but they’ve got to be. This is like a river that you’re rafting, that could have rocks all rapid, from where you put in the water to where you take out, rapid all the way no record point. And that’s different from that profile, where you have some very discreet, scary moment spread out. So you need to be prepared. Make sure you’re oriented. Make sure your raft is pointed in the right direction, aimed for the safe part of the passage through that set of rapid and I had to put in the property that I was working on yesterday. And this is a sad property, I can say it because they’ve allowed you can see what their normal profile is of expenses, all these little guys, well, they’ve become pretty much close to nothing, and they have all piled up. And now they have some real deferred maintenance. They have a leaky roof that is more than just the roofing material. They’re going to have to replace the plywood and some of the structure underneath the wood underneath the roof. They’ve just made it a very expensive project. So different negotiations have different profiles. The question is, what are the hazards in your path? You can see something coming up pretty soon for this river rafting group. Or you could see this group has gone through a hazard and it come out poorly. And in the association world, we say this is a messy special assessment, or special assessment that didn’t get passed, and the roof is continuing to leak and the asphalt is cracked, and they don’t even have enough money for the entry gate. So big problem with the survey now not the river that defined your revolt, because this is a picture of something very much like the Grand Canyon river rafting tour that I took a few years ago, where you’re going through some pretty significant rapids, but you’re well equipped. You have the equipment. You have a guide and an assistant guide, and you have a big motor at the end of the draft, so you have the wherewithal to get through trouble, and you have experts guiding your way. So even if you have a difficult situation, I showed you some of those annual expense charts. That’s where a lot of problems. If you have the cash, if you have the plan, you can be just fine. And that’s what I want to make sure you pick up here, that the upcoming expenses doesn’t mean that you’re going to suffer the expenses, just mean you have challenges. If you have a plan, and if you have the cash, you’re going to be okay. Let’s turn to that subject. How are you going to be okay? Let’s get you a plan, and let’s get you some cash. And this portion of program we call what are our options? And we start off with the understanding and the expectation that all of you are going to say, Well, my budgets tight. I get that. I’ve been in this industry 38 years, and every association that I’ve worked on says their budget is tight. Large associations, small associations, old ones, new ones, high rises, sprawling plan developments. They all say their budgets tight. What are you going to do in the light of your budget being tight? Well, Vic is a chart that I’m showing that is the cost of deterioration at this association. It starts out at at this point in time, using about $12,000 per year and gradually going to float upward with inflation and all their things, all their project get a little more defensive here. Same Association, same project, but everyone get inflated and just their roof, their asphalt, their pool, their elevator. The expectation is, this is what we’re going to have to face at our association. The question is, again, what are we going to do? Well, I’m going to divide the problem into two parts. One is the expenses, and let’s talk about that. First, can you make some of your expenses go away? Well, maybe, or maybe not. You can defer some of them carefully or creatively. We’ve done a webinar recently, earlier this year, actually, that talked about how I gave some examples where. I had an association with two elevators and very little money. They’re old elevators. They’re starting to break down more often. What we helped them figure out was to get one elevator modernized, basically cut the project cost in half, and plan to do the other one in five years with everyone primarily using the new elevator in the interim, and that was able to give them enough time to get this project done. Use the backup elevator for a few minutes, or not a few minutes for basically, was going to be about a year, and then have the new elevator that’s going to be reliable, faster, smoother, and cross their fingers that they could make it five years while they accumulated more funds to get that second one. So there’s ideas like that that you can do. You can perhaps spread out some roof projects. Maybe they don’t all have to be done in one year. Maybe you can spread them out over three or four or five years. But I want to make it clear that those things need to get done. There’s very few projects that you can actually snap your fingers or make them go away. An example might be a small solution, like a pool restroom. Let’s say maybe you have a men’s in the ladies room at this point in time, and maybe you close one and just make it into a storage room and make the other one a unisex room. That’s probably fine as much as the pool restrooms get used, and that can save you half of your cost of renovating pool restrooms. But remember ignoring roofing, painting, asphalt, hallways, elevators, boilers, chillers. Doesn’t make them go away. Those projects are still there needing to get done. So it’s very rare that you can actually make a project go away. Sometimes you can minimize the cost by taking good care of it and getting 25 years out of something that originally you expected to only be able to get 20 years of service in. So you can defer some things, if you care for them, or if you creatively manage them. But you can’t magically solve problems just on the expense side. You need to talk about cash. You need to talk about income. You have three tools here, increasing your budgeted assessments, levying a special assessment, or getting a loan. There’s there’s three tools that we have here, and I’m going to walk you through what they look like. First is talking about increasing your assessments, and the first is a step increase. Remember, our hypothetical here is that the deterioration rate at the association is $12,000 per month, and it’s going to go up with inflation. And so what the Association did, they’ve been setting aside $8,000 6000 5000 whatever, over the past 10 or 20 years, they’ve got themselves a healthy deficit, but they have a governing document, their state law, that allows them to increase their assessment to 12,500

Robert Nordlund 23:18

Okay, that’s a little bit more than their deterioration rate. They’re not falling further behind. And they’re actually a little bit each year catching up. So maybe they’re at 30% funded this year, 33% 38% 42% 47% 50% things like that, they’re gradually catching up and a conqueror. Here is that in so many cases, you don’t have to magically solve the entire problem all at once. It took you years or decades to get into this jam. Often, there’s ways to figure out a strategy that can take you years to get out but this is the case of a step increase in monthly assessments. Or you can do what we call a ramp increase. If you don’t have a pressing expense, maybe you can start to write the ship over the course of a few years, we’re starting at $8,000 a month, 9010 five. You see the progression here. And finally, your cash positive to your reserve fund, you’re rebuilding it, and for all these years, you’re rebuilding your reserve until finally, you’re pretty much where you want to be. So that’s another example of a ramp increase. You can do this if you have the time, if you have the year now, in situation where you have a pressing, imminent problem, you may be forced to do a special assessment. You need a lot of cash right now, you don’t have time to raise the assessments and collect a year or two or five years worth of higher monthly reserve. Reserve transfers. So in this case, let’s say you pass a special investment here, after you take a year to get things figured out, that solves the immediate problem is you through the rapids, and then you have a few years to catch up with your reserve funding until you’re even with the ongoing rate of deterioration. Basically, this buys you time. It gets you through the rapid and then if someone paid the special assessment, you don’t hit them with a big step increase. You just start saying, Hey, folks, to avoid a special assessment in the future, we’re on a 123456, year plan to get to where we need to be. All right, that’s what a special investment plan can look like, or it can be a loan plan. And I want to make sure you understand this same hypothetical that you started out at $8,000 per month at this place you’ve been underfunding for years, and the banker says, okay, we can give you a loan with two conditions. You pay it all back in, 123457, years, and you raise your assessments high enough that not only are you keeping up with ongoing deterioration. You’re paying me back because I need the money to I gave it to you. You borrowed it, and now it’s time for you to give it back. So what you look at here, look how high there was your funding. Everything transfers have gone 15 grand. That almost twice what they had been doing. And so the lesson here is that once you are beholden, once you are accountable to a banker who has given your money, they make the rules. They are the boss. And if they say you need to significantly increase your investment, the only thing you can say is yes, sir or Yes, ma’am. Now if I look at this, I think, holy smokes, if the association would have increased their assessment five years ago, even just up to their cost of deterioration, they could have avoided this whole problem and an expensive loan. So yes, loans are a viable option for many associations, Bucha care and expensive. All right, as I was preparing for this webinar the last week, I have a sample property, and I was going to walk you through some actual thought process and help me develop this kind of thing. And I realized I wanted to show you the examples and realize that I had enough content here that I didn’t have time to actually do the show and tell. So the question is, do you want to watch this demonstrated in real time? And so get your hands ready to raise hands, because I’ll record going through some of these decision points with our you planet software to illustrate what I would do in this situation or that situation. What other options on a sample property and give me a hands raised if you would like me to shoot a little web capture video probably end up being 20 minutes or so that you can look at on your own page. Is that? Did I describe it

Paige 28:24

appropriately? Yeah, I believe so. And it looks like hands are sure. So there’s definitely interest. Okay? And just to clarify, so this would be a video that Robert records and then includes a link in the webinar outline. So make sure that you fill out the survey at the end of the webinar to receive that outline, but it’d be something that you get to watch on your own time. Yeah, definitely some interest coming in. Robert,

Robert Nordlund 28:48

okay, cool. Are we at the 50% point? Because if people don’t care, then I’m not going to shoot

Paige 28:53

1. We are definitely getting to the 50% point. Okay, I will.

Robert Nordlund 28:57

That was my magic number. So I’ll, I’ll presume your estimate is good, and we’ll move on with the program, and I’ll do a little web capture video this weekend. In addition to cash, there may be some other problems in your path, and that’s some absence of annual increases at your association. Basically, if you’ve trained your association to not expect increases. They are resistant to change. That’s a problem. Or if you have a history of special assessments, and your owners feel tapped out, they’re like, Okay, we’ve given more than enough money to you guys, and we are done. And that sometimes goes hand in hand with no trust in the board where they the board has no what we call political capital. So there’s financial cash and there’s goodwill that is political capital. So there’s these other factors that are dialed into this, where if you have no history of increases, you basically trained your association to live in the past. If you’ve been special. Assessing them. They’re probably tired and worn out. And if you’ve been closed with your board meetings closed with Financials, if you have, well, I’m not going to go down to all the things, but I’m a real believer in transparency and open financials. So if you don’t have the owners trusting you, then you have an additional problem. And I just want to know this slide that it is very expensive to pay back a loan compared to a threshold investment, compared to budgeted funding. Budgeted funding is magic, because you put the money in over time, or 15 years, over 20 years, whatever it is you earn interest, the bank is actually helping your association. And the opposite is a case in a loan where you are helping the bank, you’re paying interest to the bank. And the whole idea here is that there are options, there’s expense side options and there’s funding side options. And discuss it with your reserves, a professional, they are going to know what custom solution might work best for you, and at the same time, start knocking on doors. Show some good will, make your message clear that the association there’s a bad guy out there. It’s Mother Nature and Father Time. We need to keep up. Our assessments haven’t kept up, and we need your help to be on board, because there’s going to be an assessment increase. You guys start knocking on doors, and that takes us to the conclusion part of our program here. So let me wrap up our webinar today, and I want to make it very clear that success at your association, success at recovering from underfunded reserves, is as much communication as it is financial. You need to take all that political capital that you have. You may need to build up some you need. You may need to be doing more smiling and shaking hands and spreading the news that deterioration is real, yet it’s worth paying more to maintain the property, our homes, our property value. And you can see at this association, the board members are all exasperated. They’re trying to talk about things the reserve funding, and people are saying, I don’t care. I don’t even buy green bananas. I don’t care about tomorrow. There are associations out there that really, it may take time just to build some political goodwill, build that political capital. So that’s it’s communication and financial. It requires political capital. It’s going to take the goodwill that you’ve earned and beyond that. Remember, owning real estate is expensive. There’s no way around that. Typically in reserves, we find that an association needs to fund their reserves at about 25% of total budget. So about 25% of all the cash you bring in should be set aside towards the reserve fund. You should only be spending 75% of your cash. That’s typical. The typical range is somewhere between 15 and 40% and the reserve fund, typical mean point is about 25% so keep that in mind, and you may have to raise your assessments to increase your the size of transfers to reserves. And then finally, understand that, in addition to success, being as much communication as it is financial taking advantage of the political capital you’ve built up. It’s not just money, understanding owning real estate is expensive, communicating that to the homeowners, success may take time to turn it around. It may take time to gather the cash. It may take time to build your political capital, and if all else fails, and you have a desperate situation and you need an emergency exit, there is an emergency exit available for some associations out there, and it’s called Association dissolution, or D conversion. It’s a whole host of new problems, but there are many associations that are starting to investigate this, realizing that they have let their associations go, and their P at their their past the turning point, and they they may be beyond the point of recovery. So there is that outside thing not going to go down that path, discussing that in today’s webinar, success is all about budgeting, to pay your bills, both operating and reserve. But by doing so, you minimize special assessments, you minimize deferred maintenance, you minimize costs because things get done on time. You maximize owner enjoyment, you maximize community spirit, and you maximize property value. If good things happen, when you provide the cash to get things done, you have a plan to get there. So it’s a journey to the future, and reserve study is going to guide you there. Now we’re here at Association reserve. You can reach us at reserve study.com We’ve prepared over 90,000 Reserve says we’re going to hit the 100,000th reserve, say, sometime this year. We have a lot of resources on our website, written and video resources, again, at reserve study.com if you are a video type person, maybe it’s easier for you to go straight to YouTube and search for reserve study videos. There a very large amount are there. If you find one that you like, sign up for our channel so you’ll be notified when we drop something new, whole size webinars, short portions of webinars, little two minute segments here and there, lots of content, care. And then, if you’re a reader, we have a book. It’s called Understanding reserves. Earlier this year, we just released the second edition of this book. It’s available at a very reasonable cost on Amazon, and understanding reserves, got a copy here on my desk that I will sign and hand out to someone who asks an interesting question in our upcoming Q A and I’ll put a link to chapter one on our webinar outline so you can get a taste see if the writing is pre your style. I do think that you will like it. And I mentioned that we have this online reserve calculator. It’s called you planet. It’s free with every completed professional reserve study here at Association reserves. It’s user friendly. All calculations are for national reserve safety standards, and it allows you to do some poking around and some what if analysis. Our clients who use it say that it really helps them explore options and see the future more clearly and nothing. Another resource we’ve developed for our specifically for board members, is our 30 minute weekly podcast for board members called HOA insights, common sense for common areas. It’s a podcast designed to encourage and equip the hard working board members out there or leading their associations forward. We feature current topics with current subject matter experts, and once a month, we have a board hero that we profile. So it’s a lot of fun that we have, celebrating board members, helping them again in the hard work they do, leading their associations forward every end of our prepared content for today, and I’ll turn the microphone over to Paige schauerman, who will coordinate our Q and A time together.