Planning the Budget for a Successful HOA

I came across an article on HOA budgets in one of our real estate related newsletters. Since I work on the finance committee of a local HOA, it caught my eye. Here is an edited version:

Every homeowner association needs a well crafted annual budget to calculate the fees to be paid by the members. A review and revision should happen each year without exception because costs change every year. Failure to revise (read "increase") each year will put the HOA deeper and deeper in the hole. There are number of areas that every budget review should include:

Historical Operating Expenses. Examine the most recent 12 months' expenses to determine your base for each expense line item.

Anticipated Increases. Utility costs typically increase every year. Contract services also are subject to increase.

Contingency. HOAs often experience unforeseen expenses and/or revenue shortfall. Add 5-10% of the total budget to cover this.

Reserve Funds. Every HOA should set aside funds for future common element repairs and replacements. Both Fannie Mae and Freddie Mac (the entities that underwrite most home mortgages) require at least 10% of the condominium annual revenues be dedicated to reserves. For HOAs with little common area or few common elements, 10% may suffice but condominiums often need 25% or more of the annual budget dedicated to this purpose.

Experts advise not comparing the fees of one association too closely to that of another association. The financial fingerprint of each HOA is unique...no two are alike. The budget needs to be based on the specific services required to maintain the operation and reserves, not what the Joneses are doing. The Joneses may be headed for disaster. Even similar HOAs can have very different financial requirements. Some have higher insurance premiums due to prior claims. Some have funded their reserves appropriately, some are catching up, and some haven't even started yet. Some take care of repairs on a pro-active basis and some have deferred maintenance. Some have earthquake insurance, cable TV and Internet access and some don't. In other words, the "HOA fee" doesn't include the same costs in all complexes so comparing the bottom line without knowing what created it is meaningless. Your HOA fees should be based on specific needs, not the neighbor's.

What about cost cutting? Most HOA expenses are not discretionary but there are some areas with great potential for savings, such as:

Insurance. Increasing the insurance deductible lowers the premium. However, if this is done, there should be an Insurance Deductible reserve spread over, say, three years to cover at least one claim. If no claims are filed during the three years, the money is saved.

Landscaping Renovation. Older HOAs often have vast turf areas which are very expensive to maintain. Replacing turf areas with planting beds filled with drought resistant plants and bushes can dramatically reduce costs.

Lighting. Compact fluorescent bulbs use 70% less energy and last years longer than traditional incandescent bulbs. They usually work with existing fixtures and the brighter light they cast enhances security.

Heating & Air Conditioning. If the HOA provides central heating and air conditioning, it is often worth installing new energy efficient equipment. Your utility company usually can provide you a cost/benefit analysis. The older your existing equipment, the faster the payback.

Hot Water Heating System. The same cost/benefit approach applies to central hot water systems. Investing in new equipment can often pay back in only a few years with the energy costs savings.

In the final analysis, the board is charged with running business in the best interest of all members. Sometimes that means ruffling a few feathers. But the board has the fiduciary duty to set the HOA fees at a level that is adequate to cover realistic operating and reserve expenses. Budgeting for success means planning, leadership and execution.