More About C.O.R.E. Services

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Doug McLain wanted to expand the opportunity to provide highly effective but fairly priced audits to condominium associations in Oregon and Washington.  I was honored he asked if I would join him on this new adventure.  We officially spun off from Currie & McLain CPA’s, focused on providing audit and review services primarily to condominium and homeowner associations.

We officially kicked off on September 1 with the new company and immediately started to set up our condominium audit processes.  Since we are looking for new ways to leverage technology to provide us better audit results while also reducing time and cost, every step, every procedure, is evaluated to make sure it fits our model.

It is now November and we are into the exciting part of marketing to condominium and homeowner management companies so we can be informed when a board wants to receive a proposal for audit or review services.

We will explore various topics relevant to condominium associations, financial management and what board’s of directors may want to look for when evaluating their financial statements and reserve studies.

We would like the opportunity to discuss how we can be of help to your condominium and homeowner association.  Feel free to write us at info@core-acct.com or visit our website at http://www.core-acct.com.

C.O.R.E. Services, focused on helping stakeholders rely upon management.

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Is Trouble a’brewin?

Two grand a month.

That is how much management is currently charging the condominium association we went to visit the other day.

$2,000 for management to provide financial statements that the board can’t make heads or tails of, vendors to go unpaid, delinquent owners to continue to not pay, projects to go over budget… You get the point.

“What are we paying for?” was the board’s overarching question.

Fascinating question.  Do you know what you are really paying for?

Here is what we believe you are, and should always be paying for, to the exclusion of everything else –

Managing the money.  Your money, your neighbors money.  Your hard earned resources that you have to turn over to your association to take care of the common property.

You have a right to know how money is coming in and how money is being spent.  Your manager has an obligation to report the activity to you.  They work for your association.  And you, my dear directors, are the elected representatives of your association.  It is often a painful, thankless task and your management is not there to make your life even more challenging.

“What do we get when we pay you?” was asked.

“Truthful reporting and strict control over your money.” was our reply.

“What about our newsletter?  Will you prepare that?”

“Do you think a newsletter is more important than your money?”

“No!” was the unanimous response.

“Then we will pass on writing your newsletter.  You can write it and we will focus on managing your money effectively and reporting to you how things are going.”

“Will you evaluate the ARC requests?”

“Do you think an ARC request is more important than your money?”

“No.” was the unanimous response.

“Then we will pass on evaluating ARC requests.  We will help control them to ensure the board and ARC committee respond timely and correctly, but we will leave the evaluating in your capable hands.  It is, after all, your community.”

As silly as it sounds, money is what really matters.  You plan what you are going to spend, you assess it and then…. what?

Do you have costs exceeding budget – only you don’t find out until year end?

Do you have off-budget spending and you never find out until someone asks about it two years later?

Are 20% of your owners not paying and you are paying extra to collect?  Or worse, splitting late fees with management?  Isn’t that an interesting incentive.

Condominium association management is all about the money.  It is all about getting the assessments collected – it is all about ensuring you get the maximum value from your vendor contracts.  Any manager who says that you ‘need’ them to send their handyman around to fix things or to show up to committee meetings isn’t really looking out for your association.

It is your money.  Ask yourself what could be more important than ensuring that you spend no more than what was assessed?  Ask yourself why you are ok with financial reports that you can’t understand – or worse – management can’t explain?  Ask yourself why you pay management to keep your accounting only to turn around and engage an accountant to make a bunch of adjustments at the end of the year to fix management’s poor accounting?

When it comes to managing your condo association, there are very few things that matter more than your money.  So, ask your management, “what do you think your job is?”

And, if they respond with anything other than, “Managing your money.” Trouble is a’brewin’. Consider finding new management that gets it.  And if they respond, “managing your money,” ask them if it is only because they read my blog.

Honestly, if you have to ask, you already know the truth – managing your money and reporting it isn’t their top priority.  And it begs the question, “can they be honest with you?” when they give you an answer which contradicts everything you know and feel.

Money matters.  Make the money your priority and you will be surprised at how well everything else falls into place.

At C.O.R.E. Services, we focus on preventing and detecting fraud so that owners can have confidence in their board. The boards are dedicated but typically outsource the management who often do not understand the vital role of systems dedicated to rooting out the risks of fraud. Our services are designed to help the board and owners rely upon their accounting and financial statements to help with the decisions surrounding their community and home. You can find more information about us on our website.

Making Sense of Your Expense

One of the more difficult aspects of our role as financial and accounting management to condominium associations is to get directors and owners to understand that spending reserve money is often a necessity.  They get used to having large balances and like seeing the interest income flowing in – or worse, want to use it as a low-cost investment fund to dabble in the market.  But there is often a cost to not spending money when it is necessary – and today we will explore that situation.

For the sake of discussion, we will work with the following example:  Association has $250,000 in a money market account drawing interest at 1.25%.  The roof had an expected lift of 15 years and the roof is now at the end of its expected life.  There are 8 units in the building, all under the one roof.

The board is getting ready to decide to replace the roof.  One director though, is holding out.  Her argument is that, since the roof isn’t leaking, there is no reason to replace it now and instead the association should continue to generate interest on the $250M.

This is not an uncommon dilemma.  The justifications might change, but the debate is the same; spend now or delay it until its broke.  The hard part of this decision is looking at it logically and letting the numbers help you decide.

First, recognize that you will, at most, receive $3,125 from the interest on your $250M money market.  This goes in the plus column as it money available to address the future replacement.

Next, you should consider the cost to your association of waiting and having the price increase.  This is that dreaded inflation factor.  If inflation is running about 3% (normal) then your $250M will potentially cost $7,500 more next year.  You offset a little less than half of that from your money market interest so you are still going to be out of pocket.

Now, address the risks inherent in waiting.

We use a weighted average approach to evaluating these types of risks.  You are concerned with the costs which would be incurred above your regular maintenance and which is also less than full replacement.  In short, if the roof leaks during the dead of winter, what costs will you incur and STILL need to replace the roof?

keeporreplace1

For this example, the board evaluates that there is a 30% likelihood nothing happens and the roof lasts through the winter up to a 10% chance that there is a major leak with significant damage to some of the units.  By weighting these numbers, you get an average of $8,425 of potential maintenance costs that might have been avoided with the roof replacement.

When you factor all of this together, you see that your costs increase about 5% by delaying the roofing project.

replaceorrepair2.png

The analysis indicates that it will cost your owners an additional $12,800 to wait on replacing the roof.  This, by the way, does not take into consideration the personal impact of potentially having their lives disrupted and irreplaceable heirlooms destroyed or damaged.

When does it make sense to defer?

keeporreplace2

keeporreplace3.png

Here, your analysis indicates that there is a 75% chance that nothing will happen this winter.  Perhaps this comes from talking with a roofing contractor who said that your roofing material isn’t fading as badly as normal.  Or perhaps your reserve study was wrong in deciding that 15 years was right – when your prior board put up 50 year life tiles…  Whatever the reason, the weighted average cost is only $2,800, much less of an impact.

And what if you were invested in a CD which generated 2.5% APY?  This almost accounts for the full impact of inflation.  Given this pattern would you be willing to defer?  Possibly.  A 3% change of significant damage is a much more acceptable risk than 10%, but it is still a substantial potential cost to the association and your neighbors.

Remember though, your role as a director in your condo association isn’t to maximize returns on investments but maintain and protect the common property.  Conservatism should be the operative word here.  Which means, when you are looking at reserve components at or over their expected life, the association should be far more inclined to replace than to hold onto in hopes of wringing out that last penny of earnings.  But do the work and back up your decision with sound financial principles and at least you can say you made the very best decision possible.

At C.O.R.E. Services, we focus on preventing and detecting fraud so that owners can have confidence in their board. The boards are dedicated but typically outsource the management who often do not understand the vital role of systems dedicated to rooting out the risks of fraud. Our services are designed to help the board and owners rely upon their accounting and financial statements to help with the decisions surrounding their community and home. You can find more information about us on our website.

If This Sounds Familiar, Ask Why

We recently met with a board to discuss the possibility of taking over their condo association’s accounting and financial management.  One issue they focused on was special assessments.

“How do you handle special assessments?”, was asked.

We create an amortization schedule in Excel.  We then record the payments to that special assessment for each owner on the date received.  At the end of each accounting period we also accrue interest – a fancy way to say we record the interest on the special assessments from the date of last payment through the end of the period – and then, finally, we reconcile the payments received to the change to the special assessment balances to ensure we recorded everyone’s payments.

“What is your hourly rate to do all that?” was the next question.

We don’t charge hourly for anything.  We perform this service for $50 per unit per special assessment annually.  So, if 100 of your owners have a special assessment balance, we charge $5,000 per year.  This works out to $417 per month.

“Ok, so how much do you charge owners for a pay-off amount?”

Nothing.  We don’t charge owners for a pay-off amount.  Our system calculates interest due through the day we open the spreadsheet (the interest accrual thing above) so we can inform an owner how much of the special assessment, and accrued interest, is due at any time.

“We’re confused.  Every management company we talk to charges between $50 and $120 whenever an owner wants a pay-off amount.  Why aren’t you charging that way?”

So let me see if I understand this.  You are charged by the hour for your management to record the special assessment.  They record it incorrectly and you have to engage an accountant to come in and get it right.  You then pay management an additional amount of money to make the adjustments to get the special assessment balances into balance… and to top it off, your owners have to pay management an additional amount of money for management to go in, record the transactions correctly, record interest properly and give the owner a pay-off amount?

In our world that is called double dipping.  We don’t believe in charging more than once to do the same work.  If you think about this logically, under their model, they get paid more money the bigger the mess they create.  How is this fair to anyone but management?

“How do you handle a serial assessment?” was asked by the treasurer.

“In what way are you referring?”

“How do you handle interest on a serial assessment when someone pays off early?”

What you are referring to is not really a serial assessment.  A serial assessment is nothing more than setting an annual special assessment for the amount of the bank loan payment.  So, if your annual payment to the bank is $240,000, each owner is assessed $200 per month to make the bank payment.  Since it is an annual special assessment, there is nothing to pay off an no interest to charge an owner for the use of the money.

For accounting purposes though, we would be required to impute interest at some market rate.  Typically, where we have an underlying bank loan and this type of transaction exists, we impute interest at the bank’s rate.  It is the lazy person’s way of doing it.  We then calculate the present value of the loan at the imputed interest rate to calculate the deferred interest part of the payments.

“That sounds complicated, do you charge extra for that?”

No.  It is all part of the same fee. We have a spreadsheet which does the calculation for us.

But what is fascinating is how complicated we have made something as basic as a special assessment.  You have a reserve project for $3,000,000, you have $600,000 in the bank.  You borrow the remaining $2.4 Million.  From there everything goes nuts.

“What do you mean?”

How do you go about collecting the $2.4 Million from the owners?  Board’s tie themselves up in knots and it seems to us that management and legal counsel are not very helpful in making sure everyone knows they are responsible for the loan payment.  So, they recommend you create hybrid repayment schemes to pass the responsibility onto future payors, all while trying to give a current owner the opportunity to soothe their conscience by allowing them to pay off their unit’s portion.  It is a philosophical problem that everyone tries to overcome through legal mumbo-jumbo.

The reality is, the reserve was short.  The current balance of the reserve is the responsibility of the current owners.  If it is short, it is short because they didn’t address the problem, either recently or when they bought in.  The underfunding problem has simply caught up with the owners and they have to pay the toll.  But boards’ spend lots of money trying to avoid holding themselves accountable.  But the problem is what the problem is.

….

I didn’t think we would hear from that board again.  Interestingly, they have asked us back for another round of Q&A.  I will keep you posted.

At C.O.R.E. Services, we focus on preventing and detecting fraud so that owners can have confidence in their board. The boards are dedicated but typically outsource the management who often do not understand the vital role of systems dedicated to rooting out the risks of fraud. Our services are designed to help the board and owners rely upon their accounting and financial statements to help with the decisions surrounding their community and home. You can find more information about us on our website.

It won’t get easier

ASC 606 implement1

Classic case of the ostrich syndrome.  Don’t know and don’t wanna know.

Yesterday, our article was on a practical way to implement ASC 606 for your HOA or condominium association.  Not surprising, many still think that this new principle will not have an impact on their association.  Perhaps also not surprising is that thinking the issue won’t impact your association doesn’t make it true.  If you are preparing financial statements in accordance with GAAP, there will be an impact and it is up to you, the association’s board of directors, to make sure management has documented the issue.

Delaying the decisions won’t make this any easier.  The closer you get to your year-end (December 31 for most of you) the less time you have to consider your options.  Yes, you may have alternatives, but you shouldn’t wait until February to evaluate them.  Many alternatives to avoiding ASC 606 will likely either require a vote of the board of directors or might even need a vote of the ownership.

Keep in mind that one option you might have is change your financial reporting framework.  If you are a small homeowners association, it might not be a bad idea.  But it should not be assumed you can simply instruct your manager to issue a cash basis financial statement.  Some associations’ bylaws have language which require that financial statements be prepared in accordance with GAAP. If you have such language in your bylaws, you can’t simply ignore it.  Nor can you likely hold a board vote to change the language as there is likely some restriction in your declaration (or another section of the bylaws or articles) which require changes to governing documents to be approved by a certain percentage of owners.

Oh, but my manager has always issued a cash basis report for the end of the year.  True but irrelevant.  If you have a GAAP requirement you should have instructed your manager to prepare the financial statements in accordance with GAAP; or you should have engaged a CPA to prepare GAAP financials.  I know, that costs money.  So does defending lawsuits against the association and your manager when someone finds out you have been ignoring the bylaws.  Check your contract – you likely agreed to indemnify the management company in this sort of situation.

And for larger, more complex associations, you might not have options.  If you borrowed money from the bank, there is likely a requirement to provide GAAP financial statements AND an audit.  Your auditor won’t be able to fix this for you.  This is a whole lot tougher than marking investments to market.

Six months.  If you have been preparing and issuing financial statements in accordance with GAAP, you have six months to get set.  You and your management need to evaluate if you have contracts with customers and then decide on performance obligations that make up the contract and how you want to allocate your assessments to those performance obligations.  Below is our little flow chart on ASC 606 from our new edition of “Trade HOA Stress… for Success” which is coming out in the fall:

ASC 606 flow

If you and your management don’t believe that you have a contract between the association and the units and unit owners, then you need to document that position.  It would likely be an incorrect interpretation of the standard but you, as the board, have the right to take such a position.  Again, you have to be concerned that your auditor will disagree.  Disagreement, by the way, will most likely require the auditor to issue an adverse opinion on your financial statements.  I am pretty confident bank’s don’t like adverse opinions…

If there is a contract, you have to decide on your performance obligations.  There can be any number of performance obligations.  One?  Perhaps but unlikely.  200?  Again, perhaps but unlikely.  Between 2 and 10?  That should encompass about 98% of most performance obligations for HOA’s and condos.    You have to decide and then document your reasoning.

This is why it won’t get any easier.  If you prepared GAAP financial statements and have them audited or reviewed, you are on your own.  Your independent CPA should not do this for you.  This is one of those standards where it is highly likely that your CPA’s independence would be compromised if they start doing this for you.  This is between you, your community management and any experts you care to bring in.  By all means, include your auditor to discuss your decisions and see if they agree with your conclusions.  Listen to their recommendations and then act.  Don’t be surprised though if your auditor doesn’t have much of an opinion.  None of us have seen this in action at the association level.

Six months.  Start setting aside time, either at a board meeting or some other workshop where you can begin the process.  Review your documents, decide which framework is best for your association now and in the future and then get started on implementing the change.  Change to ASC 606 or change your documents to allow for another financial reporting framework.  Now is the time; six months goes by way too fast.

At C.O.R.E. Services, we focus on preventing and detecting fraud so that owners can have confidence in their board. The boards are dedicated but typically outsource the management who often do not understand the vital role of systems dedicated to rooting out the risks of fraud. We are also implementing ASC 606 for our condominium clients who have GAAP requirements.  If you would like expert CPA advice to help you through this change, feel free to reach out to us.  Our services are designed to help the board and owners rely upon their accounting and financial statements to help with the decisions surrounding their community and home. You can find more information about us on our website.

 

Ideas on Implementing ASC 606

A question came in the other day: How can we begin implementing ASC 606, the new accounting principle required under GAAP?  The easiest way we have dreamed up is to start with your planning process.

Assuming you agree with our analysis of implied contracts, you might begin the process by identifying your primary performance obligations.  For most of our accounting and financial management clients, we have identified four primary obligations:

  • Management
  • Landscaping
  • Building and Surface Maintenance
  • Professional Fees

If you recall from our previous articles on ASC 606 and condo associations, we are approaching this from the philosophy that management and landscaping obligations should be treated as “ready to perform” which means the transaction price should be recognized monthly.  Building maintenance and professional fees are on a units consumed basis and are only recognized to the extent that costs are incurred.  Using this approach, we determine how much money was assessed in prior years for building maintenance and professional fees that have gone unspent.  These amounts form the basis of our deferred (unearned) revenues.

We then encourage our clients to budget as normal.  If they believe that they need to spend $18,500 for building maintenance, we would drop that number into our simplified ASC 606 planning and budgeting spreadsheet which tells us how much we should assess.  For example:

ASC606plan1

In this scenario, the client had $15,000 of prior assessments which remained unspent and, due to the method of recognizing revenues, are treated as deferred.  Our basic belief is that HOA and condo associations should budget to breakeven, which means that any carryforward amount should be subtracted from the planned expenditure to calculate the assessment.

If your association bills monthly, then you might see the following adjustment in your general ledger (GL):

ASC 606 plan2

The $9,167 is the $110,000/12; which is the amount that all the owners would be assessed every month.  You may have a slightly different process (we use a different method for our clients) so your actual result could vary but the concept will still be the same.

Next, management would recognize those revenues which are determined to be earned on an ongoing basis, the “standing ready to perform” method:

ASC 606 plan3

In this instance, your condo association is deferring the $1,334 – the difference between the total assessed and the total earned on the “ready to perform” method.  This amount is recognized when such an expense is incurred.  Such as,

asc 606 plan4

When you schedule out your unearned revenues, you should see something similar to the following:

asc 606 plan1

By starting in the planning stage, a lot of this can make intuitive sense.  The assessments for management services seems logical to recognize on a monthly basis as management services are always available; whereas building maintenance is typically consumed when needed.

The important thing is to start analyzing your association and the contract between the association and the units and unit owners.  You are trying to analyze what performance obligations – essentially the promises your association makes to the units and unit owners.  Your analysis might come up to a different result than what we have come up with – all you need to do is document how you came up with your answers and why.  But, if you decide that some performance obligation exist which can realistically be carried forward because they were not consumed, you might want to consider using a model similar to ours in determining what amounts were deferred and how you calculate current and deferred revenues from your association’s assessments.

At C.O.R.E. Services, we focus on preventing and detecting fraud so that owners can have confidence in their board. The boards are dedicated but typically outsource the management who often do not understand the vital role of systems dedicated to rooting out the risks of fraud. Our services are designed to help the board and owners rely upon their accounting and financial statements to help with the decisions surrounding their community and home. If you would like to discuss ASC 606 and how it applies to your HOA or condominium association, feel free to write or call.  We would be happy to help you.  You can find more information about us on our website.

How you got here. A time traveler story.

My post of the other day, where I stated that a condo association could simply assess the monthly payment to the unit owners apparently struck a nerve with some.  Not that part, these well-meaning people agree that you could (but did take exception to my opinion that it probably isn’t right to do so) assess a bank loan that way; they were upset by my statement that GAAP would require treating the amount due from the owners as a receivable for the present value of the cash flows.

Yes, even well-intentioned accounting professionals don’t always agree.  I can assure you though, I am correct.  But more fascinating were the questions about how you could get there.  How does it happen that there is such a huge deficit in the reserve, wasn’t anyone paying attention?

Imagine you are the treasurer of your condominium association.  There is an owners meeting tomorrow where you will have to explain the reason for a bank loan and the board of directors decision to only assess the monthly bank payment, instead of collecting the amount due from the current unit owners.  You fall into a fitful sleep and soon have a vision.

You are transported back to that very first day, when the condo opened.  You are one of the new owners and you are so excited about this purchase.  But something strange has happened… you also know what is going to happen in 20 years – that major reconstruction project which now requires borrowing $5.0 Million from the bank.

You find yourself standing in front of the community room, the same room your board of directors uses for its meetings.  The difference is the walls gleam, the lights don’t flicker and the tables and chairs have not yet been used.  This is it, the first board meeting and you are in attendance.  You often said at board meetings that you wish you could have been a fly on the wall way back then and now, here you are.

The treasurer, your predecessor who passed away 5 years ago, is addressing the board.  “… so while it is true that the association will face a reserve project of about one million dollars in 20 years, it isn’t something we should burden the new owners with today.  Think about it.  It’s a new building and won’t have any trouble for at least 15 years.  We can start collecting in two years and it will only push up the reserve contributions about thirty dollars per unit annually.  But man, buying these units cost us all a lot of money and then we have to furnish them and paint our units…  I suggest we defer the reserve assessment for this year.”

What, wait!  What reserve study said only a million dollars in 20 years?  It is $7 million and that only covers a little over have of the total cost.  And it doesn’t make sense that the board only deferred that first year because we only have $2 million in the reserve fund!  Don’t they realize that we are going to have to borrow money to deal with this problem?

Another board member, long since sold just after the eight elevators were repaired 8 years ago, asked, “A million seems pretty low, how certain was our reserve specialist about that amount?” Ah , some sanity after all you think to yourself.

“We didn’t hire a reserve specialist, we did it ourselves.  Tom used to run a construction company and I am a financial planner so we know the construction and the numbers.  We are very confident in our analysis and don’t think it is worth $500 to bring in someone who doesn’t really understand our building and the costs we all incurred to own this building.  Besides Tom, you’re a divorce lawyer and you know how good these ‘guesstimates’ really are.  Why bother?”

Your heart sinks as you start to do the math in your head.  There are 200 units in the building.   Your current $5,000,000 deficit works out to, lets see $5M divided by 200 units divided by 20 years… $1,250 per year.  Another one hundred dollars a month is what put us in this predicament?

Your thoughts continue, today, each owner is facing a special assessment of $25,000 or we have to borrow the $5 million.  You remember that it works out to almost $200 per unit for its portion of the bank loan payment.  Double!?!

Wait, this also means that when I bought in, the owners before me hadn’t paid in their fair share!  You again do the math and you realize that 5 years ago, the people you bought from should have paid in almost $20,000 more over their ownership than they actually paid!  They walked away with that additional $20 grand, leaving me to fund the balance.

You pop out of your moment of dream-like self-pity and realize that something has changed.  The lights aren’t as bright, the board members are a little older and there are even new faces.  You must have jumped forward in time!

“… and because of the addition of 24 hour per day concierge service we overshot our operating budget by $250,000.  I move that we transfer funds from our reserve to the operating to cover this expense.”  Said the treasurer.

“Seconded.”  muttered another board member.

“Any questions?” asked the chair.

“I have one.” Ah, one of the newcomers to the board.  “Why don’t we go back to the owners and simply have they cough up additional money to cover the short-fall?  From what I see, our reserves are already low and we heard at the last board meeting the elevators are probably going to have to be repaired in two years, which will drain our reserves.  Each owner will only have to come up with $1,250 to bring our operating fund into balance.”

“No way,” responded the treasurer.  “You weren’t here when we tried to get this budget passed.  It was a hard sell even before we decided to offer the concierge service.  And remember, even though we got that new reserve study showing that we are probably going to be short in fourteen years when we need to do the major project, we can’t get them to go along with an increase to cover the reserves.  No, the best we can do is take the money from the reserves and then try to get an increase passed for next year’s budget to repay it.

“Besides, it probably won’t even be as big a problem as the reserve company says.  You know they have to be conservative and add in everything imaginable.  We live here and know our building better.  Even though Tom moved on, we have Larry now who used to be in the trades and he is as comfortable as me in saying that it won’t be $6 million to completely update the building in fourteen years.”

You chuckled, humorlessly, that so never happened.  As a matter of fact, you seem to recall looking through old financial statements which showed that, in this particular year, it was almost $400,000 transferred from the reserve to operations.  And only six million dollars for the reconstruction?  It is almost eleven!  All of these terrible decisions are being made which are going to cause hell in just a few short years, don’t you understand?  You rage soundlessly in your little time bubble.

“All in favor?” asked the chair and after the six board members all stated “Aye”, pounded his glass on the table, the echo reverberating as you faded out of your dream.  But as you fade out, you hear one of the board members mutter under his breath,

“And none of us will be here when we hit that wall anyhow.  It will be the new owners problem, why should we try to solve it?”

You awaken, covered in sweat.  A nightmare, it was just a nightmare you repeat to yourself, trying to calm your racing heart.

Now I know how we got here.  What am I going to do to help us deal with it?  And you go out and do a search for thoughts on how to take control of your condominium association…

And here you are, reading my blog.

 

 

Let it be a future problem

As with anything related to contracts, there is more than one way to deal with a dreaded reconstruction project when you don’t have money in reserve.  It is, sadly, far too frequent an issue, but an association can make a conscious decision not to deal with funding a reserve and doing all major reserve projects through bank loans.

Ignoring GAAP for the moment – I will come back to it later – the concept works like this:

Condo association with 100 units borrows $2 Million at 4.0% interest.  Payment term is 10 years.  The monthly payment to the bank is $20,249.  The difference between today’s example and yesterday’s article on special assessments is that today, the board is not calling for a special assessment.  Instead of demanding payment of the $2.0 Million, the association is going to pass the monthly payment to the owners as an addition to their regular assessment.

Since there are 100 units, the monthly per unit (in our example all units are equal) comes to $202.49.  The board adds this amount into the annual budget and the owners make their assessment payment for their operating expenses, perhaps a reserve contribution, and the bank payment.

Handled this way, there is no opportunity to do anything more than pay your regular assessment as normal.  You, the current owner, are not on the hook for your portion of the $2.0 Million.  When you sell, the buyer steps in and takes on that payment as though it were a regular assessment.  This, by the way, is called a serial assessment in the popular jargon of community management.

We have seen this in practice and have not seen it done correctly yet.  Most try to make it complicated and there is no need to, although I can appreciate the lawyer’s concerns as paying principal and interest is not an ongoing operating expense; which, by the way, is the only thing you can put into the association’s operating budget according to state law in many cases.  And, it is not a reserve contribution… so, the concept is a bit fuzzy.  But, there is nothing which can stop an association from borrowing money and then passing the payment through to owners in accordance with their ownership percentage.

Is this approach in the best interest of the association?  Most likely not.  Imagine you are a plank owner and you joined your board on the very first day after buying your unit for $250,000.  The developer gave you his most recent reserve study, prepared on day 1 of turnover, which shows that the condo association should set aside $10,000 a year to replace the roof in year 11.  You concur with the rest of the board that you do not feel putting money into the reserve is necessary.

The units appreciate in value by 2% per year.  At the end of year 10, your unit is worth $335K.  You sell.  The next day, your buyer is hit with a resolution to borrow $120,000 at 4.0%.  Someone is not going to be happy.

So, while you can approach a special assessment in this manner, it should be handled carefully.  Condo associations with underfunded (or even unfunded) reserves are setting themselves up for a special assessment and the board needing to make these challenging decisions.

Now, how should this be treated for GAAP reporting purposes?  Easy enough, at least under old GAAP.  ASC 972 requires associations to take the present value of the assessment related to the amortization of the bank loan and record it as a receivable from the owners.  If you assume that the market rate of interest is equal to the bank’s rate of interest to the condo association, then, unsurprisingly, the present value is $2.0 Million.  You would debit the owner bank loan assessment receivable and credit revenue for the amount “earned” in rehabbing the condo property.

The rub is if you believe that the bank’s interest rate is below market rate.  Remember, the bank is willing to loan the condo association this vast sum of money because the association has to spend the money to collect it from owners.  Under real market conditions, your owners might not be able to borrow the money at less than, say 7%.  In which case, the present value of the amounts to be collected from the owners is $1.7 Million, with the rest considered interest.

So, a condo board of directors can call for a special assessment and demand payment, with the understanding that some to most owners will need to pay the special assessment over time, or the board of directors can borrow the money and pass the cost through as part of assessments without requiring – or allowing – payoffs.  Either of these two positions, properly managed, will produce the desired outcome; payment of the bank loan on time.

One bit of advice.  Do not try to get creative.  You are a volunteer board and your management team probably doesn’t have a financial wizard on staff.  An attempt to be creative on a condominium special assessment will leave owners confused and increase the risk that there is something materially in error in how it is either calculated or applied.  The KISS rule should always be followed to ensure that this sort of transaction works out to everyone’s satisfaction.

At C.O.R.E. Services, we focus on preventing and detecting fraud so that owners can have confidence in their board. The boards are dedicated but typically outsource the management who often do not understand the vital role of systems dedicated to rooting out the risks of fraud. If you are thinking of a special assessment for your condominium, consider having a conversation with us to discuss your options and how best to manage the ongoing payments.  Our services are designed to help the board and owners rely upon their accounting and financial statements to help with the decisions surrounding their community and home. You can find more information about us on our website.