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.