Monday, April 25, 2011

Adding Bad Debt and Contingency Line Items to Budgets

With the high delinquency rates in Associations, many Associations are not able to effectively collect dues from homeowners that are not paying. Several years ago, Homeowners Associations had better abilities to collect using the non-judicial collections process because more frequently, owners had equity in their units. Nowadays, not only do most not have equity, most are upside down.


What are the consequences of delinquent payments to a community? The Association's main source of income is to assess and collect from the members of the Association. Maintaining the common areas...the corporation's assets, depends on the assessments from the members. When members do not pay their portion, there are some detrimental affects to the Association:


1. Budgets have to be modified to include bad debt. In other words, the paying homeowners end up paying a bit more in order to cover the expenses for the individuals that are not paying their assessments.


2. Standard maintenance items become unaffordable. A lot of Associations have had to increase their dues but cut back on services. Homeowners who are not recognizing the adverse affects of this economy are not recognizing the reason for less service but needing more money.


3. One of the first areas that Boards....unfortunately....tend to cut back on a bit is the reserve contribution. Boards are fearful of increasing dues even when it is absolutely necessary. So, they subsequently fail to raise the dues enough to cover expenses and properly fund the reserves. Deferred maintenance becomes more prevalent, and future special assessments become eminent. I see this too often where Boards want to hold off on spending the reserves when they decrease the reserve funding. The property starts to appear run-down, but deferring maintenance is more costly in the long run! When the property is not maintained, the property values are also affected.


4. Any budget deficits are added to the next year's budget. However, once again, the first thing that is not paid when you have insurance, water, trash, electricity and other essentials, is your budgeted reserve contribution. So, not only did the Board slash the reserve contribution, now you can't afford to actually make the reserve contributions that were budgeted. At the end of the year, the Association has to notify the membership of this, but the following year leaves a bigger gap for the Association to catch up on. Again, more deferred maintenance, more of a need for a special assessment, and more appearance of the property being run-down.


5. Some Associations, if they have really failed to budget properly, will start borrowing money from the reserves to pay the operating expenses. The Association is required to pay back the monies borrowed within a year, or otherwise disclose to the members that the money was borrowed, the purpose of borrowing the funds, and notifying members as to why the money will not be paid back. Items 3 and 4 listed above just get worse.


6. Now Associations may turn to lenders to try to get loans to deal with capital improvements. The members have to vote to approve the loan, but often times, members are given somewhere around 1-7 years to pay off the loan. Some owners choose to pay off their portion of the loan up front, while others choose to maximize their payment options. This feels like a dues increase, because loans will usually add a big chunk to monthly assessments. The community value reduces with respect to sales prospects.


7. The quality of life of residents / owners suffers. People struggling with finances and deteriorating buildings are not happy. Usually, when a community gets to this point, this is when the politics among the members begin. These situations create rifts, adversarial groups, and a hostile environment for neighbors, managers and Board Members.


As managers reading this blog, we can all relate to this, and I sympathize with any going through this. As residents in a Homeowners Association, you may have experienced this and may have a better understanding of how things get unbearable. You may also have a better understanding now of why a 3-7% increase may not be ideal but is much better than continued cut-backs and improper budgeting just to keep members happy and in the dark about the true financial conditions.


All in all, those creating the budgets should be conscientious of bad debt expenses. If you currently have delinquencies, start factoring that in the budget. I always advise my communities that do not have fully funded reserves to maximize the reserve contributions. A few of my communities have asked me whether I advise them to decrease their dues or avoid increasing dues when it's necessary when looking at the real figures. I always advise my clients that proper funding and planning is the right way to go.


If you have any questions or would like to provide me with any off-line comments, please feel free to email me at NedaFirouz@gmail.com.