“Budgets and Reserves” –
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Episode Transcription
Bernie 00:00
You’re listening to the KSN Podcast and on this episode we’re talking about budgets and reserves.
Welcome to the KSN Podcast, where you’ll hear from the KSN attorneys, as they share their experience and insight on legal issues surrounding community associations, collections, property tax appeals, and landlord tenant law. This episode is an edited re-play of October 11 2023 webinar presented KSN attorneys Kelly Elmore, and David Savitt. Kelly and David discussed budgets and reserves for condominium, homeowner and townhome community associations. Topics include inflation challenges, expenses, capital improvements, special assessments, reserve studies, best practices for board members and property managers and more. KSN is an experienced legal resource, ready to provide you with quality advice and exceptional service. Please reach out to our law firm if you have any legal questions, we look forward to demonstrating how we’ve earned the trust of 1000s of clients since 1983. If you’d like to reach Kelly, or David or any of KSN experienced attorneys, please call 855-537-0500. You can also visit ksnlaw.com and complete the contact form to send us a message.
Kelly 01:26
My name is Kelly Elmore. I’m a principal at KSN. And with me tonight, I have my partner David Savitt and we are going to be talking about the exciting topic of budgets and reserves. So we know many of you are gearing up to do your budget meeting. All right, so first up this evening, quick overview, David’s going to run through the topics that we will be addressing this evening.
David 01:56
Thank you. So, today’s topics, we’ll talk about Inflationary challenges. We’ll do a little bit about expenses, sort of your routine, fixed type expenses that you’ll see, when you’re doing a condominium association, or homeowners association budget. We’ll talk about those capital improvements as well. These are a little bit different than your routine expenses. And we’ll get into sort of that. Later on in the presentation, we’ll talk about the ever dreadful special assessments. And then, sort of how those play into your budget considerations. We’ll then finish up with reserve studies and finally ended some best practices that Kelly and I have seen in our practice for you to consider, as you adopt your budgets for the upcoming year. And one thing we want to sort of point out as sort of a disclaimer here.
The laws and ordinances relative to the adoption of the budget, of course, vary by state.
So, it’s important in the topics that we’re going to discuss tonight, to work with your association’s attorney to ensure that you’re following all of the relevant state laws and ordinances. I always say, in my practices that you know, as it pertains to the budget, this is one of those areas where it’s really important to dot your i’s and cross your t’s to make sure you’re doing everything procedurally correct, because this is one of those areas where owners like to challenge the board.
Kelly 03:14
Yes, that’s a good point, David, because there’s nothing worse when you have spent months as a board member or a manager, preparing your budgets, agonizing over what to prioritize for the next year, sending it out to the ownership, and then only later to have a challenge by an owner because the notice wasn’t sent with the proper number of days notice or it was approved by the wrong entity. And certainly hate to have associations, have to backtrack and redo that process. So, hopefully the information we share this evening can help your association avoid some of those pitfalls and make sure you are just aware of generally, what to anticipate when you go through the budget process and as you prepare for certain expenditures.
David 04:03
And speaking of expenditures, I think, you can’t start a conversation about budgets without the word Inflation. And this has been something that unless you’ve been living under a rock over the last couple of years, you’ve definitely heard about that, I can’t tell you how many boards we talked to, that talk about the fact that Inflation is high, cost of services and goods are higher than they anticipate, you know, all indications seem, that’s going to sort of continue into 2024 and beyond unfortunately, so definitely something that we need to confront in the budget adoption process as a reality of the situation we’re dealing in. And sort of, you know, when I talk about inflation, right, we’re talking about sort of these unforeseen factors that drive up the costs and drive up the amount that you as a board need to collect and assessments from your members in order to accomplish all of your goals for the upcoming year.
So, some of the more common ones that we see in our practice, that boards confront us about is sort of supply chain issues, right? You know, in terms of getting the goods and services that you need vendor availability, because the vendors may not be as available or to do a project, there the cost for that particular vendor may have gone up from the prior fiscal year to do the same contract. So, something that we definitely need to keep in mind in terms of what you’re budgeting for goods and services. And, of course, the increased contractor rates, like I was saying, where, again, to accomplish one particular task, it may be more expensive in the next year that I was in the prior year or two years ago, or five years ago. So, all of those things, you know, all of those rising costs, again, something that, you know, boards need to realize, are an upward pressure, in terms of the cost that you’re going to need to collect from your owners. And I want to add also that, those last two bullet points are some of the consequences that we see in our practice that arise when boards raise their assessments, right, we see a situation where owners may increase the short term rentals that they’re soliciting, or certainly higher number of delinquencies, you know, something that boards need to be mindful of, in terms of their costs and potential legal costs as well for budgeting for the upcoming fiscal year that, you know, if assessments are going up to meet these upward pressures on the costs, that the association is going to incur the upcoming fiscal year. They may need to also be mindful the fact that owners might, because they, you know, need to collect additional money themselves to meet those demands. You know, maybe a more delinquent or certainly may take, you know, options like short term rentals as a way to sort of collect additional income. So, something to be on the alert for, as you budget as well.
Kelly 06:36
Absolutely. And staying on that topic. David, I think, you raise a really good point, especially about anticipating that the costs from last year or the cost from this year are not going to be what they are next year. Speaking from experience, as I have a small construction project going on myself, I can testify to the fact that the cost of lumber and some other materials that I saw last year are certainly not what we’re seeing this year, and I’m expecting those costs to increase. So, for those of you who have spent time going out getting bids, trying to estimate what the expenditures might be for next year, always a great idea to either a go out and rebid that project or just plan for some increased. What I think David and I tell our clients quite often is, very few times do constructional projects, or large capital expenditure projects ever come in under budget. But the large majority of the time with projects that we have seen, they’re actually coming out above what the estimated cost was.
So, as we’re going to be talking tonight about how you plan for expenditures, certain things like special assessments, always overestimate when you’re circulating the years and trying to gauge your ownership and estimate a project because very often are the numbers going to be lower. And as David said, you know, one of the things we have certainly seen as a direct consequence of some projects that may be sort of spiraled a little bit or the boards may be underestimated. And suddenly owners were not able to cover the costs, which were higher than anticipated. That’s when we do see owners, you know, sort of making other plans, suddenly, now they need to rent out the property, and or just stop paying assessments altogether, which is never what we want in these types of situations.
David 08:35
Exactly. And you know, that has consequences as well. But definitely something you want to be mindful of. I think, Kelly makes a great point, too, that you’re going to be generally speaking happier, if you sort of overestimate in terms of these costs, rather than under estimating and then scrambling later to either revise the budget down the road or find other ways to collect money, you know, separate and apart from the budget, that could be sort of, send you scrambling. So, definitely a good idea to sort of be realistic about these costs, be realistic about these factors that are pushing up the cost for the association in the given year, and sort of think about them now, early stages, rather than sort of try to deal with them down the road. And so when we talk about expenses, right, really what we’re talking about too, are your fixed expenses, these are your landscaping costs a year to year, these are your, you know, other types of maintenance costs, things like that you know, are going to be part of your budget year in and year out. Ideally, they’re relatively predictable. Obviously, you know, we’re not like we just talked about we’re in a little bit of a unique time relative to costs and inflationary pressures. So, while that may have been true, you know, a few years back, I think, that’s becoming a little bit less true given the dramatic increases in an inflation but the ideal situation would be though, you’d have a part of the budget as well, that should sort of be your standard year to year type predictable expenses that you know, you as an association know, you’re going to have to. And of course, though, you know, those kinds of expenses are unique to every Association, right? Certain associations have a pool, certain associations do not. Certain associations spend more for landscaping, as opposed to other associations that maybe don’t have as much green area. So, this part of the budget, of course, is customized and sort of unique to your particular association. And it’s going to reflect the things that you as a board want to accomplish, you know, for your given year, as well.
Kelly 10:28
And on those Association expenses. Well, we always like to remind board members is, the budget is really an estimate. You’re trying to predict as best you can, what the annual expenditures will be for the association so that you can set your assessment amount, whether it’s a monthly assessment or annual assessment, or your ownership. But, you know, over the years, I think, we’ve had board members come to us in a bit of a panic, you know, why do we exceed our snowplowing budget this year, we’re not expecting the weather to be what it was, and we exceeded it, it’s absolutely fine. You know, the board is not strictly stuck to remain within those categories.
Because again, the budget is just the best estimate prediction. Now, we certainly don’t want associations, you know, budgeting for certain fixed expenditures, and then going off and taking on new expenses that could have been anticipated and could have been worked into the budget. But it’s, you know, a bit of a work of art as you’re working through your annual expenditures, your monthly expenditures, and trying to come up with a best guess. And then we’re also going to talk about associations and setting aside funds, reserves or other types of accounts to plan for the unexpected.
David 11:52
In an ideal situation, right, you would learn from the years prior as well. So, this is something that is truly an art, it’s something that, you know, you sort of build off each year to make your budget more and more accurate, hopefully, to the expenses that you incur. And of course, it is an estimate and a best guess as to what your costs are going to be for the given year. Just to sort of outline some of those types of fixed expenses that that we’re talking about here. And obviously, in the interest of time, I’m not going to get into each one specifically. But you can see a lot of these things are your sort of general types of expenses that of course, you’re going to incur every year, one of which being, you know, hopefully, your legal services, right. You know, we’re obviously here in KSN, to assist as your legal issues come up, hopefully, you know, we can be of assistance. So, again, any of those type of expenses, right? Those are the things that you’re going to see in your budget, you should expect to see in your budget, year in and year out in sort of a hopefully fixed type manner.
Kelly 12:49
And you raise it and point about that, David, if you can, you know, wherever possible, I know many associations try, you know, as you bid out, particular expenditures, if you can capitalize on a fixed plan or lock into a contract a year before, you know, for example, I know, with legal services, firms like ours will provide, an annual or monthly amount or retainer plans anytime you can sort of lock in to those fixed amounts so that hopefully, there’s not going to be a lot of up and down or unexpected in your association. That’s certainly ideal.
So, capital improvements. So, this has been quite a topic of conversation for many associations over the past several years, as I think there has been a national trend of focusing on more capital improvements for associations. You know, anything that is a large project for your association, whether you’re a homeowner association, a townhome association, a condominium association, every association has their unique setup as far as what property is, either that common element or common area property, some associations have very little common area property that they are required to administer and maintain or repair and some association have quite a bit of area. So, when we talk about capital improvements in our industry, we are talking about any new common element or common area, type of project not previously installed upon completion of the community.
So, maybe a new type of improvement in your association, a solar panel, adding a new amenity, a clubhouse, a pool, a tennis court, for some high raise associations that might be adding a rooftop deck or things like that, or constructing a community dog park, but we draw attention to these types of expenditures because they really differentiate between your monthly, day to day, week to week, year to year expenses, which are really more of your operational routine expenses versus maybe some of these large big improvement projects where you’re looking to enhance your community, add value. And the reason why it is a big deal to draw such a distinction between those types of expenditures is, there’s many different jurisdictions, different types of rules that govern how we fund them, limitations that the board or the ownership might have as far as what can be approved and not. So, we’re going to, as a big picture, touch on some of those items this evening, to sort of walk you through some of the issues, you should be aware of.
David 15:47
That’s really the heart of it too, you know, with regard to capital improvements, if this is some things, we’re thinking about doing in your association, it’s really important to contact your attorney early on in the process, because you’ll remember, I mentioned at the outset, dotting your I’s and crossing your T’s. These are the types of expenses, where you’re going to want to make sure, you’ve talked to an attorney ahead of time, that they’ve reviewed your internal governing documents and make sure that you’re following the appropriate approval requirements to make sure that any expenses related to these particular capital agreements are enforceable. Like Kelly said, many times, there may be a situation where there’s expenditure limitations on what the board can authorize on its own, or it’s a capital improvement. Visa, when the owner approval is required. And there are certain steps that need to be taken, if you’re going to get owner approval to make sure, that’s done properly.
So, this is one of those examples where in the process, it’s really important to get in front of your attorney early. Let them know this is something, you’re thinking about doing. And we have that process laid out so that you’re following that particular portion of the process appropriately and approving these kinds of expenditures in a way that’s, you know, in conformance with the law.
Kelly 16:59
And I am seeing a couple of questions on that topic, David, about expenditures. But one of the questions was about, Can a lobby renovation be considered a capital improvement? Certainly, you know, a lot of and I see a couple other questions about, are certain items considered a capital improvement. One, it’s going to depend on, you know, how your association is set up, whether your HOA condo townhome, and then also how the particulars of your governing documents define certain items and or the jurisdiction in which your association is located. So, those are typically a little bit more facts, the civic, and I think, one of the questions about, Can capital improvements be repair to existing elements, you know, again, depending on the history of what the project is, what exactly the association is doing. I know, over the years, David and I have had a lot of discussions and, you know, analysis on. Okay, well, is this more about repair? Is this more of a replacement? Is this more of an enhancement that would be considered an improvement? And it really just depends on the particular situation.
David 18:10
Everybody’s favorite legal answer, right. It depends. And it is a fact specific issue. And it’s one of those things where, like I said, it’s really important to get that in front of the attorney early so that we know this is something you’re thinking about doing, can sort of analyze that for you. And then, we can guide you appropriately. And these are the types of the questions like Kelly was outlining. These are the questions that we ask from a legal perspective to make sure, we’re funneling those improvement, requirements appropriately.
Commercial 18:39
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David 19:22
So, the next thing we want to talk about is, maybe the word that catches everybody’s attention the most is, the dreaded special assessment. And when we talk about special assessments, what we’re talking about are assessments that are separate from your regular assessments. So, let’s say, you budget and you didn’t budget enough for the particular year and you need to collect additional funds. This is your vehicle to do that. And, you know, if you’re thinking about doing a special assessment, that may affect how you budget your regular assessments. Maybe you say, to the owners, you know what, we’re going to adopt a budget that’s maybe a little bit lower in regular assessments, it’s more appealing to them with the idea that you’re considering a special assessment. You know, to supplement, you know, so special assessments are definitely something in my experience, and I’m pretty sure, Kelly as well that owners pay attention to, it tends to be to those situations where the special assessment gets announced, you suddenly start to see, instead of having five owners at your meeting, now you have 50. Right? Seems to be, that’s the case.
So, this is something that definitely catches people’s attention. Kind of like capital improvements as well, definitely something you want to get legal advice on, to make sure you’re doing appropriately, because it’s definitely one of those areas that owners love to challenge. And of course, there’s differences in state law, in terms of how you authorize and enforce a special assessment. So, really important to sort of get that in front of the owner, like attorneys, like I said, to know those requirements, again, spending cap in terms of what the board can levy, do you have to get order approval before you levy this special assessment. I will tell you in Illinois, we have a pretty favorable provision in the condominium property that generally gives the board, the ability to adopt a special assessment in any manner, it sees fit, there are certain limitations to that. But generally speaking, gives the board lots of flexibility in that regard, without having to go to the owners for approval on the front end.
And of course, certain situations may require special assessment, when we’re talking about threats to common property or emergencies. When we talk about immediate dangers, or the structural integrity of the common elements, or common areas, or to the life, health, safety or property of the unit owners are certainly mandated by law, these are kinds of things where associations we’ll use, that as an ability to sort of circumvent owner approval requirements that may or may not exist in a particular governing documents or under the law. But generally speaking, these are the types of questions, that you’re going to want to think about, if a special assessment is something that you’re thinking about doing, you know, as you sort of plan on introducing that to the owners.
Kelly 21:51
Absolutely. And, you know, as you pointed out, the differences in state law, and potentially in your governing documents, could have a major effect on the analysis for your association. So, for example, in some states where we represent associations, some of the associations require owner approval for certain types of special assessments. So, even though the board can put out there, what is expected as far as the need for future expenses, the owners have the ability to approve certain expenditures. And so education, I think, is one of the key tenants that we usually promote, as board members and managers, as you’re going through this process. As David said, you really want to plan really well in advance, if you know you’re going to have a project because how you educate the owners on, this is a project that needs to be done, here’s why it needs to be done. Here are the things that we looked at here, the cost that we’re anticipating, the education and the upfront advance notice can really cut down on issues at the end of a project.
You know, earlier, we talked about delinquencies and associations who unfortunately experienced problems, if certain expenditures aren’t anticipated. We have certainly seen quite a few issues in associations where, you know, for whatever reason, whether they weren’t able to or just decided not to set aside funds for unanticipated expenditures. And a special assessment was required due to a sudden urgent issue. You know, it’s a lot harder when you’re sort of behind the eightball to go and maybe, get an association loan to fund the project or a line of credit. It’s just a much smoother process, if you can plan for it in advance. Oftentimes, we recommend speaking with a financial representative, a banker, there are many who specialize in working with just community associations. So, as much as you can plan in advance, it’s never too early to start talking about that as a community, especially as we began seeing this, focus on how associations are administering the common property and whether or not boards are taking care of the property.
David 24:18
And this is a comment for our Illinois listeners tonight. With regard to Illinois law in special assessments. One of the other things you need to be really mindful of, and this is with regard to, you know, talking about it early and planning early with a special assessment is on your resale disclosures. We here in Illinois, have a requirement that boards need to disclose any special assessments that are contemplated in the current fiscal year and the two succeeding fiscal years as well. So, something that look, once you start to talk about and contemplate this type of a special assessment is really important to also plan early to have your Association’s attorney. Update your resale disclosures to make sure that, special assessment is properly being disclosed even if it’s in the early stages to your potential buyers to make sure that you don’t run into a situation where a potential buyer who becomes an owner then refutes the special assessment for not having been properly disclosed at the time they closed. So, really important thing as well to plan for early on in the process with regard to a special assessment, setting the stage for a special assessment that’s ultimately enforceable against any of your owners.
Kelly 25:24
And one thing, I want to highlight because I know not only have I received questions in this seminar, this evening about this topic, but I think, I’ve received three or four inquiries just this week about the cost of insurance for associations, so many of you are aware of what occurred in Surfside, Florida, you know, the increased focus on capital expenditures and maintenance, and we’re going to be talking about reserves and what the definition of reserves study. But one of the costs that we’re hearing quite a bit in the industry about our insurance costs. And I think, what we’re hearing from some of the insurance professionals is that, many of the insurance companies who were previously insuring community associations, condo associations, homeowners associations are, you know, stepping out of that market, and it’s becoming a reduced pool. As far as the insurance companies who are willing to insure these types of properties. What that means is, that we are anticipating an increase.
Now, whether that, you know, I do think it varies state to state, and again, whether you’re a condo association versus a homeowner association, because you know, the liability issues are vastly different. But I am hearing anything from 20, 30%. And then, you also have to take into account for your association. If you’ve had prior claims, if you’ve had a history of litigation, or delinquency issues, things like that, all of those factors play into the rates that we’re likely to see coming out. So now might be a good time to touch base with your associations insurance provider. And one thing, that we always recommend, especially as we are dealing with a client, right now is going through a very difficult situation, please make sure you are working with an insurance company and an insurance agent who specializes in Community Association insurance. So, it’s a unique subset within the insurance industry. And you really want to make sure, you are working with an agent who is qualified to give you opinions on, Are we properly insured, Do we have enough insurance, Are we covered as far as liabilities for everything from slipping and falls to issues with maybe your association is large and your employ, an agent or an employee on site, as well as directors and officers liability insurance. So, annually, we always recommend please make sure that you are looking at your insurance coverage, and you are adequately covered going forward.
David 28:11
Now, with regard to notices, this is a, you know, another one of those dot your i’s and cross your T requirements. I can tell you here, in Illinois, we have very unique language in the condominium Property Act that governs notice requirements for special assessments. Even though, it’s a board meeting, we have a little bit of a nuance in our law, that says, you still have to notice a meeting, a board meeting for a special assessment in the manner, that you would a meeting of the owners. So that’s no less than 10, no more than 30 days notice. It’s just an example of the kind of works that exist, that you just need to be mindful of, if you’re going to be a special assessment, and one of the reasons, why you want to make sure, you talk to your attorney ahead of time to make sure, you’re giving the appropriate notice requirement because that’s something, that’s very easy to mess up thinking, it’s a board meeting, when you’ve got that little bit of a quirk in the law, in terms of how you notice.
Kelly 29:02
And for those associations. I know for our Indiana associations and some other states, where we have associations, it’s a little bit trickier. You know, we’re looking at your governing documents, the nonprofit act with respect to guidance on notification to the owners. Generally, it’s a reasonable notice. But we are particularly paying attention, especially in Indiana to the requirements under your bylaws and or your declaration for the type of notice regarding a special assessment.
David 29:35
And just as a quick comment to you know, when we talk about owner share of the special assessment, right, that’s going to be something that’s governed by your government document. It’s going to depend on sort of what structure your association is. Again, very important to consult an attorney, make sure you have that information ahead of time, because the owners will want that information. Once, the board adopts a special assessment. It’s usually good practice to send out a notice to the owners after the fact letting them know, this is what the board has adopted, here are the terms of the special assessment and reducing that to writing so that there’s a record of it, and giving them their respective share. So, it’s really good practice to get into, I know something that our office can assist you with.
And we routinely do for our clients, making sure that term language gets reduced to writing, making sure that it’s clear for everybody, what the repayment obligations are, and that the board has adopted this. And it’s clear what their respective percentage and what their percentage of the special assessment is, right? We want to make sure people pay what they owe, that they’re clear on the obligations, because the last thing you want with respect to special assessments is higher delinquencies. Yes, this is a way of ensuring that everybody knows, what their obligations are going forward after the board makes this decision.
Kelly 30:46
All right. So, moving on to a topic that we’ve been receiving quite a few questions about. I know in the past few weeks, as some associations are looking at doing a reserve study of generally speaking, a reserve study is prepared by an engineer and or a company that specializes in community associations. And when a reserve study is prepared, an expert will come out, they’ll review the building, they’ll look at the history, property, you know, the various buildings, townhomes, lots, whatever your association is. And they will provide a summary of the condition of the property really from top to bottom, and give you an educated opinion on the lifespan of various elements of the property. Generally speaking, I think most reserve studies can look out maybe 10, 20 years, we often get the question, How often should we do them? Or are we required to, for our Indiana communities, there is no requirement under any law in Indiana, regarding the necessity of maintaining a reserve study. So, currently, if your association has a requirement, it’s something that would be found in the declaration, but there is no legal requirement, unlike in Illinois, where there is provision under the law, requiring that some reserve account be maintained. And when these experts come out, again, they’re looking at your community as a whole the history, prior expenditures, prior repairs and improvements that have been done. And generally, we’ll deliver a very comprehensive report, again, trying to identify, here the things you need to do over the next year, two years, five years, 10 years. And generally, their estimate of the cost, I do always remind owners and board members and managers. You know, a lot of times if you have a reserve study, and let’s suppose it was done eight years ago, kind of going back to earlier what David was talking about with costs changing from year to year, we generally remind board members to try and go, you’re ready to move forward, you’re going to want to bid that project out. So, the numbers, likely, if they were prepared eight years ago or five years ago, are probably not going to match up with the realistic cost in today’s numbers. But the idea with the reserve study is, One, it’s going to identify major areas within the association, that the Board should plan for repair, replacement, improvement over time, and hopefully also a general idea of the costs.
David 33:38
I think, those are great points. And also you know, I like to tell my clients too, when it comes to reserve studies. Reserve studies are a guide, right? They are not a mandate. So, it is not legally required that you follow your reserve study to a T. And the reason I bring that up is, there’s been a recent change in the Illinois condominium Property Act, you’re in Illinois, that requires boards under Section 19 of that Act to produce a copy of the reserve study if requested by an owner. So, the reason that’s significant is, prior to that there wasn’t an obligation to produce these reserve, says, even though many boards did to your ownership, and we see lots of times, and I’m sure this is true wherever your association is, and when owners get a copy of that reserve study, and if the board hasn’t followed it to a T, they essentially try to use that as a way of saying or critiquing the board or saying, that the board hasn’t lived up to its fiduciary obligations. That is not true. The board is not obligated to follow that reserve study. One of the things, I have done with our clients is, suggested that KSN prepare a cover letter, if that reserve study is going to be circulated and made public to the owners letting them know exactly, this is a guide. It is intended to be educational, maybe potentially aspirational, but it is not necessarily a mandate to follow. So, you know it’s really important that if you’re going to share those findings in the reserve study with your owners, or if you’re required to make sure that they’re couched in the proper terms.
Kelly 35:05
And that’s a really good point, it would be kind of, where that issue comes up a lot. You know, earlier you were talking about disclosures by [Unintelligible 00:35:12] when someone’s going to sell, whether it’s a condo unit or a home, you know, certainly now, we’re getting a lot of questions from potential buyers, Are there anticipated expenditures, and Is there an anticipated special assessment. And I think, oftentimes people get those terms confused. And association can anticipate expenditures within the next few years. But that doesn’t necessarily mean that there’s going to be a special assessment, if a board is you know, listening to a fantastic seminar by some [Crosstalk 00:35:47] properly plans or this expenditure over time, then the cost can be absorbed, and there never is a special assessment. So we do always like to highlight, there really is a difference between, you know, anticipating certain expenditures, and then, special assessments.
And then, as David said, the reserve study, if your association does actually do a reserve study, it’s not a mandate. So, if it says, all of these items, you know, should be repaired or replaced, there are some associations that simply cannot absorb certain replacement. So, for example, let’s talk about Windows, in certain types of associations, that can be a very costly expense to do a full scale replacement project. And that might be the Rolls Royce option, and a great option for the long term. But if you’re an association, where you have other priority issues, and it just can’t absorb that kind of costs, you might go with the repair option. So, you know, the reserve study is intended to be instructional and a guide for the board. But as David said, it is not a mandate, how often should we do it, that is going to depend on the size of your association, what type of association you are. So, for example, a brand new high rise association that was just built in 2022, that might look a lot different than in association that was built in 1960. So, and experiencing some issue. So, our best response to that is consult with your attorney, you have a management company, also, they’re such a great resource. They’ve seen everything typically. So, we’d recommend that you consult with your experts in deciding, what makes the most sense for our association, as far as, Should we get a reserve study, How often we should get a reserve study, and then also amounts.
You know, as far as setting aside funds. I’ll quickly talk about it again, in Indiana, I know for our Indiana communities, there’s no requirement to set aside a reserve under the law. So, if your associations governing documents does require that the board set aside reserve funds, if there are any parameters, we would look to your governing documents. But even in our Illinois associations, for example, condominium associations, while there is a requirement to set aside amounts for reserved funds. There is no mandate as far as the percentage. So, there are some guides as far as elements, you can look at, what the board should consider in setting the amounts. But there is no specific mandate as far as a percentage of the budget or anything like that.
David 38:37
One of the common ones that gets thrown around that I’ve heard about is 10% of your association income should be contributed to reserves. I’ve heard people say, that as a mandate, and that is a guideline, I will tell you just to sort of add to everything we’ve talked about with reserve studies, Fannie Mae and Freddie Mac, since Surfside, one of the things that they do ask about is a reserve study. So, if your association hasn’t had a reserve study, and you’re not one of those newer type of properties, really something you might want to consider, because that is something that, those authorities are looking at as part of their analysis as to whether to insure mortgage loans. Not saying, they will do it without a reserve study, it is just one of the things that they are looking for in their analysis. So, definitely something that’s worthwhile. And again, though, I do want to emphasize, here in Illinois, especially, it’s just one of many factors that you consider in terms of setting your reasonable reserve. It is not a mandate, it is just a guideline, and something that should be a helpful tool for you, when you set your reserves going forward. You know, paying for reserves study again, I mean, you know, it’s something you want to budget for, right? If it’s something that you’re thinking about doing. They’re not cheap, as far as I understand. So, they’re definitely something that you want to think about ahead of time. You know, it’d be something that you budget for as a regular assessment payment, something then you would do a special assessment for perhaps If it’s something that you maybe didn’t necessarily anticipate in the budget, but want to ask owners for as a special add on to your assessments that are collectible for the fiscal year.
I think, Kelly made a great point, you know, management’s a really great asset in terms of trying to come up with reserve studies and plan for that process. They’ve seen it all. So, a good management company, somebody that you can rely on as a board, to sort of plan that out and work with them in terms of structuring, how you’re going to go about paying for this reserve study, when you’re going to go do it, and when it’s necessary, and how often you should do it, they’ll definitely have good information relative to that issue.
Kelly 40:39
Yes, and as you’re planning for the collection of assessments, or special assessments, especially if you’re either trying to set aside funds for reserves or for projects, one factor, to always keep in mind is the potential for delinquencies. So, if you know, you need $500,000 for a project and the board, decides to or the owners, you know, does proceed with a special assessment in the amount of $500,000. You know, always be prepared that there might be some owners, who can’t or are unable to pay. So, that should also always be factored into, as we talked about earlier, always add a little bit of cushion, whether it’s for increased costs, or, you know, work orders or unanticipated items. But it’s not just about the construction project itself, but also just your ability of the owners to absorb costs.
As David started out talking in this presentation about inflation, certainly, it is something that’s already on the forefront of our minds as we go into 2024. If rates continue to increase, there usually is a direct correlation with increased delinquencies, increased foreclosures. So, that’s another factor as you all are looking at your budget this season and setting your amounts for next year. Keep in mind there, you know, there might be some owners, who are going to pay late, but then, there also may be some owners who might be forced to go into foreclosure, who might be un-able to pay and those funds are ultimately not collected, or only a portion is able to be collected.
David 42:25
Way to hedge against that. Hedge against those risks have a healthy reserve account. So, something definitely you want to think about, this is your savings account, right? Because our healthy reserve account can take a lot of the stress off, because you have that money sitting there for those types of contingencies, right, those things that may or may not happen. So, definitely something you want to think about as you’re planning your budgets going forward. And I mentioned at the outset, we’d sort of brought some best practices, that we have seen in counseling associations through their budget process.
And I think, you know, one of the ones that we’ve been harping on sort of this entire presentation is the idea of being proactive in timing, a good budget to meet is something that’s sort of anticipated early, you’re spending time doing it and contemplating these estimates, something that you’re throwing together at the last minute, Is it really going to be a comprehensive budget, Is probably going to be something you’re ending up revising during the year, or we’re going to have a shortfall in terms of what you collect visa via your expenses for the year.
So, you know one of those things where you really want to spend the time on and you really want to start the process early, have the time to review the information before you need to send that budget out to your ownership, you know, really important they’re, establishing goals as well, right? Making sure that your budget reflects your community’s needs, I mentioned earlier, you know, it’s unique to you, right, every budget is unique to the association it’s for. So, you’re going to want to make sure, if you’ve got, you know, heavy landscaping costs coming up that your budget reflects that. And then, their goals are, you know that in terms of, what you want to contribute towards that particular expense, if you want to have a big capital improvement, right, and this is something that your association has been in dying to do, you know, making sure your budget reflects that. So, really making sure that those goals are met and are incorporated in your budget. Not only is it going to be good for your association, but it’s going to make your ownership happy as well.
And of course, looking to your past, right learning from prior budgets, if you know the last five years, you budgeted in a way that hasn’t met your expenses, but you kept your assessments consistent, probably not the best thing to do a six year in the row of that, right, it’s probably better to start thinking about, maybe we need to raise our assessments, maybe we need to learn from the past and make sure that we’re collecting enough so that we’re not facing a deficit at the end of the year. So, those are really three things that you can do in this process to make the process go smoothly and come up with a budget that’s going to work best for you all.
Kelly 44:47
Your point about being proactive. I think we can underscore that enough, especially if, as an association, you know, we’re probably going to need financing. I know one of our associations asked this Evening pen [Phonetics 00:45:00] and attorney assist, if we’re looking to get a loan, does it help having legal counsel, I will, again, go back to the comment earlier about working with professionals who really specialize in this particular area of community association representation, because I do think that professionals in the industry, whether they’re vendors, whether they’re bankers determining, whether or not to provide a loan, things like that, I think that they do place a lot of value on associations, who have all of their ducks in a row. They’re working with professionals, whether it management company lawyers, things like that, who are very well versed in this area, and who will make sure that, you know, if there is funding provided or you know, they engage in a contract with an association, that they’re surrounded by the professionals, that they need to ensure, that they properly fund and approve a project or a loan.
David 45:59
Then, sort of, you know, continuing on our topic of best practices, you know, we’ve talked about this as well, tonight, adequate reserve funding is it at all, when you have an emergency or unexpected expenses, we talked about hedging some of those risks that come up with budgeting, right, the reserve account, like a savings account, like a healthy savings account, is something that’s going to help you sleep at night, right? It’s still that kind of thing that you know, the more you have in reserves, the healthier that is, the easier it’s going to be in terms of your budgeting, maybe you don’t need to raise as much this particular year and regular assessments knowing you’ve got that sort of fall back if something were to happen. So, definitely paying attention to that reserve account. Even if you don’t have the legal requirement to have one. It’s something that in terms of a best practice is going to help with the operation of your association and help you budget. You know, it’s really important to make sure that your assessments are adequate.
I can’t tell you how many times, I get calls from associations that say, we really have not collected enough in assessments last couple years, we’ve really been trying to just keep the assessments consistent. And now, we’re in a position where we have to raise the budget at 50%. Right, that’s sort of an artificial thing to do for your ownership, it’s really more important to have a budget that overtime reflects your actual cause rather than sort of dumping a large increase on your ownership under the name of trying to keep your assessments sort of consistent for a number of years, it’s really important that you know, as a budget be or honest with your owners, in terms of what the expenses are going to be, so that you’re not in a situation where the other foot drops a few years later, and you’ve got this really large increase. And of course, with regard to Illinois law, one of the things that exists is, the inability to forbear on the collection of assessments, that means no matter what, you as a board have an obligation to collect your assessments as they become due, that’s your lifeline for the association. The association doesn’t print money, it only collects money from its ownership. So, really making sure that you know, if delinquencies do happen, your timely processing those in the manner consistent with your governing documents, or your collections policies that exist and turning over to KSN for collection as well. Yes, something we can definitely assist with.
Kelly 48:05
We got extra some interesting questions this evening on again, and going back to requirements within various states. So, in Illinois, there is no requirement that an association obtain a reserve study, there is a requirement under the Illinois condominium Property Act that a board set aside funds, you know, in a reserve account, and that provision of the Act does provide some guidance, and some factors that the Board should consider, when determining how much just set aside for a reserve fund. But again, there’s no specific mandate as far as the percentage amount. And there was one interesting question about, Does the state get a copy of the reserve study? And that raises actually a really good question, because I think, that there could be associations who might be concerned, like, hey, if we go get a reserve study, now, we’re going to be on the hook for all of this.
And once it’s out there, now we have to do everything. No, the state does not get a copy of the reserve study unless the state becomes an owner and is eligible to request a copy of your reserve study. But the state does not in any way, you know, jump at no state, you know, jumps in and says, you know, this was in your reserve study, you’re required to do this. I think, public policy fosters the idea that we want associations to be able to freely go out and hire professionals to educate the board members on what should be done as far as your property. So, there are no mandates. You know, I think overall, the resounding messages, reserve funds are a great tool and a great backup cushion for your association to have for the unexpected, but again, you know, your state law is going to vary. So, whether you’re in Illinois, Indiana, Florida, Arizona, or any of the other areas where we represent various association. The key is just working with your specific attorney on your particular building or property or association, and knowing exactly what your requirements are into your governing documents, or state or local law.
David 50:14
Right. And I think, I just want to emphasize too, because I think, Kelly brings up a great point, which is, it’s important to couch your reserve study, if it’s something that you’re going to make available to your owners to read, I really think, that putting that into place in terms of the overall perspective is really important for owners to understand that, it is a tool, that it is a guideline, that it is helpful, but it’s not a mandate. I think, that’s going to take away a lot of questions from owners or complaints about owners, if you’re not following that reserve study, to a T. And many associations are not so you know, that’s something that you definitely want to consider. It’s something we can help with. If you get a request for a reserve study to be published or provided your ownership.
Kelly 50:55
Absolutely. There are a number of services that we can assist your association in providing, whether it’s… It looks like, we got quite a few questions about, can you point us in the right direction of whether it’s a management or managing agent who can assist us in figuring out some of these issues. We’re a professional for reserve study, we are happy to work with you to get you to the right professionals and happy to coordinate. In addition, as David mentioned, we can assist with updating your rules and regulations, assessment collections, that becomes an issue in your association, advice on reserve funding, violation issues litigation, and for those of you pursuing projects, reviewing your contracts. If you have questions, please feel free to reach out. We’d love to be a resource and assist your association.
Bernie 51:47
That was KSN attorney, Kelly Elmore and David Savitt. KSN is an experienced legal resource, ready to provide you with quality advice and exceptional service. Please reach out to our law firm, if you have any legal questions, we look forward to demonstrating, how we’ve earned the trust of 1000’s of clients since 1983. If you’d like to reach Kelly, or David or any of KSN experienced attorneys, please call 855-537-0500. You can also visit ksnlaw.com and complete the contact form to send us a message. Thanks for listening.
Outro 52:23
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