One way of funding reserves and capital expenditures is by special assessments — when money is needed, current owners contribute the funds. Several complications exist with special assessment funding:
Owner Vote is Required
- The board may not have the authority to approve a special assessment and must obtain a vote of the owners. This could make securing approval for a special assessment difficult.
They are Unfair
- A special assessment impacts only current owners – it does not impact future owners, which may reap the benefit of projects funded by the assessment.
- Current new owners that have not yet enjoyed the facilities are forced to pay for those that have already benefitted from the facilities but have already sold their units.
Hard to Collect
- At any given point in time, a certain number of owners are unable to pay a special assessment because of divorce, job loss, disability, illness, or other valid reasons.
- The result is the same: cash flow problems for owners means cash flow problems for the Association.
- The Association can file a lien against the delinquent owners or even foreclose their units, but the money is still not available when needed.
Short Term Thinking Syndrome
- Associations with large number of seniors often have little interest in investing in long range planning, paying for capital items, or properly funding the Association’s reverse account.
- Many owners see reserves as paying for a benefit they will never enjoy. Reserve funds are used to pay for assets that are used up bit by bit every single day.
- When collected monthly, in the form of a regular assessment, reserve contributions pay only for projects from what the current (and not future or past) owners derive benefit.
- Paying into reserves is like refilling the gas tank of a rental car – you put back only as much as you have used.
- You do not want to pay for repairs and improvements that you will not “use up” fully while living in the unit – you should not pay for projects that provide enjoyment and benefit for other owners (future or previous owners).
- Why should you pay for someone else’s future roof?
- Fairly allocated reserve funds do not pay for someone’s future benefit. They only pay for the portion of the reserve components that current owners used up – no more, no less. With the fair funding approach, each owner pays into reserves only an amount needed to replace what they personally benefitted from, whether it is one year’s or ten years’ worth.
- Do not be fooled by the “we’ll pay later” arguments. Paying later shifts financial responsibility to others that do not owe the money, and the board will surely be faced with raising an unpopular and maybe uncollectible special assessment.
- To keep reserve funding fair, all owners should pay a fair share of reserve funding needs. Paying less than a fair share puts the burden on others in the future to make up the difference.
- With a reserve plan funded with regular contributions, each member contributes his or her fair share based on the time of ownership. For example, if a member owns a unit for three years, he pays for 3 of the 30 years of the improvement’s useful live; one that owns a unit for two years only pays for 2 of the 30 years. There are no gaps in contributions, and all owners pay equally.
- The money is available when needed, and the board knows when to spend it.
- All reserve fund contributions should come from regular assessments – just like income taxes are paid as earned, reserve fund contributions should be made at the rate the assets of the Association are being used up or consumed by its owners.
- Advance planning is crucial.
Consider the following common scenario:
Roof cost: $40,000
Useful life of the roof: 25 years
Number of units in the project: 15
Cost of roof use or consumption (depreciation) per unit per day: $0.30 ($40,000/25/15/360)
Every owner “uses up” (benefits from or enjoys) 30 cents’ worth of roof each day.
- Owner David purchased his unit from Robert two months after a new roof was installed on the building. There was a special assessment of $2,670 levied against each owner, including Robert, to cover the cost of the roof. Robert paid for 25 years of roof use but enjoyed the roof for only two months.
- David did not have to pay the assessment but enjoyed the use of the roof for more than 24 years for free before selling his unit to Roger, just before the existing roof reached its expected useful life twenty-five years later. David never paid a penny for the use of the roof, which protected his unit practically during the roof’s entire useful life.
- Now, a new roof needs to be installed on the building. Roger pays a special assessment of $2,670 for the new roof that is expected to last for another 25 years. One year later, Roger sells his unit to Mark . . . .
- Roger used the roof for just over a year but paid for 25 years’ of use. Mark gets a free ride on the roof.
- Sharing Fairly. Future repair costs must be accurately predicted. Since current owners are “using up” common area assets, owners should share fairly in the cost to repair or to replace them. If all owners contribute their fair share as part of their regular assessment, there will be no more special assessments.
- Funding reserves by way of regular contributions, which are built into the regular assessment of each owner, as opposed to special assessments, is the fairest way to address reserve fund needs.
- Special assessments penalize those that have to pay them since former owners were able to use common area assets without contributing their fair share to the cost of rebuilding those assets or of creating new common area assets as capital improvements.