T.C. from Connecticut writes:
Dear Mister Condo,
What % of condo associations have debt? Is it unusual or common to have debt to finance deferred maintenance? What % of CT HOAs have debt? Is it 10 %, 50%, 90% or other? What % of a condo association’s annual revenues should be used to service debt ie. what % of annual revenues should principal and interest payments be annually?
Mister Condo replies:
T.C., that is a series of great and interesting questions, not just in Connecticut, but nationally as well. While most governance documents suggest that the association prepare and observe a Reserve Study and make regular Reserve Fund contributions, many do not. Even in states where there are additional laws supporting this practice, it is still fairly common for associations to get themselves upside down in the long run because they opt to underfund their Reserves or not fund them at all. Why? In a word, because the sweetness of low common fees outweighs the bitterness of paying more every month for maintenance that won’t happen or years. Current owners don’t care about repairs that will be needed years later, especially if they have no intention of living within the association a few years from now. I can’t speak for the specifics in Connecticut but my guess is that the percentage of communities with underfunded Reserves is roughly 70%. Worse of that 70% underfunded, almost one half of those associations are so poorly underfunded (if funded at all), they will surely need to either borrow money or levy a Special Assessment just to make the known repairs that are coming due or have come due already. There are no “one size fits all” formulas to apply here. Each association is different and each requires its own Reserve Study (even if done in house by volunteers). Once the dollar amounts for future repairs are known, the common fees should be adjusted to save for that known expense. If an association decides to go the route of an HOA loan, as many do, all they are really doing is transferring the debt from the owners when the asset deteriorated and passing it on to future owners. Personally, I wouldn’t purchase into a community that didn’t have a strong Reserve Fund and plan in place. Without the funds available, the new owner is very likely going to pay for the previous deterioration of the common assets. It is patently unfair and a tremendous risk to the association. The FHA recognized this shortfall in condominiums many years ago when they started tracking Reserve Fund contributions in associations where the buyers needed FHA-backed loans. The FHA required the association to get certified and provide evidence that they were putting at least 10% of their annual dues into the Reserve Fund. In reality, most associations need between 20% – 30% to adequately fund their Reserves. So even though an association may be FHA-eligible and compliant with the 10% rule, that is no guarantee that there is nearly enough money being saved for major common element replacement. Roofs will fail, driveways will deteriorate, siding and windows will need replacing. It’s not guesswork. Only proper planning and funding can make the association fiscally solvent. Anything less leads to the numbers and problems you may be seeing in your own association. All the best!