By Daniel Furlow, CFO / Published August 2022
Editor’s Note: The recently passed Senate Bill 4-D will affect reserve projects and funding options for many communities.
Buying a house is a big investment. As many homeowners agree, it’s a decision that is not often taken lightly. When selecting a new home in a condominium or HOA community, there are endless components to consider in your decision. You may be attracted to the beauty of the community’s
landscaping or appreciate how well your neighbors maintain their properties. You may be drawn to the robust amenities or envision yourself participating in the community’s exciting lifestyle activities. All of these elements enhance the overall enjoyment and sense of pride from living in a community; however, it is important to note that they are not feasible or sustainable without the strong financial health of the community. To provide attractive landscaping, offer engaging community events, and maintain common area facilities, an association must be adequately funded. There is no time of year more crucial to maintaining community financial health than budget season.
Budget season is an opportunity to re-evaluate where the community stands financially and set a future path to success. It is the time to make necessary adjustments for previously unforeseen financial hurdles or prepare for community enhancement projects for future improvement. At Leland Management, budget season typically begins in mid-July, but timing may differ for communities that have a fiscal year-end other than December 31. The reason July is such an ideal month to begin the processes is because it provides the board with six months of data on current-year expenses. This allows boards to get an idea of how their communities are performing relative to their current year’s budget and adjust accordingly. It also provides enough time to draft multiple revisions, if needed, and field open discussion without risking the opportunity to approve the budget in a timely manner at the annual budget meeting. For condominium associations, they must also consider the Florida Statute 718 when scheduling the completion of their budget as there is a statutory 14-day meeting notice requirement to adhere to, with a proposed budget included. Whether you live in a condominium or an HOA, all communities should review their governing documents for any additional requirements.
There are two major elements to every budget: operating expenses and reserve funding. Let’s begin with discussing operating expenses. When attempting to predict future operating expenses, it is important to consider how you’re performing against the current budget. You will also want to consider future changes in vendors, planned community events, any pending large projects, and additional services such as bulk cable or full-service lawn maintenance.
Current performance may be one the best premonitions of what to expect in the future. Remember, the budget process usually starts halfway through the current year, so you will not have a full 12 months of expenses available. Since there is no crystal ball to consult with, it’s worth the extra effort to determine a best estimate of each expense through the remainder of the current year. A fixed contractual expense such as landscaping, pool service, or security can be reasonably forecast. Utilities typically increase a bit in the summer months but are otherwise generally consistent. Certain expenses like printing and postage can be a little trickier to lock in, though still possible to account for with review of prior years and some planning. Other expenses such as repairs to irrigation, gates, or clubhouse facilities are often unpredictable and prone to large fluctuations throughout the year.
A large repair that may cause you to go over in the current year may also actually reduce future repair costs. A great example of this would be an old gate operator that requires constant repairs. Installation of a new operator would increase your expense in the current year, but it will likely reduce further repairs down the road. That’s why it’s important to pay close attention to the details of each expense line. A good report for reviewing that detail is the general ledger, which shows all transactions. If expenses are consistently above budget, then raising that budget line should be considered. Having an up-to-date, well-documented maintenance program goes a long way to help anticipate future needs.
There are other factors that may cause significant increases in your operating budget. Some are more controllable, such as changing vendors, large projects, and adding services to your community. One of the largest expense line items for most communities is landscaping. If the community is changing vendors, it’s important to have bids available before starting the budget process. Landscaping contracts can vary by thousands of dollars and dramatically affect next year’s assessment. The association may also be considering large enhancement projects in the community. One of the board’s primary goals is to enhance their community’s appeal, and as a result, increase the home values for all. That can be accomplished by enhancement projects and adding new amenities. Estimates for each project should be obtained prior to the budget process.
Associations must also consider increases to the cost of current expenses such as insurance, utilities, and payroll. Over the last several years, the cost of insurance for property and general liability have consistently increased due to abundant storm damage and related ongoing litigation throughout Florida. It is advised to contact your insurance agent annually to obtain the expected increase to your premium. Premiums can often increase by over 10 percent from one year to the next. Utility costs can be expected to rise as well due to global shortages of raw materials.
One item in particular that should not go overlooked is the cost of payroll. There has been an ongoing national labor shortage due to the pandemic, and employee wages have also seen significant increases recently. Not every community has on-site staff, but those that do must consider the competitive labor market. If the association wants to retain valued employees, they may want to consider offering raises and bonuses. This additional cost must be budgeted for next year.
In our final topic, we will cover the most significant part of the of budget process—funding of replacement and deferred maintenance accounts. There are types of replacement and deferred maintenance accounts that should be funded each year—statutory reserves and non-statutory “limited voluntary deferred maintenance” accounts. Reserve funding is specifically regulated by Florida Statutes and, if not budgeted properly, could lead to significant financial trouble for your community. “Reserves,” per Florida Statute, can only be used for their intended purpose. Roof reserves must be spent on roofs, road reserves spent on roads, and so on. If the board wishes to use roof reserves for anything other than roofs, they must obtain a vote of the membership to reallocate those funds. You may be asking, what makes it a reserve per Florida Statute? The condominium statute is very specific that roofs, painting, road resurfacing, and items with costs of over $10,000 are required to be funded.
As it relates to HOAs and Florida Statute 720, historically the most common reason reserves were statutory is the developer funded them before turnover. If a developer budgeted for the replacement of a community element, it was required to be funded after turnover. However, as of July 2021, that law has been updated and this rule may not always hold true. Other reasons a reserve may be statutory are documents requiring funding, vote of the membership, and local city/county ordinances. We advise all clients to consult with their association attorney before deciding to underfund reserves on your budget or move funds between reserve accounts.
Non-statutory reserves or “limited voluntary deferred expenditure accounts” are essentially contingency funds. They are accounts for insurance deductibles, funding future projects, or the ever-familiar roofs, painting, and roads. The main difference is these accounts are not restricted by Florida Statutes. The association’s board can vote to create these accounts or spend the funds on any association-related expenses.
Whether your reserves are statutory or not, it is strongly recommended to get an engineering reserve study, regardless of whether a structural integrity reserve study is specifically required. A certified engineer will review all the association’s important infrastructure to give you an estimate on the remaining useful life and replacement cost of those elements. They will detail the annual funding level required to replace those items in the future. It is recommended that each community obtain an update to the reserve study every three years, especially with the current rise in construction costs. Professional reserve studies can cost a few thousand dollars; however, underfunding of reserves can lead to a special assessment which could cost each owner much more than that.
There is a lot to consider when compiling your annual budget, including review of current expenses, planning future projects, and ensuring there is enough money to replace important infrastructure. However, when done correctly, a smart budget will ensure your association has the necessary funds to reach its goals and make every owner proud to call their neighborhood home.
Daniel Furlow, CPA, CFO
Daniel joined the Leland team in 2013 as a director of finance and was later promoted to the role of chief financial officer. Daniel is a CPA with a master’s degree in accounting and finance from Florida State University. Soon after college, Daniel joined the accounting firm PricewaterhouseCoopers, followed by landing a role in the corporate finance department of a national public company. With Leland, Daniel is now responsible for the accounting department, internal control, and systems and operational improvement. For more information, visit www.lelandmanagement.com.