How Should Associations Pay for Capital Projects?

Current Issue

Click to read.

How Should Associations Pay for Capital Projects?

By Doug Weinstein, Vice President / Published March 2020

Photo by iStockphoto.com/William_Potter

When associations are considering a capital improvement project, they are often focused on the scope of the project itself and then how the association will fund the capital needed to do the work. Funding the project can entail many different options, depending on the current financial situation of your association.

     The options include reserve fund contributions, special assessments, lending institution financing, or a combination of all. When contemplating options, one of the most important items to consider is the cash flow required to complete the project. Typically, on a large-scale project you will be utilizing an American Institute of Architects (AIA) form of contract. This form will dictate the frequency of payments to the contractor performing the work. For many projects, such as concrete restoration, the need for funds will be driven by the monthly payment applications submitted by the contractor based upon the amount of work completed for the indicated time period.

     Another common schedule of payments is where you provide a down payment once you sign the contract and then set predetermined benchmarks for additional payments, such as delivery of equipment, installation of equipment, and commissioning of equipment. Be reminded that being able to make your payments on time during the project will ensure that the work continues without delays caused by the contractor waiting for her payment.

     Let’s discuss some of the options outlined. Depending on your reserve fund method and the association’s financial health, these funds may be used to supply either full or partial funding provided the project includes elements in your reserve schedule. This is the most straight forward method available, as the association will have the cash on hand.

     Levying a special assessment is one of the most frequently used funding methods. Your board will need to take into consideration the ability of its ownership to absorb the assessment, how long the assessment will be in place, and what your payment schedule will be. In addition, many associations have given each member the ability to reduce his overall amount by paying the assessment amount in full upfront rather than electing to pay his share under a long-term payment schedule. The route to any assessment will be dictated by your association documents, which will dictate how the assessment will be decided and whether or not it requires a vote of the membership.

     Lending institution financing is available, depending on numerous factors that include the financial health of the association, the percentage of absentee owners, and the level of reserves. Bank financing can involve different instruments. Potential options include lines of credit or construction loans as well as straight line financing.

     Lines of credit are popular, as the association will usually need to pay interest only on the amount actually drawn down as the project progresses. It is important to keep in mind and be aware that these lines of credit do eventually expire so they should be tracked.

     Construction loans are a little more complicated, as the typical terms require the lending institution to inspect the progress of the work and sign off on all payment applications. This can delay the ability of the association to meet their contractual obligations to the contractor; and should this type of loan be contemplated, appropriate provisions will need to be included in your contract language.

     Straight line financing will have the association receive the full amount of the loan at commencement and requires paying down the loan with applicable interest from day one. Your board will need to consider whether this would be a cost-effective method.

     The association should consult with their management company as well as their accounting firm to determine which is the best financial option for the project(s). Each option has different pros and cons which only can be ascertained by an analysis of your association’s financial ability to repay the financing. Your documents should also be consulted for any restrictions, and should your association currently have financing in place, does that financing allow for the association to take on further debt? Note that some banks will require that associations transfer over certain bank accounts, such as the association’s operating account, to their respective bank to acquire the loan.

     Another option that may be available to add to the mix is contractor financing. This is a method whereby the contractor performing the project(s) will agree to spread out the payments for a period in excess of the project timeframe. In doing so, the contractor will probably require a rate of interest on these longer payment schedules. This option is most often utilized when an association does not have the ability to procure conventional financing.

     One other item to consider on any project, but particularly when you are utilizing outside financing, is whether to have a performance/payment bond for the project. A bond will ensure that should the contractor not have the ability to complete the work for reasons covered by the bond terms, then the bonding company will provide the means to complete the project for the contract amount. Note that there is a cost to the association for deciding to bond the project and that depending on the financing type chosen, it may be required by the lender. A bond will generally add between two to three percent to the cost of the project depending on the chosen contractor’s rating.

     While the above is a brief outline of the different methods available, your association will need to look carefully at each option to determine which not only is the most cost effective but also meets the needs of the particular project(s) being undertaken.

Doug Weinstein

Vice President of Operations, AKAM On-Site Inc.

     Doug Weinstein is Vice President of Operations with AKAM On-site Inc. He has more than 30 years of experience managing capital improvement projects and ground up construction. He has successfully managed a portfolio of capital improvement projects that include concrete restoration, HVAC system replacement, interior renovation, roofing replacement, and overseeing ground up construction of a state-of-the-art fitness center building. He has also acted as consultant for pre-construction planning for multiple high-rise residential structures. Doug Weinstein may be reached at dweinstein@akam.com.