Smart Funding for Capital Replacements

Smart Funding for Capital Replacements

By Craig Finck / Published February 2022

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Association board members have a variety of responsibilities. Foremost among them is the fiduciary responsibility to protect and maintain the assets of the association. This responsibility does not stop with the funds in the bank accounts. If you live in a high-rise condominium, association assets would usually include the building itself and all of the systems, from the roofing to the foundation and most everything in between. Even in a homeowners association, where individual owners are responsible for their homes and lots, the association could have responsibility for such things as retention ponds, streets and sidewalks, a clubhouse, and any number of additional structural items that make up the community. While every association is structured differently, most associations have some level of responsibility to protect and maintain something. 

     Every association is a business, and it should be managed as such. While statutory requirements can be a guide to planning and funding reserves for future capital replacements, they are nothing more than a minimum baseline legal requirement. History has shown that legislators are reluctant to define strict guidelines in regard to reserve funding, instead allowing individual associations the ability to manage their own financial destiny. Additionally, these legal guidelines vary substantially based on the structure of your association, be it a condominium, homeowners association, or cooperative. While it would certainly be helpful to have legislative guidance that was better defined, this article is not intended as a political debate, and none of us should wait for additional common-sense legislation. 

     So where do you start? Like anything else, you start at the beginning—having a firm understanding of what your association has the responsibility to maintain, what condition it is in currently, how long it will last, and what will it cost to replace when the time comes. How do you quantify the necessary information to make responsible fiduciary decisions regarding capital replacements? There is an argument to be made that it is virtually impossible without a formal, professional reserve study. While not required by statute, a reserve study is an essential tool to provide clarity in the funding of capital reserves. In my years of experience working with hundreds of associations, I have met few boards with the experience and forethought to complete the complicated analysis and planning that can be found in a reserve study. While there is a cost involved with a professional reserve study, it is usually minimal relative to the value of the association assets a board is tasked to maintain. 

     Whatever method is used to identify and quantify future capital reserve obligations, how best to fund for these future expenditures requires less debate. When a community is new, no one is concerned about capital replacements, but that is exactly when it is most beneficial to start the process. Like saving for retirement, the earlier you get started, the more likely you will have a positive outcome when the time comes. Again, every association is different, and many factors will affect the ability to fund for future capital projects. Having a plan in place and assessing owners a regular smaller amount  earlier in the replacement cycle is the cheapest and most equitable way to fund for future capital replacements. 

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     The overwhelming tendency is for associations to underfund their future capital replacement needs. Whether a board has not properly planned, or they have planned but want to keep monthly assessments low for their owners, the result is always the same. Ultimately the time to replace comes, and the association is short the funds necessary to maintain the capital item. The association may still have options, but they will most certainly be less attractive to owners and ultimately will be more expensive than it should have been. I will outline some of the more common options and the negative consequences of each.

     The most common solution to a lack of funding for capital reserves is the one-time special assessment. When the association has failed to properly plan or has planned but has proactively decided to underfund or not fund their capital reserves, a common option would be to go to the owners for a one-time special assessment. It would be unfair to minimize the financial impact a large one-time special assessment can have on owners. While some owners may be able to afford the payment due, there will be some who cannot. This assumes, of course, that the association will be able to meet the requirements of the statute and their legal documents to pass the needed special assessment.   

     Additional costs must also be considered; mailings and legal costs associated with passing a one-time special assessment can be substantial, and those costs will just be added on to the total of the project being funded. What is not always considered is the fairness and equitability of a one-time special assessment. In the process of ongoing funding of capital reserves, the owners in place at the time are paying into the ultimate replacement fund of the capital item. As the roof is being used, for example, the owners in the building at the time are paying to someday replace that roof. A one-time special assessment takes away that fair and equitable part of the process, instead placing the entire financial burden on the owner in place at the time of the special assessment. Even if that owner has been in place since inception of the association, funding a large one-time special assessment may still present a financial burden.

     Taking the above situation into consideration, many associations decide to pass a special assessment in conjunction with bank financing. In most cases, the special assessment is allowed to be paid in a one-time payment, if possible, or over a longer period of time in conjunction with the repayment of an association loan. While this option can help to spread out the financial burden to an owner over a longer period of time, it is not without its own set of negatives. In addition to the potential costs and administrative burden of passing a special assessment, this option adds another layer of costs and administration to the process. While it most certainly can make the current financial needs more tolerable for owners, it will ultimately be a more expensive solution. Additionally, the issue referenced previously with the special assessment not being a fair and equitable funding of the capital replacement remains. 

     Even with the best planning and the most thoughtful and responsible board, capital reserve funding is not an exact science. Buildings can deteriorate faster than expected, material and labor costs can go up, and unexpected situations can arise. Like everything else in life, nothing is guaranteed. Having and following an ongoing reserve funding plan will give you the best chance of success regardless of the ultimate outcome. This method will be the cheapest and most equitable for all owners in the long run. We are already seeing that mortgage providers are starting to take a harder look at associations, asking more specific questions about capital reserves and levels of replacement funding. As this becomes more prevalent, associations who neglect their fiduciary duty in regard to reserve funding may become less marketable, potential owners may not be able to get mortgage financing, and associations may see their lack of planning reflected in the market values in their community. Recent catastrophic building failures have caused the legislature to start looking at more comprehensive requirements for capital reserve funding. The question is, will your board plan to wait and do the minimum that may someday be required, or will your board do the right thing for your community and owners and start the planning process today? What are you waiting for?

Craig Finck, CMCA

Association Banking Sales Manager, Centennial Bank

     Craig Finck, CMCA, has been working with community associations for more than 15 years and is currently working as an association banking sales manager with Centennial Bank. He is also serving on several committees in multiple CAI chapters, and he is a past board member of the Illinois Chapter of CAI. He believes strongly in providing education and resources to association board members and was an eight-year board member of the 2,300 unit homeowners association where he lived in Illinois prior to moving to Florida. Craig can be reached at or (941) 451-9617.