Defining Financial Soundness for Florida Condominium Owners Associations
Determining whether a Florida Condominium Owners Association (COA) is financially sound can be subjective, as opinions vary depending on who you ask. In this article, we will consider “financially sound” as an Association’s ability to responsibly cover current operating costs and adequately prepare for future anticipated repair and replacement expenses, without burdening owners or accumulating debt.
Although the focus is on Florida COAs, the fundamental principles of good financial management also apply to cooperatives and HOA communities.
According to the Division of Florida Condominiums, Timeshares, and Mobile Homes, as of late June 2022, there are approximately 25,000 registered residential Condominium Associations in the state. These associations collectively comprise over 1.4 million individual condo units.
This implies that around 1.4 million owners contribute assessments (dues, fees) to their Associations for the management, operation, and maintenance of shared common elements and physical components within the buildings or communities. Owners’ payments typically cover expenses such as building maintenance and repairs, landscaping and exterior lighting, swimming pools and pool decks, elevators, parking areas, driveways, onsite amenities (e.g., fitness centers, tennis courts), building insurance, management fees, and COA property taxes.
Following the tragic collapse of a condominium in Surfside last year and recent legislative reforms, one critical budgetary aspect has gained considerable attention: Reserve funding.
While this overview will not delve into detailed discussions of deferred maintenance, physical deterioration, Reserve funding calculations, or specific Florida Statutes references, it aims to provide a general introduction and basic understanding for individual unit owners, particularly those who are new to the workings of Florida Owners Associations.
Understanding Reserve Funding for Condominium Common Elements
Scheduled assessments paid by owners, typically on a quarterly basis, play a crucial role in covering the costs of current, ongoing, and anticipated future repairs and maintenance of the Association-owned property.
To illustrate this concept, let’s consider the example of a community swimming pool. Associations often hire a pool service to perform daily tasks like skimming leaves and monitoring chemical levels, which falls under current ongoing maintenance. However, it is important to recognize that there will come a time when the pool requires more substantial work, such as being drained and resurfaced. This larger-scale maintenance is categorized as expected future maintenance.
All physical components owned by the Association that will require future service, repair, or replacement are assigned an Expected Useful Life, denoted in years, along with an Estimated Replacement Cost at that specific point in time. These components should have corresponding entries for Reserve funding in the Annual Budget and Deferred Maintenance Schedule/Reserve Study.
In simple terms, Reserve funding for condominium common elements refers to setting aside a portion of funds each quarter, ensuring that there will be sufficient resources available when significant maintenance or replacement of common area items becomes necessary. The aim is to accumulate enough funds gradually to cover these future expenses, thus avoiding sudden financial burdens on the Association or its owners.
By implementing a Reserve funding plan, Associations can proactively allocate resources towards the future needs of their common elements, promoting financial stability and responsible management.
Ensuring Adequate Reserve Funding for Common Physical Components in Florida COAs
In order to adequately prepare for anticipated future service, repair, and replacement needs, the following common physical components should have designated Reserve funding accounts:
- Building exterior paint and waterproofing
- Roofs
- Driveway and parking area paving
- Elevators
- Swimming pool and deck
- Balcony/lanai railings and concrete deterioration
- Lobby, meeting, and fitness room windows, doors, furnishings, and equipment
- Front gate mechanisms and security systems
- Any Association-owned common component that will require major (costly) repair or replacement at the end of its expected useful life
It is important to address the concerning trend in Florida COAs where Reserve accounts are frequently waived or underfunded. The allure of lower quarterly assessments may be tempting for both Boards and individual owners who prioritize short-term financial relief.
However, when owners consistently vote for waiving or underfunding Reserves, they are essentially engaging in a risky financial game known as Florida Condo Roulette. This gamble involves betting that they will have already sold their unit and will not be responsible for the inevitable and substantial Special Assessment that arises for significant common maintenance expenses such as new roofs, elevators, or balcony/lanai concrete repairs. In essence, they prefer to shift the burden onto future owners who may have only recently purchased their units, leaving them to foot the entire bill for years of deterioration.
This short-sighted approach fails to account for the long-term financial health and stability of the community. It is crucial for Boards and owners to recognize the importance of adequately funding Reserves, ensuring that future maintenance and repair expenses are adequately covered without causing undue financial strain on owners or resorting to sudden and burdensome Special Assessments.
By prioritizing responsible Reserve funding, COAs can safeguard the well-being of the community, promote transparency, and avoid passing on significant financial obligations to future owners.
Ensuring Financial Transparency: Key Questions to Ask When Reviewing Florida COA’s Reserves
It’s important not to take an Association’s budget and financial statements at face value when determining its financial soundness. To accurately interpret the information presented, it’s crucial to know what to look for. Here are some essential questions to ask when reviewing a Florida COA’s financials regarding Reserves:
Was a comprehensive Reserve Study conducted by an independent, third-party professional based on an on-site visit and inspection? It’s important to differentiate between a genuine Reserve Study and Deferred Maintenance Schedules created in an office using “industry standard” useful life timeframes. The former holds more weight and provides a more accurate assessment.
Were the financial statements from the previous year independently audited by a third-party professional before the creation and approval of the next year’s budget by the Board? Independent audits add credibility and ensure accuracy in financial reporting.
Particularly for high-rise buildings, has a structural inspection been carried out in recent years by a licensed engineer or architect? Structural inspections help identify potential issues and ensure the long-term safety and stability of the building.
Who determined the initial Expected Useful Life numbers used? It’s crucial to assess whether artificially extended numbers were employed to lower the calculated Reserve contributions required. Common components naturally deteriorate over time due to physical exposure and insufficient maintenance, and these factors cannot be accurately accounted for through mathematical calculations alone.
Have on-site physical inspections been conducted recently to assess the accuracy of Remaining Life estimates? The Florida environment accelerates wear and deterioration of Association physical elements. As a result, Remaining Life estimates must be regularly adjusted to reflect the impact of environmental exposure, maintenance levels, and usage. Physical inspections and documentation of common element deterioration should occur at least every three years.
Have Replacement Cost estimates been reviewed recently to include current materials and labor costs? Additionally, have changes in building codes influenced future Replacement Costs? Relying on outdated Estimated Replacement Costs, typically 3-5 years old, can lead to significantly inaccurate projections.
Have Remaining Life estimates been appropriately adjusted year-to-year in the Association’s financial documents? Instances where the same Remaining Life is shown for consecutive years without a physical inspection raise concerns. Is this a mere clerical error or an attempt to defer required maintenance and its associated costs?
Have there been any unexplained transfers into or out of Association financial accounts since the last maintenance schedule and annual financial statements? Monitoring account transfers helps identify any discrepancies or irregularities.
When discrepancies are revealed in the answers to these questions, it’s likely that owner contributions will need to be increased to bridge the gap and bring the Association’s Reserve accounts closer to being fully funded. The challenge lies in the fact that these crucial questions are seldom asked by owners and Boards, highlighting the need for greater awareness and diligence in financial oversight. By addressing these concerns, Associations can enhance financial transparency and ensure the long-term stability and viability of the community.
The Consequences of Underfunded Reserves: What Happens When Maintenance is Neglected
What are the repercussions of having insufficient funds in Reserve accounts to cover necessary maintenance, repairs, or replacements? Let’s explore the available choices in such cases:
Delayed Maintenance: When there is a lack of Reserve funding, essential maintenance work often gets postponed beyond the required service time. Unfortunately, this delay not only ends up costing more in the long run but also poses significant safety risks to residents. Boards, taking advantage of owners’ limited understanding of Deferred Maintenance and Reserve funding, have sometimes been able to defer necessary maintenance for extended periods. This has been identified as a contributing factor in incidents like the Surfside collapse.
Increased Assessments: Some Boards opt to increase current owner assessments in order to generate more funds and address the needed work in a couple of years. However, this approach primarily focuses on the financial aspect while the deterioration of the component continues to spread. Eventually, the underlying issues must be addressed to ensure resident safety and prevent further damage.
Special Assessments: Boards may levy Special Assessments on all owners to gather the required funds. These assessments are additional payments that owners must make alongside their scheduled assessments. Depending on the circumstances, these payments may need to be made in full by a specific date or can be paid in installments over the next year or two. Regardless, they are unexpected and unbudgeted expenses for owners.
Bank Loans: In extreme cases where Reserves have been consistently underfunded, the Association may resort to obtaining a bank loan to cover necessary repairs. However, this is a clear indication of long-standing underfunding. If the loan is utilized to address components for which there should already be a Reserve account, such as roofs or exterior building painting/waterproofing, it raises concerns about irresponsible financial management. Loan payments increase owners’ scheduled assessments and divert funds from other essential budget items.
Ignored Repairs: Another unfortunate outcome of underfunded Reserves is the neglect and non-addressing of repairs or replacements. This neglect not only jeopardizes resident safety but also diminishes the amenities associated with property ownership. It significantly reduces owners’ enjoyment and utilization of their properties.
One particularly severe consequence of delayed or overlooked maintenance is water intrusion. This can occur due to roof leaks, improperly sealed balconies/lanais, or neglected exterior building walls. In Florida, even the slightest water intrusion can lead to concrete deterioration.
To delve deeper into this topic, you may find this article from earlier this year of interest: “Why Do Florida Condo Buildings Collapse Into The Sand? Apathy.” (thefloridarealestateblog.com)
The Surfside collapse has heightened awareness among potential buyers of Florida condos regarding deferred maintenance, physical deterioration, and Reserve funding. Condos governed by Associations with well-funded Reserves, timely maintenance practices, and vigilant monitoring of physical deterioration present much lower financial risks to buyers.
Buyers now understand that delayed building maintenance not only compromises resident safety but also leads to expensive and unexpected Special Assessments. Many Florida condo buyers are now equipped with the right questions to ask when reviewing a COA’s finances. The answers to these questions significantly influence their purchasing decisions and the offers they make.
This serves as a brief introduction and overview for owners regarding COA Reserve accounts and the importance of common component physical maintenance.