Set Your Standards, Then Set the Budget

QUESTION: Our condominium’s finance committee is trying to prepare a budget for the next fiscal year. I remember an article that you wrote last year about all of the areas that the board of directors should consider when making budget decisions. Could you please reprint that article?

ANSWER: The article that you remember generated a lot of positive response from readers. Here is the question and answer just as it previously appeared (Nov. 10, 1991).

Frugal Fine but Budget Must Be Adequate

Q: The board members for our condominium association are working on the annual budget. Since our fiscal year ends on Dec. 31, I understand that we must deliver the new budget to the owners right away. Can you give us any last-minute advice that we can use to debate with our treasurer who always wants to cut corners and adopt a “bare bones” budget?

A: Your question is often asked by board members and other concerned owners. You are correct about the requirement for distribution of the new budget. It must be distributed to the owners from 45 to 60 days prior to the beginning of the fiscal year.

I am glad to provide some suggestions for your discussion with the treasurer. I have very little patience with treasurers who keep such a tight fist on the association’s money that the whole complex suffers from deferred maintenance and inadequate reserve funding. Being frugal is fine, but treasurers and, indeed, all of the board members have a responsibility to adopt a realistic budget and to act in the best interests of the whole association.

I recently found an article from the Community Assns. Institute’s newsletter titled “Ten Budgeting Mistakes Made by Community Associations.” It was written several years ago, but the advice in it is timeless. The authors, Arthur W. Hiban and James T. Derry, certified property manager and certified public accountant, respectively, give the following advice: “The annual budget is the most comprehensive planning tool available to the condominium or homeowners association. If properly approached and carefully conceived, the budget will become the basis for successful management of the property.

“The budget must be approached with the goal of providing for efficient operations and for funding adequate reserves to meet long-term requirements.

“When an association loses sight of this goal, the result is usually an inadequate budget, improper management and a community burdened by seemingly insurmountable problems.”

Your association cannot afford to ignore the aging process. Each year, maintenance costs become more expensive. More money must be spent on preventive maintenance in order to preserve the life expectancy of your mechanical systems and other major components.

An example of an expense that some associations scrimp on is landscaping costs. They budget for mowing, fertilization and weed control when more comprehensive services are needed as the landscaping matures. Proper tree care and trimming is expensive but necessary because mature trees are an asset that should not be ignored. The association should plan for replacement of shrubs and trees that may be affected by drought or cold weather.

Don’t underestimate maintenance costs. Anticipate that you will have emergencies and plan your budget accordingly. A leaking roof must be repaired. A broken water line must be replaced. Your property insurance will not pay for these emergencies because they are maintenance expenses. Insurance may pay for the damages that result from an emergency but the insurance carrier will soon refuse to pay for claims if your facility isn’t properly maintained. A high number of claims will then affect your insurance costs in the long run.

It is a mistake to low-ball your budget and then expect to find contractors who will meet your price. Don’t assume that you should always accept the lowest bid for repair projects. The board must make prudent business decisions based upon complete specifications including warranties, compliance with deadlines and many other considerations in addition to the quality of the materials and the cost of the labor.

The board needs to determine the type and quality of the services that the owners expect. How often are the corridors going to be vacuumed? Do the garages need cleaning by an outside contractor on a periodic basis? How many times per week does the swimming pool require service? Would the owners like to hire a management company that will provide 24-hour emergency service?

Hiban and Derry encourage the association to define the level of service or maintenance standards. “Too many communities ask: What can we afford? What is the lowest price we can get for services? How can we reduce the condominium fee? They ignore the standards before preparing the budget. The results can be disastrous. If you prepare a budget without first considering standards, then the standards, goals and specifications will be determined by the budget and not the other way around.”

I believe that associations should plan their budgets so that they can afford to rely on the advice of experts when the need arises. The association should rely on professionals to assist in their decision-making on complex matters or legal issues because the board’s liability is reduced by doing so.

For example, the association may want to hire an independent insurance appraiser to establish the insurable value of the property. The directors’ and officers’ liability insurance will not protect the board members if they have made an error that causes the association to be under-insured when a loss occurs.

The association may need to hire an independent roofing consultant to determine the scope of the work, write specifications and supervise the contractor’s progress when major roofing work is required. Too many associations spend an incredible amount of money on roof repairs because they don’t want to face the decisions involved in a total reroofing project.

I encourage associations to set aside funds for hiring a licensed accountant to prepare the year-end financial reports and tax returns. Don’t rely on the services of a volunteer board member, even if he or she is a licensed accountant. The board should eliminate the appearance of a conflict of interest.

The association should have the funds available so that an attorney can be consulted when legal issues or questions arise. Legal issues will, most assuredly, arise. Be prepared by having an attorney selected who is familiar with the laws that govern community associations, case law and your own association’s legal documents.

A serious pitfall for budget preparers is basing the budget on political considerations. Hiban and Derry cite the following examples:

“The developer wants to make sure that the monthly assessments are low enough to sell the units quickly; the board president wants to be able to ‘sell’ the budget to the community; the managing agent wants to prepare a budget that makes him look good so he can keep the contract; and the treasurer was elected to the board on a platform of holding down the condominium fees.” Basing the budget on these “political” reasons will sometimes result in financial crisis.

When I hear a board member say proudly, “We haven’t increased the assessments in five years!”, I tend to wonder about deferred maintenance, short-sighted decision making and under-funded reserves for future repair and replacement. Perhaps the budget was grossly overestimated five years ago but this is unlikely.

Long-term planning is essential if the association is going to be financially secure. No one likes special assessments to pay for major projects. If the annual budget is not adequate, the association may pay a greater price later on because of the lack of preventive maintenance.

Finally, in my opinion, preparation of the budget is a year-long project, a continuing evaluation of the service levels that are desired by the general membership, and an analysis of the adequacy of the reserve funds that are being accumulated for the future.

The boards that adopt bare-bones, unrealistic budgets will find themselves pinching pennies in order to stay within the budget, and future boards will have to resolve their mistakes. Budgeting controversies and special assessments may lead to criticism of the board and an unwillingness on the part of others to run for the board in the future. All of these factors have an effect on the overall value of the condominium complex.

Boards should remember that their first and most important responsibility is to preserve and protect the investment that each of the owners made when they purchased their unit. Boards not only have the authority, but also the responsibility to approve a budget that is both adequate and realistic.

An association that is properly funded and well maintained means proud owners, ease of finding mortgage lenders for refinancing or potential buyers, general community respect and retention of property values. These are important considerations for all board members to keep in mind when they are making their final decisions about the bottom line of the annual budget.