Letting it Slide... The Pitfalls of Deferring Expenditures

Letting it Slide...

 It’s the same dilemma that single-family households across the U.S. are facing:  What bills need to be paid immediately and what bills can wait? And should we  stretch ourselves thin, taking more out of our bank accounts to pay for private  schools and that desperately needed vacation? Or should we cut back on  restaurants and renovations to put more into savings? The same goes for co-op  and condo buildings. While it may be tempting to delay payment on some bills,  or delay expenditures on maintenance or needed repairs, in the long run this  may end up costing far more than we ever realized.  

 Just as the federal government faced a serious financial crisis over the debt  ceiling, which still rages today, boards face some very difficult decisions  when it comes to what bills need to be paid, and what capital projects are most  important. Questions arise such as, do we really need to fix the flashing on  the roof right now, or can it wait a few months? The truth is that deferring a  minor repair now may, in the long run, cost the building and the board a whole  lot more.  

 There are many quick fixes that boards consider when faced with rising costs and  static income. The most tempting is to prioritize and pay the bills that are  the most important, while putting off other expenditures to a later date. This  is a tempting “solution,” but it is one fraught with inevitable downsides and danger.  

 Another option, one that is much more prudent that boards may opt for, is  raising revenue. This option has its downsides as well, with so many families  living on tight budgets, they may not be able to pay an increase.  

 A third option is to levy a one-time assessment to all households in the  community. This also may seem like a good solution, however, this is only a  stop-gap measure usually reserved to pay for a major capital improvement such  as roof repair or the installation of a new HVAC system.  

 There are options, but in today's tough economic times, how does a board know  which option to embrace. How does a board prioritize what bills and  expenditures are important and what aren't important? If the board is able to  answer this question then it makes the decision-making process much easier.  

 First Things First

 The first step is to figure out the basics: What bills must be paid? What is the  cost of maintenance? What expenditures are ancillary? In other words, are there  certain expenditures that are not necessary, such as weekly deliveries of  flowers for the front desk? These are key questions that must be answered by  the board.  

 Like most companies, co-ops and condos have two important, yet distinct budgets  which allow boards and owners to manage the day-to-day and long-term financial  requirements of their buildings, according to New York City architect Douglas  Lister, AIA, who does work in New Jersey. “The operating budget includes recurring expenses such as salaries, taxes,  utilities, insurance and maintenance items, while capital budgets are the  long-term budgets that monitor building conditions. Capital budget items  require a different kind of planning because the expenditures are infrequent  and unfamiliar. Capital budgets allow more latitude and evaluation: You have to  heat your building (operating expense), but you don’t have to replace the roof (capital expenditure) every year,” he says.  

 The board must always be cognizant of what's going on in the community, even  something as minor as a crack in a hallway wall is something they should be  aware of. That crack, if not repaired could become larger in time and the  repair may cost much more if not taken care of immediately. An even worst case  scenario: that hallway crack could be symptomatic of a larger maintenance issue  and left on its own it could become a major maintenance headache.  

 These kinds of sudden emergencies always pop up. What happens when the boiler  goes on the fritz, the roof springs a leak, the electricity bill rises or the  common areas require new carpeting: you can't ignore the problem, you don't  want to raise maintenance fees, or have a one-time special assessment. So how  does a board plan?  

 “They should be receiving every month a financial statement from whoever’s managing them that gives for that past month—actual vs. budget, as well as year-to-date, actual vs. budget,” says Jules Frankel, CPA, MBA, a shareholder at Wilkin & Guttenplan, P.C., a certified public accounting firm which has offices in New  York and New Jersey. “And with the property manager they ought to be identifying areas that may be  going awry.”  

 Boards should review their expenditures very closely, agrees Philip Miller of  the Manhattan-based accounting firm of Miller & Cusenza, P.C. If there are ancillary costs that are cutting into three months  worth of operating costs, they should be looked at with an eye to cutting or  eliminating that cost.  

 “Boards should review their budgets continuously. Every month they get a  management statement. On the statement, it breaks it down for one month, for  two months, for five months. The statements should account for any  discrepancies between the budget and the actual every year. The budget is a  feedback tool,” Miller says. “It enables people to see if they're on track or not. They should look at it  every month, and see that they are in line with the budget to some degree.  You'll have periods when you aren't. For example, you won't have a lot of fuel  expenses in July, but you will in January or February. Even though it's an  annual budget there are fluctuations that you need to account for.”  

 Not the Best Option

 The two major downsides to deferring bill payment are; one—in the long run it will damage the building or the association's credit and; two—eventually the bills have to be paid, and the bills will have increased. By not  prioritizing bill payment and reining in monthly expenditures a board may have  no option but to increase maintenance fees, or impose a special assessment. In  this case, the board is being forced to do exactly what it wanted to avoid.  

 Boards must remember that there are rules in place to make sure the maintenance  fees and other charges don’t increase too high or too often. What maintenance charges or special assessment  fees can be imposed by a board or association, really depends on what the  community’s legal and governing documents say, according to Frankel.  

 “Depending on how the documents are drafted there are some that have a percentage  limit increase, (very few), and there are some that require that the board can  determine the passing of a special assessment, and there are others that the  community has to have some involvement in either a special assessment or  sometimes a capital assessment,” Frankel says. But that’s a minority, the vast majority of times the board can do it, but you have to  look at each building’s or association’s documents, he notes.  

 Sticker Shock

 To avoid shocking unit owners with an assessment or fee increase out of the  blue, most legal and management experts advise boards to keep their residents  informed throughout the year of the increases in the operating budget, and what  the board is trying to do to rein in costs. The board can do this through  newsletters, a website, a personal letter from the board president and via  financial reports. As long as homeowners read their governing documents and  attend their board or association's yearly budget meeting, they will understand  the financial health of their building community.  

 Most increases are the result of capital repairs, delinquent unit owners,  foreclosure and price increases for insurance or other expenses—and if this is explained clearly and honestly to the shareholders or unit  owners, there will likely be less push-back when the time comes to reduce  amenities, or impose an increase or special assessment. Make sure to invite the  shareholders and unit owners to e-mail the board with further questions or with  clarifications of any of the points they may not completely understand. Better  yet, invite them to serve on the board itself, or on the budget or financial  committee.  

 Planning Prevents Surprises

 When asked if the budget should be automatically increased each year, most  experts say it depends on the circumstances. Miller answered in the  affirmative, because, “there will always be contingencies,” he explains. People tend to procrastinate, and put things off, but building in  a budgetary increase is a good thing to do. But, he adds, “it's very rarely done because of the fact that people don't want to pay for  things. They just don't want their maintenance to go up. They want to run and  hide, and people always look for alternatives to these things.”  

 Frankel says it depends on a number of factors. An operating budget for a New  Jersey HOA usually contains things like payroll, common area electric charges,  utility and heating costs, insurance, and it also might include things like  landscaping and maintenance costs, some of which may be fixed expenditures. In  New Jersey, the vast majority of associations set aside money into a  replacement fund, sometimes called a capital replacement fund, says Frankel. “It’s there to set aside monies for major repairs and replacements down the road. If  you’re talking about replacement funding, you should follow your latest engineering  reserve study. If your reserve study is old, meaning more than 3 to 5 years  old, or you’ve spent a lot of money, then you ought to update that study.”  

 For example, if your building is currently paying $100 per week for landscaping,  and the next year, it still will cost $100 per week, then there would be no  immediate need to tack on any extra costs to the shareholders or unit owners.  Of course, if the price of the landscaping goes up, a board could either decide  to cut into the three months of operating cash to pay the landscaper; they can  increase maintenance fees, or perhaps, come up with a more creative solution  such as turning a flowerbed into a concrete area to decrease the cost of  landscaping; or at last resort, negotiate with other landscapers and sign a new  contract.  

 Risking a Special Assessment

 If the board doesn't get expenditures under control and continues to defer bills  until balances rise and then suddenly that crack in the hallway wall becomes a  dangerous hazard, the board may be faced with the distasteful option of  imposing a special assessment.  

 Special assessments are usually reserved for financing a major capital project.  Unlike maintenance increases, special assessments aren't necessarily  predictable. There’s no cap on how much they can be, and depending on the reason, they may cost a  relative small fortune for the homeowners. A special assessment can only be  requested if there’s a sudden infrastructure issue, such as a broken roof, a faulty balcony or  window that may become dangerous if not replaced.  

 Frankel said it depends on what the emergency situation is. In New Jersey, for  example, you may have a series of enormous snow storms and a bad winter, the  basic concept I believe in are the people that benefited are the people that  pay. “So if you had a large snowstorm, you probably ought to be passing a special  assessment, specifically to those people that are there now. Whoever benefited  would pay.”  

 Ensuring Safety and Property Values

 Deferring expenditures can be a risky proposition, say the experts. “It depends on the nature of the improvement,” says Miller. “If you're going redo your hallways, it's not as necessary as redoing your roof,  which could be leaking all over the place,” and could pose a hazard, he explains.  

 One instance to never defer, says Frankel, is when the issue is public safety. Also the primary fiduciary responsibility of the board is to protect property  values. But, in some places where property values are low, deferring an expense  may not make a difference, he says. In other places, if you defer that expense,  and the community or building doesn’t look the way you want it to look, you will directly impact your property  values. So you have to use your judgment to strike that balance.” The classic example in New Jersey would be if the siding needs painting and you  don’t paint and the thing starts peeling, you’re going to hit everybody’s property values.”  

 And according to the legal pros, those dangers go beyond the obvious ones to  life and limb. If an owner is injured as a direct result of deteriorated  property, both the association and the individual members of the board could be  potentially liable. So even if it seems like a good idea to hold off on repairs  or maintenance projects in the name of thriftiness during a tough economic  patch, doing so could come back to bite board members where it hurts.  

 On the other hand, residents also want—and require—a building that functions well and is safe. Residents not only want their home  well-maintained, but, equally as important, residents want a building that is  well-managed. A smart homebuyer will look at how the board handles the budget and what the  reserves are.  

 Final Thoughts

 If the board is finding it more and more difficult to pay the monthly bills and  the board has decided that a fee increase is not an option then the board will  have to make some very tough and possibly unpopular choices. One option might  be to reduce amenities if the board wants to avoid falling behind in  expenditures and avoid increasing fees. Boards must remember though that if a  resident is promised a certain amenity when buying into a co-op or condo, the  board will have a hard time legally and practically doing away with the perk.  

 Above all, the most important and effective tool a board can utilize is  communication. Everyone realizes the downsides and implications of deferring  bill payment but residents have to be kept in the loop. Informing all residents  of the budget process is key to garnering support and will in the long run help  the board if it does have to reduce amenities, eventually raise fees or impose  a special assessment. There are both good and bad ways to go about explaining  these options to residents. Most importantly never defer paying a bill—what may seem like a quick way to balance the checkbook, may end up costing more  than anyone ever realized.      

 J.M. Wilson is a freelance writer and a frequent contributor to The Cooperator.  Managing Editor Debra A. Estock and Editorial Assistant Tom Lisi contributed to  this article.  

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