Pulse Exclusives (120)
Records Retention Guide for Homeowners Associations
Written by Gary PorterFor many Associations, maintaining adequate records is a significant problem. There are several aspects to this issue:
- Creation of appropriate records to begin with
- Adequately storing and maintaining the records so that they are accessible in future periods
- Creating policies and procedures for the systematic destruction of records at the appropriate time
- Creating policies and procedures for digital records storage
Entering the era of digital records storage actually adds a new layer of administrative burden, as many people that have finally mastered their paper documents storage system discover that management of electronic documents is another whole ballgame. Digital records don’t take up lots of space like paper documents, but should still generally have the same retention requirements as their paper counterparts.
While the creation of adequate records and documentation is considered a part of this records retention problem, it really is a completely separate subject. Our firm has developed several guidelines for use by our Association clients in determining what records should exist. We have attempted to summarize these guides in the form of our minutes checklist and our suggestions for a resolutions manual, which is the subject of a separate article. Records creation is a problem for the same reason that records retention is a problem for many Associations: there is a lack of continuity on the Board of Directors, and many times there is inadequate continuity with management companies to ensure that adequate records are created and retained.
The subject of records retention is further compounded by the question of who should be maintaining the records, the Association or the contract management company. We offer no specific recommendations on this issue, but it is clear that it is the responsibility of the Board of Directors of the Association to make sure that the records are adequately maintained. We recommend that an Association maintain a storage facility for important Association documents that is separate from storage facilities maintained by the contract management company. This storage facility should not be in a member's home or garage, but should be in an area that is commonly accessible to future Boards of Directors. This may be an offsite public storage facility that is rented on an annual basis, or may be a segregated and secure area on the Association grounds. As an example, a portion of the clubhouse area or a storage area within the clubhouse complex could be utilized.
It is very important that once a storage place has been selected, that an index or catalog system be maintained of the contents of all of the boxes stored in the storage area so that anyone wishing to find a particular item will not have to search through a hundred boxes to find one specific paid invoice or minutes for a specific board meeting.
If you are an Association that files records electronically, there are legal standards to follow. Please consult with your legal professional for further advice.
The records retention checklist attached represents suggested guidelines to the Association in maintaining their records. This is not intended as an all-inclusive list, but as a starting point for the Association in developing its own records retention policy. We suggest that you contact both your accounting and legal professional advisors before making major modifications to this schedule as there may be state laws requiring that certain records be maintained for a specified period of time.
Click here for records retention checklist.
Reserve Study Versus Insurance Appraisal or PCA
Written by Gary PorterBy Gary Porter, RS, PRA and David McDermott, AIA
Three relatively similar services are frequently provided to communities within the homeowners’ association industry. Because there is still some confusion over what each service represents, an Association can occasionally have expectations that far exceed the scope of a reserve study (the most superficial of the three services).
The three services are the reserve study, the insurance valuation (or appraisal), and the PCA( or property condition assessment, also known as the project condition assessment). In certain parts of the country, the reserve study is also typically referred to as an “engineering study,” which further adds to the confusion, as it implies a level of service not contemplated by a reserve study but more suggestive of a PCA.
What distinguishes these three separate services are their purpose, the methodology used in compiling the data, and the data presented in the final report.
The reserve study report is a budgetary tool based on a physical evaluation of the replaceable common area components of the Association. The purpose is to prepare a financial forecast( normally for a 30-year period) of future expenditures, and to understand the required reserve contributions to fund these future expenditures. In a condominium Association, replacement of the condominium structure itself is generally an excluded component, as it is considered to be a lifetime structure. However, painting of exterior walls, possible replacement of siding, ad roofing replacement would be included in the reserve study, as they represent the major replaceable components that are part of the condominium structure. The reserve study is based on future replacement costs.
The insurance appraisal report is a valuation service of all of the common area components of the Association. This list of common area components will necessarily include a number of items that are not considered in the reserve study. The purpose is to determine the overall insurable values of the property, to make sure that the Association is carrying adequate insurance. For purposes of the insurance valuation report for a condominium project, the condominium structure is the single highest cost item included within the study. Rather than evaluating each of the separate components of that building (ie, building envelope, roofing, mechanical equipment, etc.), the insurance valuation is generally based on a cost per square foot for replacement of the type of construction used in the project. The insurance valuation report looks at current replacement costs as the basis of the valuation.
The property condition assessment (PCA) report is an overall evaluation of the physical property that results in a report to help interested parties understand the condition of the property. The PCA report should generally include the following elements, presented in a clear and easily understood format:
- Summary of the property’s visible components, including site development /landscaping, exterior envelope, structural elements, interior finishes, equipment and systems, and handicap accessibility compliance
- Details of any physical defects or damage discovered during the property inspection
- Identification of any maintenance deficiencies
- Estimate of costs for correcting observed deficiencies
- Quality of workmanship
- Quality of construction materials used
- Statement of the terms and conditions of the report
The PCA can be viewed as a blend of both the reserve study report and the insurance valuation report.
First, like the insurance appraisal report, it considers all components of the property, not just the replaceable components. But unlike the insurance appraisal report, it does not attempt to arrive at an overall valuation for replacement of the project. The PCA is based upon current costs.
Second, like the reserve study, it should identify physical defects or damages observed, and provide an estimate of the cost for correcting the deficiencies noted. The PCA does not use future costs. Contact names and numbers of vendors supplying systems maintenance and replacement are usually included in the PCA.
What are the benefits of a PCA? It provides an expert evaluation of the quality of construction and the integrity of the related building systems, and identifies necessary repair costs to bring the project to a normal condition. Readers of the PCA report are thus provided the information they need to make critical decisions. For commercial real estate transactions, the PCA is very important to lenders and investors related to the potential purchase of real estate. Insurance underwriters use the report for setting rates. Within the homeowners’ association industry, the PCA may often be a guide to determining the scope of future repairs and possible replacement with alternative products. In a more extreme example (and we've seen this happen more than once), it may help the Association board of directors determine whether a particular building is salvageable through repairs, or whether it should be torn down and replaced. We have seen 40-year-old clubhouses that were not adequately maintained razed and replaced with new, multi-million dollar clubhouses. In some associations, aesthetic values also weigh heavily on such decisions.
Providers of PCA services are generally architects, engineers, or contractors that have extensive construction knowledge. It is necessary for the provider of the service to have an understanding of the latest industry standards on structural components. Familiarity with construction products and materials and knowledge of mechanical equipment, fire protection (such as sprinkler / alarm systems), lighting, and other interior systems are also important.
While it is desirable for a reserve study provider to have that same level of knowledge, the reserve study is a budgetary tool and as such, is a more superficial analysis that does not require the same level of knowledge. The reserve study report should be a reflection of the Association’s maintenance plan. Therefore, far more reliance is placed upon the knowledge of the Association’s operating and reserve maintenance activities, as well as interaction with the vendors that supply those services.
October 1st ObamaCare Deadline - or, $100 Per Day Penalty?
HOAPulse StaffEmployers who thought they were off the hook until 2015 for ObamaCare regulations may be in for an expensive wake-up call next month. The Patient Protection and Affordable Care Act (ObamaCare) is so complex that there is probably no one person who actually understands all of it. It contains multiple deadlines by which certain activities must occur, most of which occur between 2014 and 2018. However, there’s one sneaky little deadline coming up on October 1st (yes, just two weeks from now) that virtually no one is talking about.
8 Steps to Selecting an HOA Management Company
Written by Chuck MillerNow that you have made the decision to hire a management company, how do you go about selecting the right management company? Since finding the right management company is crucial for your Association, the directors must execute their search with due diligence. Where does one find management companies? The best place to start is the management company directory at HOApulse.com. This directory lists more than 2,500 management companies throughout the United States. It is the largest dedicated management company list available on the web.
7 Benefits of Hiring an HOA Management Company
Written by Chuck MillerOver the years, I have worked with several associations as an interim manager, or on a consulting basis, with the understanding being that the goal was to eventually hire a professional management company to provide ongoing management services for the Association.
We are right in the middle of the reserve study busy season and are again being asked by a number of our clients whether or not it is permissible for them to have contingencies within their reserve study. In some Associations, this is just a given. In other Associations, there are member factions that will react quite strongly against the inclusion of contingency in the reserve study.
There are a number of issues to consider when addressing the issue of adding a contingency factor into a reserve study.
- Is a contingency reserve permissible under state statute?
- Is a contingency reserve permissible under the Association’s governing documents?
- Is a contingency line item permissible under tax law?
If you're determined to have a contingency factor within your reserve study, once you get past the above issues, you then have a decision to make as to HOW contingencies will be included within the reserve study.
a) Will contingency be a separate line item expense within the study? If so:
- -will it be a flat dollar amount?
- -will it be a percent of current year expenditures projected in future years?
- -will it be a percent of reserve fund assessments?
- -will it be the excess operating income that is transferred annually from the operating budget?
b) If contingency is not treated as a line item within the report, can it then be factored into the study as a percentage of future expenditures?
And the last question, will your reserve software support the reserve calculation method you prefer?
As you can see, there a number of factors to consider in response to the simple question we are often asked of “Can we add a contingency factor to our reserve study?”
Some reserve preparers are adamantly opposed to ever including contingencies within the reserve study, perhaps because of the multiple unknowns identified above. Other reserve preparers don't seem to have a particular problem with contingencies, but generally have a specific manner in which they prefer to present the contingencies.
Let's take a look at each of these issues identified above:
- State statutes - The answer to this is not as transparent as we may wish, simply because most state statutes are silent on the issue of contingencies. Statutes primarily address the physical common area components for which the Association has maintenance responsibility, if they address content of the reserve study at all. I have not seen contingency specifically listed within state statutes. That doesn't mean it doesn't exist; it just means that I haven't seen it. Many interpret state statutes as being specific about reserves not being able to be included in the reserve study by the absence of a discussion on the matter. Others state that you are not necessarily prohibited from having a contingency reserve simply because it is not enumerated in statutes; many other things are also not specifically listed in statutes. However, depending upon how a contingency factor is added to the reserve study, it may not be an issue. (See item “b” above.)
- Governing documents - The position here is very similar to that of state statutes. Most governing documents do not have any language at all that addresses the issue of contingency within the reserve study. Therefore you are left with the same question of whether or not it is permissible to include contingencies in the reserve study simply because of the absence of any language addressing the issue.
- Tax law - For what may be the only time we can ever say this, the fact is that tax law is quite specific on the issue of contingencies within a reserve study. Many people may disagree with the following statement simply because it is exactly the opposite of what they have been told numerous times, but the fact is the IRS takes NO position with respect to contingencies in the reserve study.
The IRS cannot force any taxpayer (Association) to include or exclude ANY item from the reserve study. The only thing that the IRS can do is to react to what has been included in the reserve study by telling you the appropriate tax treatment of that item. While the HOA industry thinks in terms of operating versus reserve, the IRS thinks in terms of capital versus non-capital. They are not the same thing.
The IRS has issued three specific Revenue Rulings, 74-563, 75-370, and 75-371, all of which address the issue of reserves. All three rulings take the same position that for reserves to be excludable from taxable income under Internal Revenue Code Section 118 (contributions to the capital of a corporation), the reserve assessments must be for “specific capital purposes.” For that reason, IRS takes the position that contingency reserves, because they are not for a specific capital purpose, cannot qualify for the exclusion from taxable income under code section 118.
That is definitely not the same as saying that contingencies cannot be included in reserves, but it does reach a similar result. Why is this a critical distinction? Because many Associations are regularly including contingencies within their reserve study. How can they do that without incurring the wrath of the IRS? Simple! File Form 1120-H. On Form 1120-H, the IRS does not care if you included contingencies in your reserve study because the contingency reserve additions for any given year are considered to be exempt function income which is not taxable on Form 1120- H. That is the exact opposite of the tax treatment on Form 1120. On Form 1120, the contingency reserve addition for the current year is considered to be “member” income, which means it gets added back to your operating income. If net member income is a positive amount in a given tax year, it will be considered taxable income unless the Association makes an election under Revenue Ruling 70-604.
Next, let's look at the calculation methods identified above as items “a” and “b.” These calculation methods can also have a very significant impact upon how the contingency factor is included within the reserve study, how it is perceived by readers of the report, and how it is treated for tax purposes.
In all variations of item “a” above, the contingency factor is effectively presented as a line item within the reserve study, even though the methods of calculation may be different.
However, in item “b” above, the contingency factor is spread out amongst all of the components of the reserve study and loses its identity as a separate contingency line item. In fact, it cannot even be seen within the reserve study, but it still exists. Probably the easiest way to understand this is to conceptually treat the contingency the same as you would treat the inflation factor that is part of the reserve study. Let's look at an actual example. If a component has a current replacement cost of $100,000, and you are using a 3% inflation factor, and a 1% contingency factor, then the replacement cost calculated in the reserve study one year from now will be $100,000 (currently placement cost) plus $3,000 (inflation for one year) plus $1,000 (contingency for one year) for a total estimated future replacement cost, including contingency, of $104,000. Imagine that same calculation being repeated for dozens of items within a reserve study, and you'll see how the contingency factor can certainly exist but not be separately identifiable as a contingency line item.
Is this defensible from a tax standpoint? The answer is yes, because it is no different than an estimate for future inflation. That means it is part of an overall calculation that determines each year’s funding within the reserve study, although no part of it is separately identifiable as a contingency reserve.
The larger question is, “Should an Association have a contingency reserve?” Since all future costs, as well as future inflation and future interest earnings, are nothing more than estimates - no matter how sophisticated the calculations determining those estimates - there is little likelihood (a virtual impossibility) that future costs will occur exactly as planned. Therefore, many may consider a contingency factor to be a prudent judgment.
What if your Association is extremely underfunded and your current assessment structure makes it virtually impossible to raise reserve assessments to a level needed to bring the Association to a stable funding platform? Adding in an additional contingency factor that increases assessment requirements makes no sense in that scenario.
What if the Association is either very highly funded or even overfunded? Does it make sense to have the contingency factor then? It makes more sense then, but it still does not make it a necessity. It may be considered more prudent to recognize early on the highly funded or overfunded situation that exists, and reduce reserve assessments so that any overfunded situation works itself out.
Bottom line, there is no right or wrong answer to the issue of including a contingency factor in the reserve study. The reserve study belongs to the Association and it should reflect their best estimate of future major maintenance and replacement costs, and the funding plan that is appropriate for the Association.
The IRS (notice how that spells the word “theirs”) has recently developed a new program to extract money from corporate taxpayers, which happens to include homeowners associations. This is an extension of the “Form 1099 Matching Program” successfully applied to individual taxpayers more than a decade ago. But now, corporations are the target. Not just YOUR association, but all corporations. It only feels like it’s your association, because you’re the one that received the notice from IRS. This is not really an IRS audit, but it does require your response. Two CPA firms that practice in the community association arena have reported receiving multiple notices.
Why is IRS doing this? Efficiency – the same reason that a business would use. The underlying concept is that rather than using expensive IRS Agents to verify income, the computer can do the work instead. Every time a bank issues a Form 1099 to report interest income, or a lessee issues a Form 1099 to report either rents paid or laundry room proceeds from your third-party concessionaire, that information is received (usually electronically) by the IRS. That allows them to cross check the recipient’s (YOUR Association) tax return to make sure that the income was fully reported and that the IRS has received all the tax it was due.
This Form 1099 matching program was wildly successful when it was applied to individual taxpayers. Turns out that our “voluntary” tax reporting system had a few people that “overlooked” some income. The IRS tax collections far exceeded the cost of the program. The reason it worked so well is that all individual taxpayers report on the calendar year, the same reporting period required for Form 1099. Also, individual taxpayers report income on the cash basis, so the reporting methodology also matches the Form 1099.
So, apparently, the IRS reasons that by extending this matching program to corporations, they will get the same result: more income and more taxes. IRS has just overlooked a couple of “minor” factors; (1) not all corporations operate on a calendar year basis, so in those cases the Forms 1099 will never match the tax return because of the difference in reporting periods, and (2) corporations are (generally) required to report income on the ACCRUAL basis (not cash), so the reporting methodology is also different.
Let’s look at a couple of real examples –
Example 1 – ABC Association operates on a calendar year (January 1 through December 31). Its reserve fund invests in a bank certificate of deposit (CD) for $200,000 for a one-year period, starting July 1st, which matures the following June 30. For simplicity, we’ll say that the bank is paying 1% interest, and that interest is paid only at maturity of the CD. So, on June 30 of year two, the Association receives $2,000. (That’s what we call “cash basis”.) The bank issues a Form 1099 in year two for $2,000, and files a copy with the IRS.
The Association, on the other hand, is an accrual basis taxpayer. During the financial statement audit, the CPA makes sure that interest income for the first six months of the CD term (that portion occurring in year one) is reported as accrued interest receivable (on the balance sheet) and interest income (on the income statement). (That’s what we call “accrual basis”.) The CPA then prepares the tax return based on the accrual-basis, audited financial statements. He reports the $1,000 of interest income “accrued” in year one. If this were the only “taxable” transaction, IRS is not going to have a problem with it. They don’t care if you over report income; if your association tax return contains more interest income than is reported on Form 1099, IRS just ignores it. So, in year one, you don’t have a problem with the IRS.
But in year two, the association again reports $1,000 of interest income on the accrual basis. However, the IRS now has a Form 1099 from your bank reporting $2,000 of interest income. The IRS computers don’t get a match and assume that you have under-reported interest income by $1,000, so they send you a notice – form letter “Notice CP 2030” which states:
“We have received additional information from third parties that changes the amount of your tax, deductions, and payments. As a result you owe $325 ($300 of tax, assuming you file Form 1120-H, plus $25 of interest), which you need to pay by DATE.”
What makes these notices even more fun is that you sometimes receive the notice after the due date, which makes it difficult to make a timely payment.
Sometimes the IRS will send you a notice which starts out by saying, “We noticed an error on your tax return.” As a tax preparer, that really bothers me, because in virtually every instance, the error is on the part of the IRS. Meanwhile, I have to explain to my client what really happened.
Example 2 – XYZ Association operates on a fiscal year that ends March 31. Using the same circumstances as described above, nine months of interest income is accrued in year one, and only three months in year two.
So, the IRS notice will report an even larger difference.
What should the Association do? If you feel comfortable in responding to this issue yourself, go ahead and do so, but there are dangers in this. For most associations, if you didn’t prepare the tax return, you may not have enough information to adequately respond to the notice. There is also the risk that if you get involved in a discussion with the IRS, the situation could degenerate into an expanded issue.
As an example, the IRS, in looking more closely at the tax return - since you’re now going to involve a real human being at IRS (question – do they have real human beings at IRS?) - may raise the issue of the deductions you’ve allocated against certain income sources. Do you know the tax law on this? On Form 1120-H, the test is that deductions must be “directly connected to” the production of income, while on Form 1120, a slight looser “reasonably related” test applies. Are you familiar with the Concord Consumers Housing Cooperative versus Commissioner Tax Court case, which specifies the types of deductions that can be applied against interest income? You may be short-changing yourself.
A better strategy is to contact your tax preparer and provide him or her with a copy of the IRS Notice CP 2030, copies of Forms 1099 received, and a copy of the tax return.
If you don’t have a paid tax preparer and think you need some help, check out the sponsors on this HOA Pulse site, or take a look in the business directory.
Expect to pay for this service. The tax preparer cannot control the IRS and will expend time in analyzing the issue and preparing a response.
Whatever you do, don’t ignore the notice. IRS does not just go away.
* * *
Conversation overheard in an IRS office between two IRS Agents talking about a certain provision of the tax code:
“Just because you don’t understand it and I can’t explain it doesn’t mean we can’t enforce it.”
How exactly does that work?
I recently participated as a panelist in the white collar crime presentation. Each of the five panelists could relate several, if not numerous, cases in which they had been involved as a professional of some manner, in the aftermath of an embezzlement of association funds. What struck me is that none of them were the same cases, meaning our group of panelists had knowledge of dozens of separate embezzlement cases. While this doesn’t mean that embezzlement of association funds is a widespread problem, it is still too common a problem to ignore.
Protection of association assets is one of the primary responsibilities of the treasurer and board of directors of every association. As associations and the financial markets become more sophisticated, many more associations have now adopted investment policies to insure that association funds are protected from the risk of market losses. However, simply due to their size and nature of operations, many associations do not, or cannot, take adequate steps to protect association funds from physical theft.
There are three general categories into which associations fall which have an impact on the physical protection of assets.
First, many small associations use volunteer board members to actually run the association. There are no employees nor is there an outside management company. The entire burden of association fiscal matters resides with the volunteer officers. At that point, the safety of association funds depends almost entirely on the honesty and integrity of the individuals involved.
Second tend to be mid-size associations who hire professional management companies to oversee their operations and report on association financial transactions. This arrangement works very well for the vast majority of associations. But this often removes the board members from active participation, so they act more in the role of passive overseers of financial transactions. For associations in this category, the best actions that a board can take to assure the safety of associations funds is to sign all checks, carefully review all financial reports, bank reconciliations, and transactions that are processed by the management company.
Third, many larger scale associations hire their own employees to act as on-site managers and accounting staff. It is rare that there will be enough employees to allow for a complete segregation of financial duties. In other words, simply due to a limited number of people involved in the accounting function, there will be an inherent conflict of duties performed by certain of individuals within the accounting function. As an example, the association’s controller or bookkeeper may send out member assessment invoices, make deposits, prepare bank reconciliations, write checks, and file paid invoices. If that person also records all transactions in the association’s general ledger, then they effectively have total control over association funds. The only activity not under the direct control of that controller or bookkeeper then becomes the actual signing of checks. Since there are many conflicting duties being performed here, there are opportunities for that person to misappropriate funds. The board should, in this situation, carefully review all financial records and also design the accounting system so that opportunities for misappropriation of funds are reduced.
Tips that the association may consider for protecting association assets include:
1) Conduct an annual audit, review.
2) Make sure your accountant gives you a management letter, and ask if there were any immaterial items noted that were not included in the management letter.
3) Make sure bank statements are reconciled monthly, and review both the bank reconciliations and bank statements.
a. Compare bank statements to the bank reconciliations. The bank reconciliation should begin with cash per bank and reconcile down to cash per books. The reconciling items will generally consist of deposits in transit and outstanding checks. Investigate and question any large or old outstanding checks. Deposits in transit should not be outstanding for more than 30 days.
b. Examine the bank reconciliations and see that they agree to the amounts reflected as cash on the balance sheet.
4) Require monthly financial statements, and review them closely, particularly budget-to-actual and year-to-year comparisons. Demand explanations for any significant variances. It may help to develop a checklist to assure everything is reviewed.
a. Review the bank statement to ascertain that all interest income has been recorded in the financial statements.
b. Make sure that all bank accounts are recorded in the general ledger of the Association.
c. Examine the aged receivable listing and compare it to the balance sheet. The total of assessments receivable should agree to the balance sheet.
d. Thoroughly review the check register and any fund transfers to assure all expenditures and transfers are proper and authorized. Question any large amounts, assure proper approval and documentation.
5) Make sure that the board signs all reserve checks and approves all reserve transfers. (This is where the big money is spent). Never sign a blank check.
6) Establish an investment policy with an emphasis on safety of principle.
7) Prepare written collection policies, and follow them without fail.
8) Require a fidelity bond for manager and/or employees and purchase directors and officers (D&O) liability insurance.
9) Require disclosure of conflicts of interests. This would apply to any significant relationship with any vendor or service provider, board members, or members of the association.
10) Establish fiscal policies.
a. Do not receive cash, if possible.
b. The person that opens the mail should stamp the payments (For Deposit Only). The person posting the payments to the computer system should not open the mail.
c. At least one Board member should review all payables to assure proper invoicing and approval, and review costs for both reasonableness and propriety.
d. The person who approves the invoices should not be the same person who writes the checks.
e. Have the signor of the checks mail checks to vendors; don’t return them to the person who wrote the checks.
f. Bank signature cards should be updated when any signor is changed.
g. Bank statements should be opened by a person other than the person preparing the bank reconciliations. Canceled checks (or images thereof) should be reviewed for irregularities.
h. Keep reserves in a separate bank account with Board control.
1. Two board members should sign expenditures or transfers from reserves.
2. Assure transfers to the reserve account are made timely.
3. Any expenditure from the reserve account must be properly documented (in the minutes) and approved by the Board.
Implementation of the above checklist requires that the Board be more than simply passive observers. Directors should take an active part in protecting the assets of the association. This now comes back to the white collar crime panel discussion. One of the common threads that I noticed in talking with each of the other panelists is that the crime occurred when somebody wasn’t doing their job, meaning they weren’t performing some or all of the above suggested procedures. If they had, most of the white collar crimes that occurred would have been prevented completely or detected quickly because of the adequate safeguards and controls in place.
Setting the scope of the reserve study is the first step in selecting a reserve study company. If you don’t know where you want to go, you probably aren’t going to get there. See attached article on setting the scope of the reserve study. After you have determined the scope, then write your RFP (Request For Proposal). This is important, because if you don’t write an RFP that establishes the scope of the reserve study, then by default, you are allowing the scope of the study to be determined by the reserve study company that you select. And, you may be making your selection based on inaccurate assumptions, because each reserve study company submitting a proposal may be using different criteria in how they will perform the reserve study.
There are three significant factors to consider in this process:
- The services to be performed
- The format of report to be received
- The availability of software to allow you to continue to manage the process yourself
The onsite services performed are relatively similar, although different reserve study companies may have different capabilities in performing the component condition assessment. What is critical here is following the scope established by the Association. If the Association is only interested in meeting a statutory requirement or estimating an overall budget amount, the level of component data identified is not a critical factor. If, however, the Association has established a scope that they want a sufficiently detailed level of component data that they can use the reserve study as an ongoing management tool, then the reserve study company must both understand the goal desired and be prepared to compile the component inventory at the appropriate level of detail.
The format of reserve study reports varies significantly between reserve study companies, although most will contain similar information. It is important for the Association to establish certain assumptions that will be used in the calculations of financial data, such as estimated interest and inflation rates, whether or not taxes on interest income will be paid from the reserve fund or the operating fund (this is an issue because certain state statutes specify what types of expenditures may be made from the reserve fund, and taxes may not qualify) and how percent funded will be calculated (current cost, future cost, or inflation adjusted cost).
More Associations are now demanding that they be able to manage the reserve data. This means that the reserve study company should be able to provide software. Our company uses the Facilities 7 reserve study software to prepare your reserve study, which allows us to turn over the online access to the Association at the end of the process. Facilities 7 is an internet-based software system that gives the Association the full power of the same software that we use to prepare the reserve study.
Once you have completed the above process, it is a matter of sending out your RFP to several reserve study companies. You should be requiring a written proposal that meets the requirements of your RFP, as well as a sample report (which may be in the form of a link to a sample report on the reserve study company’s website).
When you have received the various proposals, read them carefully to understand not only the fee proposal, but also the company’s ability to meet the Association’s scope requirements in both service and reporting. Any reputable reserve study company will generally welcome the opportunity for an interview by the Board or management regarding their proposal. We often request Skype interviews to cut down on travel time and still allow a face-to-face interview process. In-person meetings are often not reasonably possible. As an example, many Associations will want to interview reserve study companies that are not located locally to the Association. Given the relative small dollar value of most reserve study contracts, it is not reasonable to request a reserve study company to attend an in-person interview where it involves hours of travel and travel expenses. Skype solves that problem.
Ask each reserve study company for references, and follow up on the references. Ask questions like:
- Was the reserve study accurate and helpful?
- Did the reserve study company perform as promised?
- Was the reserve study report prepared in a manner that was easy to understand?
- Was it easy to work with the reserve study company?
- Were any problems taken care of willingly?
Evaluating cost of reserve study services is important. For too many Associations, it is their only consideration. The homeowners association industry might borrow a practice used commonly in the governmental sector, where proposals are broken into two parts; a technical proposal and a fee proposal. Some governmental agencies make an initial selection of “final bidders” based solely on technical proposals, and only then will consider fee proposals from the finalists selected. That prevents placing too much emphasis solely on cost.
Following the above guidelines should help you in your decision making process. If you have trouble making a decision, you may not have enough information. Obtain more bids if necessary. Call additional references. Talk to each reserve study company and be open about your concerns. Be wary of any reserve study company that is not willing to discuss your concerns. Remember that the reserve study belongs to the Association, and the reserve consultant is simply helping you in the process. Selecting a consultant for intangible services can be difficult. The above steps should help clarify the process and increase the likelihood that you will be successful in your search for the right reserve study company.
Setting the scope of the reserve study is one of the most overlooked aspects of the reserve study process, and is one of the primary reasons that Associations may be dissatisfied with the end product reserve study that they receive. This article explores the reasons why you choose to have a reserve study, and how that affects the scope of the reserve study. Scope of the study also affects the cost you will pay for the study.
There are several different reasons why an association may decide to have a reserve study performed. In states like California, Nevada, and Utah (amongst others), state statutes may drive your decision to have a reserve study. If that is the case, then cost of the study is likely to be your most important criteria in selecting a reserve study company to perform your study.
Other associations want a reserve study to help them determine the appropriate assessment amount for reserves. This typically means the association has a higher level of interest than just complying with a statute. If that is the case, then cost may not be the most important criteria in making your selection of a reserve study company, although cost is always important.
Finally, a much smaller group of associations has embraced the concept of using the reserve study report as a management tool to help them better manage long term replacement costs. For this group, the most important criteria in selecting a reserve study company is making sure that the reserve study report produces component information at the appropriate level of detail.
Theoretically, reserve studies created for any of the three goals described above may produce overall budget information that is very similar, the first two will generally not provide sufficient information to allow the reserve study to truly be used as a management tool. An example is a reserve study we completed recently for a large master association. Several areas stood out as examples of the difference in reserve study approaches. The prior reserve study contained single line items only for several key components; roads, HVAC equipment, fitness equipment, and playground equipment.
Let’s focus on just one of these, fitness equipment. The prior study contained a total current replacement cost of $80,000, with no detail to support that. We broke fitness equipment out into approximately 20 line item components that allowed the Association to track each item of fitness equipment individually. The total cost per our analysis was $92,000. The cost difference was not so great that it would, by itself, cause any significant difference in funding requirements. Although many of these equipment items are assigned the same useful life, they will generally not all be replaced at the same time. When you have this situation and only a single line item, you can’t easily update your reserve study. If the equipment items are individually identified, then you can easily update the reserve study, and manage your replacement budget.
Along with this added detail in the reserve study comes the requirement that data can be managed within the reserve study software. Too much unclassified component data can simply overwhelm the user of a reserve study report. The software must be able to manage and summarize the data in a manner such that it is easily broken into smaller, recognizable segments that are easy to deal with. The Facilities 7 reserve study software we use has three category levels and two component levels, which allows for tremendous flexibility in managing component data, and allows us to present summary level reports for general use, while still being able to provide detail where necessary.
Our philosophy is that any exhibit should be able to be summarized onto a single page. We find when making presentations to a board of directors that single page exhibits, although at a summary level, are easily understood. As soon as you move to a multi-page exhibit, people have difficulty following the presentation because there’s too much data. The needs of the board of directors are generally different from the needs of the management and accounting staff. Directors generally prefer summarized data, whereas the management and accounting staff must have more detailed data to be able to manage the process.
What this all means is that the Association needs to determine exactly what it wants before it even attempts to request bids for their reserve study. And, let’s address that also, because simply requesting bids from several reserve preparers is the wrong approach. The right approach is that the Association needs to establish scope of the study, then prepare a RFP (Request For Proposal) that forces the reserve study companies to submit proposals that will meet the Association’s previously established requirements.
As technology advances and the homeowners association industry matures, we find that many more Associations are requesting something that few reserve study companies can provide; a reserve study created at the appropriate level of detail to be used as a management tool, AND an internet-based software product that the Association can use to keep their reserve study updated. This doesn’t mean that the Association is completely taking over the process of the reserve study, they are performing the update to the component database based upon their maintenance program and information obtained from their accounting system regarding contributions to and expenditures from reserves.
Selecting a reserve study company for intangible services is always difficult. Setting the scope and using an appropriate RFP process will help the Association reach their goals.
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The HOA Board of Directors: How to Make a Positive Difference
Written by John T. KalasEven though HOA boards of directors and property managers are responsible for property, the issues that arise most often are likely to be related to people rather than real estate. That makes the job more difficult, and board members have to navigate with a little finesse to succeed. Follow some basic rules and your board and community will work well.
First Things First: Give Others Due Respect
Care and respect go a long way in our society, and the same applies to the relationships between HOA board members, as well as with the communities they serve. Think of an HOA as a democracy and you’ll have a strong foundation. Like any democracy, the community you live in is made up of diverse individuals. We need to approach others with an authentic caring attitude and give them the respect they deserve. That even goes for times when we don’t agree, and when respect is not reciprocated.
Perception is Everything
Anyone who has been on an HOA board of directors knows this fundamental truth about communication: It’s not what you say; it’s how you say it. Remember, perception drives behavior!
Successful HOA boards are sensitive to the need to act and communicate with care, because perception drives behavior. Having too many extra meetings or taking an action without a meeting, for example, can communicate to the association that the board isn’t operating democratically.
Take the “Four-Way Test”
A good rule of thumb for boards is to heed the “four-way test” approach, developed almost 100 years ago by the founder of Rotary International. The method helps ensure that parameters around a problem are clear, which leads to better decisions and relationships.
When finalizing a decision, ask yourself:
Is it the truth?
Is it fair to all concerned?
Will it build goodwill and better relationships?
Will it be beneficial for all concerned?
Looking at a fairly typical issue with many HOAs, you can see how applying the four-way test can save the day—or at least the board’s effectiveness.
An Example: Internal Dispute
Board members for an HOA got involved in a bitter dispute over the association’s landscaping contract. One board member was upset over a decision that had been made regarding a landscaping company. The board argued and the dissenting member resigned.
How could this have gone differently? What would have happened if instead of arguing, members had a discussion about moving forward with the decision already agreed upon, but with a “let’s see how it goes” attitude. Applying the tests of honesty, fairness, relationship-building and universal benefit, the board could take a course of action that everyone could live with: honor the originally chosen landscaping contractor; schedule an open meeting down the road to talk about the company’s progress and the landscape appearance; and choose an alternate vendor so that, should the current vendor do an unsatisfactory job, it can be replaced at the end of its 90-day probationary period.
Ultimately, HOA board members have the privilege of being in a position to make a difference in the quality of life within the community. It’s about how they make decisions and a commitment to communicating with mutual respect, honesty, fairness and an authentic and caring attitude.
Years ago I was invited by a fellow manager to attend his Association's annual meeting and act as inspector of elections. He promised it would not be much work, as his staff would handle all of the mechanics of the election process. I just needed to oversee the process itself. He told me that in his community of approximately 700 condominium units, the normal turnout for an annual meeting was fewer than 50 people.
The reserve study consists of a number of estimates and assumptions. All of them are important, but one stands out as having significant impact upon the calculation of needed reserves - remaining life of components. As an example, if your previous reserve study indicated that the remaining life of the roof was 15 years and it is now determined to be only 10 years, then you have much less time to accumulate the needed funds, which translates into higher assessments. That is considered a change in estimated remaining life.
So how is remaining life calculated? First of all, recognize that it is an estimate. Unless the major repair or replacement is imminent and the date is known, the remaining life is an estimate. The actual remaining life may be shorter or longer than what is estimated in the reserve study. In more than 20 years of reserve study experience, we have seen components that have lasted only a small percentage of their original estimated life, and others that have lasted multiples of their original estimated life. One of the purposes of the reserve study is to attempt to predict the remaining life as closely as possible.
When a component is placed into service, the first estimate of remaining life is likely to be based upon a warranty, manufacturers’ representations, contractor estimates, cost estimating database, or common industry practice. You may, in fact, have different estimated lives from each of these sources. It means you've got to make a decision as to which estimated life you choose to use for your reserve study. This life is known as the useful life and the period of time is known as the normal life cycle or replacement cycle, as virtually all components are anticipated to deteriorate over a period of time known as their normal life cycle.
As time progresses, the condition of the component will change, and perhaps not in accordance with the original estimated life. This, again, is normal, as components rarely deteriorate exactly in accordance with the estimated normal life cycle. That means the estimated remaining life may be adjusted in each reserve study after the component is placed into service. That's not likely, but it can occur. One of the primary reasons for performing the component condition assessment as part of a reserve study site visit is to determine the estimated remaining life of each component. Again, this may be accomplished in several different ways.
- 1)We, as reserve preparers, ask you (or your maintenance staff, support vendors, or contractors) what your future plans are for major repair or replacement of each significant component. As an example, it does little good for me to assume that a roof with an estimated original life of 40 years that is now 15 years old (and therefore should have a remaining life of 25 years) is going to reach its full lifecycle when you already know that you have significant issues due to either product failure or improper installation, and that you are estimating you need to replace the roof within the next 10 years.
- 2)We ask you about your current maintenance activities and any factors (such as excessive use or extreme wear and tear) that exist that may impact the remaining life of each significant component.
- 3)Based on our own observations and experience, and with knowledge of when the component was placed into service, we evaluate the condition and form our own estimate as to the remaining life of each significant component.
- 4)We inquire about warranties and product quality (which is not always evident from visual observation).
Clearly, judgment comes into play in making the remaining life decision based on any of the methods above.
Since the reserve funding requirement is a function of the aggregate remaining lives of all components combined, the more accurate the remaining life estimate, the more accurate the funding plan will be. For those associations that use a baseline funding goal, any significant reductions in estimated remaining lives can plunge you into special assessment territory. That is one of the reasons why our reserve study company continually recommends against using a baseline funding plan. It simply leaves you no room for significant changes in remaining life or replacement cost.
A caution here - many times we have gone on site for the first site visit of an Association that is a new client for our Company and, as we have our initial discussion with Association management and maintenance staff, are told that they intend to repave the streets (or pick any other reserve activity) simply because the prior reserve study says now is the time to do it. That's putting the cart before the horse. The reserve study should be based on your maintenance plan, and your maintenance plan should be based upon operating maintenance activities and the physical condition of the components. While the reserve study may be the financial representation of a maintenance plan, it is not itself a maintenance plan. Don't confuse the two.
The Servant Leader
Much has been written about a form of leadership called the “servant leader”. This title, dubbed by Robert Greenleaf as a form of leadership in 1970, has been hailed as the modern model of leadership. But is this really a new form of leadership, or is it simply a variation on a theme?
As in many organizations, the president of the community Association is recognized as the leader of that organization. The actual task of management is often delegated to an employee or an outside management company. But is the president still performing a management function? The answer is yes, as the leadership function itself is divided into two sections: leadership and management. The vision promoted is the leadership function, while the serving activities constitute the managerial function. The delegation of a portion of the management tasks to an employee or third-party management company simply reduces the number of management tasks that the president performs.
Here's a list of characteristics that many believe are central to the concept of the servant leader:
- Awareness - The servant leader must understand his or her own values, biases, strengths, and weaknesses, as well as the values of those served.
- Foresight - The servant leader has a well-developed sense of how the past, present, and future are connected.
- Stewardship - The servant leader is a steward who holds the organization's resources in trust for the greater good of those served.
- Listening – The servant leader is one who can listen effectively to others.
- Empathy - As discussed above under “awareness,” the servant leader must be able to understand the perspective of others.
- Persuasion - The servant leader is recognized as one who influences others through his persuasive capabilities.
- Conceptualization - The servant leader is someone who can integrate present realities and future possibilities.
- Commitment to others – The servant leader is responsible for serving the needs of others. This means thinking about you, not me.
- Building community – The servant leader is someone who helps create a sense of community.
- Diversity – The servant leader values diverse opinions and seeks out opposing points of view.
- Trust - The servant leader cultivates a culture of trust.
- Humility – The servant leader does not wear the title of president as a badge to show who is in charge. Rather, he knows that it's not about the leader; it's about others.
The primary thrust of those promoting the servant leader model of management and leadership appears to be setting forth a leadership model that is directly opposite that of the dictatorial leadership model. But is it really a distinct leadership model, or is it simply a difference in emphasis and style? There are many different definitions of management, but they all seem to focus around a core concept of creating maximum benefit from the resources available.
The dictatorial leadership model could often be described as the most efficient form of management. It can work well with a strong leader who has a clear vision of the future and takes whatever actions are necessary to reach that vision. Those promoting the servant leader model of leadership appear to claim that the dictatorial leadership model in fact is not leadership at all; it's simply management. I don’t see it that way. The vision itself represents the leadership function; the management style adopted represents the management function of how to reach the vision.
Can you actually separate leadership from management? I'm not sure you can. The servant leader is one who uses persuasion to influence others towards his or her vision. The dictator simply orders others towards his vision. The dictator is probably very efficient; the servant leader is likely less efficient. The dictator, however, is not nearly as likely to have the “buy in” or support of his followers, while the servant leader is very likely to have a majority or full support of his followers in achieving goals. If the vision happened to be the same between these two leadership styles, the net result in achieving the goal might be the same. The difference is that the dictator likely would not have the support of his followers to perform the next task, whereas the servant leader would likely have the support of his followers in achieving the next task. In the long run, that may turn out to be a more efficient form of leadership.
The type of organization may have a significant influence upon which form of leadership works best. For instance, in corporate America the dictatorial/top-down leadership style is the most common model of leadership. However, those served by corporate America are both the employees and customers of the company. Assuming the company is producing a product that is desired by the customers, then it is the employees who are most affected by the leadership style. Employees are not volunteers.
In the community Association, those served are the members of the Association. While membership in the Association is voluntary, once a member buys a unit or lot within the Association, they become a fixed portion of the group or members served by the Association leadership. One huge difference from corporate America is that the members of the community Association are volunteers. They don't have to participate in any way in their community Association, and many choose not to do so. In fact, the primary reason many people buy in a community Association is that they can have the benefit of recreational and other amenities on a group basis that they could never afford on an individual basis - and they don’t have to worry about maintenance of those amenities. For the leader of the community Association, the challenge is much greater than in corporate America simply because the members are volunteers, not employees. They can make a choice every single day as to whether to participate or not to participate.
One of the ways that the community Association leader can influence or persuade other volunteer members is by example. Treating your fellow members as you would like to be treated yourself is the first step. My many years of experience in the community Association industry have demonstrated to me that the vast majority of members of Associations are well-satisfied with the Association experience. Unfortunately, that doesn't make the news. What we see in print news is the very small minority of interactions that don’t work well. Some of these actions are the direct result of a failure of leadership. As an example, those boards where the directors rule with a firm hand without demonstrating empathy towards their fellow members are much more likely to have an unhappy group of homeowners.
I have not reached any conclusion with this article. I simply wanted to share my thoughts and observations on this concept called leadership. Others I have talked to appear to have fully embraced the concept of the servant leader model. I still need some convincing, but probably just with the issue of it being a completely separate leadership model. I can’t argue with any of the characteristics described above. I see great benefits to that style of leadership, particularly as compared to and contrasted with the dictatorial style of leadership. However, I'm not sure I really see it as a completely different model of leadership. I simply see it as a difference in emphasis and style.
