In a Hole
By: Nena Groskind
If the fence around the condominium playground is leaning precariously, if the playground itself is overgrown with weeds, if the decks are sagging and the buildings are in serious need of repainting, you don't need a degree in finance to suspect that this community's finances are probably a mess.
But appearances can deceive. The financial records may reveal serious, even life-threatening problems beneath the surface of a community that seems to be healthy, well-managed and well-maintained. We asked several accountants who work with community associations to describe the financial warning signs that tell them a community is in trouble, or heading in that direction. These are the 14 that disturb them most.
1. The budget doesn't balance. This may mean the community's expenses are out of control, the common area fees are too low, or both. But for whatever reasons, the community is consistently spending more than it collects in fees - a situation that obviously can't continue forever, Bonnie Whittemore, CPA and Karen Mericantante, CPA, partners at Keane + Company, PC, observe. "If the board doesn't address this right away, it could lead to bigger problems down the road," Whittemore says.
Boards that are relying on bank loans or borrowing from reserves to meet operating expenses (practices most accountants strongly discourage) are ignoring the obvious message: Their fees are too low. That's a message boards don't like to deliver and owners don't like to hear, Christopher Barrett, a partner in Barrett & Scibelli, observes. "It doesn't make accountants very popular."
2. The board attempts to balance the budget by slashing services. "When the lawn is being mowed every other week instead of every week, Barrett notes, "there is probably a reason." The warning lights flash for Ken Bloom, CPA, a partner in Bloom Cohen Hayes, LLC, when he sees a board reducing insurance coverage or deferring essential maintenance to cut costs. "These are the first places boards look when they're trying to avoid raising fees," he says. He sees this most often when newly elected board members, who have vowed to cut costs, discover that "there isn't nearly as much discretionary spending as they assumed."
3. The association has no reserves, doesn't fund reserves regularly, or doesn't fund them at all. "One of our top suggestions to boards is to commission an independent reserve study and follow its recommendations," Mericantante says. It is boards that don't have studies that are most likely to ask if they can use reserves inappropriately - to close budget gaps or fund non-capital projects. "If they have a study, they know what the reserves are for," she notes. If they don't, "this becomes a grey area for them, and could lead to the potential misuse of the funds."
Barrett agrees. "An association that is using all of its revenue for current expenses and not funding reserves isn't thinking about the roof that will have to be replaced one day." And that community, he says, "is going to be in trouble."
4. Accounts receivable - payments owed to the association, are exceptionally high or are increasing. There is only one explanation for this, Bloom says: Owners aren't paying their fees and the board isn't doing a good job of dealing with the delinquencies. "This problem only gets worse over time," he says. "The bigger the accounts payable number, the worse the community's cash flow crunch - and the deeper its financial hole - becomes."
5. Accounts payable - payments the association owes others "are exceptionally high and/or increasing. Odds are the communities having trouble collecting payments (the accounts receivable problem noted above) are also having trouble paying their bills. "If the board is paying June bills with September fees" - or sending assessment notices early to accelerate owners" payments - Barrett says, "you know something isn't right."
Recurring late charges on overdue bills make that warning light flash brighter, Mericantante adds. "If you're paying late charges because of cash flow problems, you're throwing money out the window" and exacerbating the association's budget woes.
6. The association's special assessments aren't special. A special assessment is a planned "13th payment" some boards levy annually, Bloom says - another way to raise the fee without acknowledging that that's what you're doing. It's a way to increase the monthly fee without announcing an increase. While there are appropriate uses for special assessments, Bloom agrees, this isn't one of them. "If you're anticipating $500,000 in expenses, you should collect enough in common area fees to cover that." Special assessments should be used, if necessary, for "extreme and unexpected expenses." That is not only a poor management practice, Bloom says, it is also misleading for new buyers, who discover that their fees are higher than they expected - and possibly higher than they can comfortably afford.
7. The association raises fees repeatedly - or doesn't raise them at all. Both indicate that the board isn't being realistic about what the association's funding needs. "If you have to increase your fees every year, you're not budgeting or planning properly," Filomena Scibelli, Chris Barrett's partner in Scibelli and Barrett, notes. "But if you never raise your fees," she points out, "you're falling behind somewhere," because the cost of most goods and services increases over time.
For that reason, a letter from the board telling homeowners, "we're happy to announce that there will be no increase in fees again this year," doesn't always make Mericantante and Whittemore happy, because "it isn't always the right answer," Whittemore says. "The goal isn't to avoid fee increases," she adds. "It is to make sure the fees are high enough to cover normal operating expenses." Whittemore and Mericantante recommend a small (2 to 3 percent) annual increase to establish a "cushion" that can avoid the need for a large, unexpected one-time adjustment in the fee.
8. The association's debt load is high. Accountants generally agree that associations shouldn't use bank loans to cover operating expenses (most banks won't approve loans for that purpose), but they differ on the merits of borrowing money to finance unanticipated expenses or large capital projects. Bloom feels strongly that a special assessment (which should be labeled a temporary fee increase to protect it under the association's priority lien) is usually the best option for unexpected expenses, while large-scale repair and replacement projects should be financed with reserves. "That's what reserves are for," he says.
Banks are far more willing than they used to be to offer condominium loans, and many associations, in Bloom's view, are far too enthusiastic about seeking them. He also worries about the "car buyer" mentality that leads some boards to extend the loan term in order to reduce the monthly payments. The problem, he says: "You get a loan for one purpose, then you get another loan for another purpose before the first has been repaid. Soon, the debt equals $20,000 per unit," and the association is saddled with what becomes a permanent debt, with one or more loans always on the books.
"With rare exceptions," Bloom suggests, "there are no circumstances where a loan is a better option for an association than drawing on reserves or levying an assessment. "It's not black and white," he agrees. For some communities in some circumstances, a loan may be the only viable solution. "But too many boards see it as the first choice" rather than the last resort Bloom thinks it should be.
9. The board puts vendor contracts out to bid every year. This indicates to Bloom that board members are focusing too much on the cost of services and not nearly enough on their quality. "Single minded obsession with the lowest cost isn't prudent and isn't in the best interests of the community," he says. Boards that make the lowest bid their priority and change vendors repeatedly, he cautions, may be sacrificing loyalty as well as quality. "When the blizzard comes, you probably aren't going to be at the top of the contractor's list."
10. The board doesn't review financial reports. Board members have a fiduciary obligation to manage the association's affairs responsibly and protect the interests of owners. They can't discharge those obligations if they don't understand the association's finances and aren't closely monitoring its financial condition. "The board should be comparing the monthly financial reports to the budget so it knows where the association is financially in relation to where it should be," Barrett says. If boards aren't doing that, he suggests, it's because "they don't want to know."
11. The board gives one individual too much control over association finances. That is both an indication of poor management and an invitation to fraud. All of the accountants we consulted made this point and made it emphatically: You don't want the individual who writes the checks also to be responsible for reconciling the bank statement. You want more than one set of eyes on the books, more than one pair of hands on the checkbook, and multiple signatures required for large expenditures and for withdrawals from reserves.
12. The association lacks adequate fidelity and crime insurance. The rule of thumb holds that insurance should equal: The total of the association's funds at risk, or (if greater) either the amount required by the association's bylaws or the minimum required by the secondary mortgage market - three months of assessments plus current reserve funds. Without this protection, a community could be devastated financially by the fraudulent acts of board members or a manager.
13. An association bank account is opened in a board member's name and with the board member's ID number. "We never like to see this," Scibelli says. Even if the intentions are honorable, the appearances are suspicious. "If the management company changes,ˇ± she notes, "the account could fall through the cracks." If the new management company doesn't know the account exists and other board members forget about it, she says, the temptation for the board member controlling the account to simply take the funds "would be hard to resist."
14. The manager or board members refuse requests to provide financial information. As indicators of potential problems, this one is quite clear, Bloom says. "Generally, when someone won't turn over something, it's because they have something to hide. You don't have to be a detective to figure that out."