‘Tis the Season: Budgets

Yes, it’s that time of year again for HOAs. No, not the holiday season—it’s budget season! Most HOAs use the calendar year as their fiscal year, and now is the time of year that many boards of directors are formulating their budgets for next year. Here are some tips for making the budget and next year’s finances run smoothly and in compliance with North Carolina law.

Reserves: Analyze the property that the HOA is required to maintain to determine its useful life and the cost to rebuild, repair, or replace it when the time comes. This is especially important for large-ticket items such as roof and siding replacement, detention-pond repairs, paving jobs, and refurbishing of swimming pools, clubhouses, and other amenities. This process is known as a “reserve study,” and there are professionals known as “reserve specialists,” usually persons with engineering and construction backgrounds, who can perform these studies for you. The result of a reserve study is a road map for how much money from assessment income the HOA should be setting aside into reserve accounts to meet these needs when the time comes. When done correctly, performing a reserve study and following its findings will avoid the need for large special assessments to be levied against owners in future years as the need for these projects surfaces.

Contingencies: Expect the unexpected. Include an allowance for unexpected expenses, also known as “contingencies.” Due to the current economic environment, we expect to see higher rates of defaults and consumer bankruptcy filings over the coming year or two, so it is imperative that HOA boards do not delay in filing liens on homes with delinquent assessments.  The odds of getting paid in a bankruptcy are immensely higher if there is a lien in place before the bankruptcy is filed.  Also make sure your budget provides an allowance for “bad debt,” or uncollectible assessments. Few associations collect 100% of their assessments. Use historical data from prior years’ financial statements to determine the proper allowance for bad debt and adjust upwards to take into account delinquencies attributable to any adverse economic conditions.  Other contingencies include repair costs for damage to common property that is not covered by insurance.

Capital projects: Many boards focus their efforts only on the operating budget—the regular income from assessments, and the regular expenses for management, landscaping, utilities, insurance, maintenance of common property, and professional services—but your budget should also disclose any expected capital expenditures for the coming year. For example, will you be using reserve funds or a bank loan to replace the roofs on the condominium buildings, install a new playground, or refurbish the clubhouse and replace the furniture?  If so, these expenditures should be reflected in your budget.

Lean on your professionals: All professional community association management companies should be familiar with budgeting.  It is imperative that boards and managers work collaboratively to craft a budget that suits the needs of the community, and most management companies can draw on years of experience to assist the board with the budget. 

Don’t be afraid to increase the budget: Some HOA boards like to boast that their budget has remained unchanged from the past year, often while ignoring the huge shortfalls that will result.  Underfunding a community lacks foresight, and it can decrease home values in the long term.  Many communities’ governing documents also tie annual budget increases to the last-approved budget.  An oft-seen provision is that any budget more than 10% above the prior year’s budget must receive a 2/3 membership vote for approval.  Years of unchanged budgets puts these communities at a disadvantage when the board cannot raise the budget enough just to pay for basic services without a supermajority vote.  Believe us when we say that there are a lot of communities where “static” budgets over the years resulted in large, deferred maintenance costs that resulted in huge special assessments on unsuspecting owners.  That’s poor financial planning.

Budget ratification: North Carolina law requires all condominiums, and planned communities formed in 1999 or later, to allow the members to review and vote on proposed budgets. The applicable law for both condominiums and planned communities says,

“Within 30 days after adoption of any proposed budget for the [condominium or planned community], the executive board shall provide to all the lot owners a summary of the budget and a notice of the meeting to consider ratification of the budget . . . The budget is ratified unless at that meeting a majority of all the lot owners in the association or any larger vote specified in the declaration rejects the budget. In the event the proposed budget is rejected, the periodic budget last ratified by the lot owners shall be continued until such time as the lot owners ratify a subsequent budget proposed by the executive board.”

Thus, the budget doesn’t actually have to be affirmatively approved by the members; it is approved automatically unless a majority of all the lot owners (not simply a majority of those present at the meeting) vote to reject the budget. Note also that meeting quorum requirements do not apply to budget ratification meetings, and the notice of meeting must state this fact.

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