I recently was processing a loan application for $2.8 million for a Washington State condominium association of 66 units. The loan repayment was going to cause the Association’s regular monthly level income to triple. Not surprisingly, the Association responded that they could not afford such an increase. I appreciated that perspective and agreed. The sad part of the negotiation was that they still needed the funds in order to keep the property in a habitable condition. They were effectively looking for me to be a Genie and turn the Loan application into a Grant request. They were frantic because they were out of options.
I have been specialized in lending to community associations nationally for over 20 years. I have, in recent years, noted a concerning trend with loan applications. The loan requests have gone from funding the replacement of a single component such as a roof to becoming wholesale renovations of the respective buildings. The per-unit project costs have gone from an average of $2,500 to $25,000. The core issue is the underfunding of the Reserve Fund for easily determined future capital maintenance upgrades.
There are States that require, by law, community associations to have professionally prepared Reserve Studies and even require that the studies be updated periodically. The irony is that those proactive States do not require that Reserve funding indicated by the required Reserve Studies be fully funded. One of the States with the most rigorous set of regulations related to reserve studies is California. However, contradictory to logic, it is my most prolific market for loans due to excessive deferred maintenance of associations with inadequate reserves. The state wants the associations to know they are underfunded but they do not require that they solve the problem. What exactly is the point?
Reaffirming my anecdotal experience of excessive deferred maintenance is the number of loan applications that are due to a property being “Red Tagged”. This is something have I only been exposed to in the most recent five years. It is municipalities stepping forward and giving community associations formal notice that they have a specific date to get required repairs completed or the property will be condemned and must be immediately vacated. These types of circumstances do not come about overnight. Typically, there are warning notices issued over extended time periods. Yet, the Associations do not take the steps required. The dialog that ensues with me once these notices occur is that the unit owners cannot afford the repairs. Which is also to say that they could not afford the little bit of extra added to the monthly dues that would allow for building of cash reserves. Effectively, the unit owners never could afford to live in the particular property that it is about to be taken from them.
In theory, loans for capital maintenance upgrades are not a product that should exist. There is no valid reason for a community association to be significantly under reserved. There is a very accurate and sophisticated system practiced by skilled and licensed professionals to generate life cycle analysis of community association components. The report generated is able to determine the estimated level of cash reserve needed at any point in time for the association to self-fund improvements. Special assessments should be limited to the potential differences in those estimates when actual repairs occur. The additional reality is that most people cannot afford to live in the units they currently occupy because they “claim” they cannot afford the projected future capital maintenance need that should be added to their monthly association dues.
There are 3 realities to living in a community association:
- The property will wear out.
- The improvement projects will not go away or become less expensive.
- The only place the funds to support the improvement projects will come from is the unit owners whether by building reserves, special assessments or loan payments.
It is my perception based on the ever-expanding problem. In the near future, regulatory agencies such as FHA, the insurance industry or the mortgage industry are going to inject themselves into the problem and require proper levels of reserves. Community associations are not likely to solve this pervasive problem themselves.