Budget Season 2021-22: New Factors to Consider Post Pandemic and Post Tragedy
Preparing an annual budget is by no means an easy task. Those charged with preparing condominium or HOA budgets will soon begin reviewing costs, gathering data and projecting expenses for the coming year. A well-defined, well-written budget is a powerful financial tool allowing funds to be saved and/or allocated for specific costs and projects; budgeting is a way to estimate expenses and allow for those funds to be available when needed.
However, this past year has caused many communities to reflect on the lessons learned from both the ongoing pandemic and how it factors into new cost areas, as well as the recent tragedy with the collapse of the condominium tower in Surfside, Florida.
First Things First
Budgeting for condo and HOA communities actually involves not one, but two budgets, each covering a specific range of expenditures. Recurring (and more or less predictable) expenses such as taxes, utilities, staff salaries, insurance and maintenance are the line items most frequently found in the operating budget. This year has added additional costs to those recurring expenses that must be considered going forward, such as additional cleaning supplies, PPE costs for employees, and more frequent cleaning services. Major projects, and long-term plans, and emergency funds are budgeted for in the capital budget, and those items will vary, depending on the individual community’s needs, wants, and means. Many older communities are now considering taking a more proactive approach to upcoming inspections and certifications in order to mitigate risks and help residents feel more secure.
While expenses are divided into operating or capital expenses, income is generally obtained only from HOA dues or fees, and any fines or penalties incurred and repaid by residents. When any member of the board is unclear or confused on which budget should be assigned which cost, it can be difficult for the board to function properly and to uphold the fiduciary duties for the community. That’s why it’s important for every board member to have at least a working familiarity with the way their community’s budgets function and interact.
The Budgeting Process and New Pandemic-Related Expenses
Reviewing the existing budget and formulating a budget for the upcoming year is an annual duty for a board of directors and the property manager usually prepares the draft, typically using the prior year’s figures, historical information, and estimates for future projects in the drafting stage. The draft budget is then usually reviewed by the treasurer or the budget/finance committee. After any changes and adjustments are made, the board will likely hold a budget workshop meeting for additional fine-tuning, and then formally approve the budget in a final board meeting.
The issue of course with last year’s budget is that it was hard, if not impossible, to budget for the Pandemic of 2020 and to foresee what additional and new expenses were going to emerge.
As one would imagine, the pandemic is affecting finances and causing communities to spend a lot more money than they were expecting in various areas.
For example, communities had to buy personal protective equipment for their common areas such as lobbies and security desks. Many purchased plexiglass barriers and other equipment to protect their employees, which are not considered major repairs or replacements. Therefore, these items were not eligible to be charged to the reserve fund and had to be taken from the operating fund. Many of these COVID-related costs which were unbudgeted caused negative variances in the operating expenses.
Communities also had to purchase significant amounts of cleaning supplies, especially hand sanitizer and dispensers, as well as other important disinfectants, to keep common areas clean and safe. Once again, as these were new items or cleaning supplies, they could not be taken from the reserve fund and subsequently inflated the operating expenses.
While these costs were significant, they did not create as much of a financial issue as the following important line items in the budgets, which unfortunately had a very negative impact on overall expenses during the past year.
Water is absolutely the largest single negative consequence of this pandemic. Since many residents have stayed home to work over the last year, there has been a tremendous increase in water expenses. Hundreds of condominium clients revealed increases of anywhere from 10 percent up to 40 percent, according to a recent CAI survey. In a typical high-rise building, the water expenses can be between $100,000 and $200,000 per year. It follows that if those expenses were to increase by approximately 15 to 20 percent, it would have a significant effect on the budget.
That being said, in some newer condos, the owners pay for their own water consumption. In those cases, it will not affect the condo’s budget but instead each resident’s own monthly water bill.
The other expense category that has been causing financial pressure on communities is cleaning contracts and concierge/security contracts. Many communities have increased the duties of the cleaners and/or the security staff in order to ensure common areas are safe and sanitized. Given that these contracts are usually fixed monthly amounts in community budgets, an increase in these services will have an immediate and negative impact on the year-end financial results.
The pandemic has altered an interesting and often overlooked item in the budget, which is not a cost at all, but a loss of revenue. Many communities have clubhouses and party rooms that are rented out. This provides a significant amount of revenues that are budgeted for and help offset some of the operating expenses each year. Often these revenues can be budgeted in the range of $20,000 to $50,000 per year. With varying restrictions on gathering and non-essential travel, these revenues have all but disappeared during the past year, which leaves the budget short once again.
To add insult to injury, there is one more expense that has increased beyond any of the aforementioned items and was not related to COVID-19 but nonetheless could not have come at a worse time. In the past year, insurance increases in many condominiums have been significant, ranging from 10 percent to as much as 30 percent in the past year. Adding this on top of cost increases from the pandemic has created significant headaches for the boards of directors and management when trying to create new budgets for the next year. This is further complicated when considering the ability of the owners to absorb further increases in association dues during this challenging time.
Lessons From Unexpected Changes
What lessons can we learn from these unexpected changes to the revenues and expenses of community associations? The important lesson is strategic planning and budgeting. For years, we have consistently supported the concept of the board of directors leaving a “cushion” in the operating fund or creating a contingency fund to leave some money aside for unexpected events, such as this unimaginable pandemic. Those associations that had saved extra funds have been able to weather this storm without having to increase association fees in any significant way. However, those that have been operating in a deficit or with little to no surplus are now having to figure out how to pay for these significant unbudgeted expenses.
At the end of the day, there is really only one group from whom to obtain the money needed to pay these new bills and that is the owners. Unfortunately, some boards may need to increase monthly association dues by a significant amount or even pass a special assessment onto the owners to cover the deficits. During times like these, this will not be an easy task, nor will it be well received by the owners.
Therefore, one lesson learned is for communities to consider putting some money aside, whether that be into an operating fund or a contingency fund. If owners question this decision, just remind them of the above unexpected consequences of the COVID-19 pandemic.
Learning From Both Tragedies and Natural Disasters
If natural disasters and the recent building collapse tragedy has taught boards anything, it’s that chance favors those who are prepared, and that preventative maintenance is key. One best practice is keeping budget folders for upcoming years to understand proposed projects and contracts for each year and the changes that might be required in each budget. A reserve study can be done as a first step to help set the budget for capital repairs and replacement projects. This approach can help anticipate the expense of large reserve projects and allow ample time to build the reserves. It’s highly recommended to use a professional engineer for the reserve study to help eliminate any big surprises in the budget.
The use of a reserve schedule formula helps to further indicate when a repair or replacement project will mostly likely be needed. Reserves are calculated by using a formula that takes into account the useful life of an item, the remaining useful life, and the replacement cost component. This information is required to be on the proposed budget for every Florida condominium association and for those HOAs that have statutory reserve funds. Florida statutes also require condominium associations to budget for any capital repair or deferred maintenance with an expected expense of $10,000 or more.
Best practices also recommend allocating funds for near-term services, while keeping a strategic plan in place for the future. For example, there are many energy-saving options for buildings today – from lighting modifications to geothermal heating options that can lower energy usage and costs over time. These modifications generally require an initial capital investment, however, so it is important to keep these future expenses in mind when budget planning.
Starting the budget planning process early is key. When the mid-year mark has passed, the association’s financials will carry sufficient history to prepare a budget draft. The community association manager can then meet with the treasurer and committees to discuss and edit the budget. This early preparation allows sufficient time for the association to notify the membership and hold the required meetings.
While these suggestion and recommendations may sound like a lot of work, 75 to 80 percent of the budget is normally reoccurring expenses, like utilities, insurance, and lawn maintenance. But repairs can be hard to estimate.
Factoring in Capital Expenses
Repairs, hurricane or storm damage, painting, roofing, pool resurfacing, and other restoration projects are paid from the capital budget. When a board is underfunded, special assessments may be required to fund capital projects, however, most boards will take a proactive stance to avoid special assessments whenever possible. So, who is best qualified to help determine future cost for big projects in the budget? Contractors and service providers can help with annual costs, but an independent reserve analysis can best determine future annual cost and times of big projects.
The independent analysis should arm a board with lots of information that can help define the scope of projects and even negotiate better contracts and save the association money. It is also wise for the manager and board to contact the association’s current vendors – particularly the insurance agent, utilities, waste services, and others – to ask them if there will be a cost increase in the coming year, and if they can provide an estimated increase amount. Reviewing the expense history and calling in the vendors for cost projections is also key. By contacting vendors early, a board may also negotiate a better rate with the current provider, or have time to shop for better pricing, particularly if contracts are up for renewal.
Budgeting for Mother Nature
In addition to the general 60-90 days of working capital every association should also have some ‘rainy day’ savings. If an association has the ability, saving over time for the insurance deductible is a great tip. You never know when—or if—these funds will be necessary, but any amount will help for emergency cleanup and or the association’ deductible payment.
By being proactive and budgeting for emergencies that do not materialize, a board may build a surplus. While this can be a nice problem to have, once a surplus is accrued the board and management team have a legal and moral obligation to show those funds in the annual statements and financial reports. How the surplus is handled depends on the individual property, and the needs of the community. Sometimes surplus funds are rolled into working capital or transferred to the reserves. There is always the option of refunding the surplus to residents but often that is not the best course of action, and everyone agrees refunds are a rarity. Some associations vote to save the surplus in an interest-bearing account, roll it over to the following year, or allocate the surplus funds for a special project. Whether surplus funds are saved, rolled over, or spent on special projects any community managed well enough to have a surplus is sure to benefit from the extra funds