KEY INSIGHTS AND RECOMMENDATIONS FOR HOMEOWNER ASSOCIATIONS
George Wilson Adams CPA MBA November 21, 2019
Introduction
Most homeowner associations ("HOA's" hereafter) hold their annual meetings in December. This article is intended to offer constructive suggestions and general advice. I am not an attorney and nothing in this article should be construed as a legal opinion or legal advice. Always consult with a qualified attorney on important matters.
In 2019 according to the leading industry website HOA-USA.com there were 351,000 HOA's in the U.S. consisting of 40 million households, or 53% of all owner-occupied homes. (These numbers include similar type organizations.) 70% of HOA's were managed by unpaid volunteers.
Most Maine HOA's created after 1982 are governed by the Maine Condominium Act ("The Act" hereafter) and are required to be non-profit corporations. See:
http://legislature.maine.gov/statutes/33/title33ch31sec0.html
HOA's are much like a municipality where the goal of an annual town or city budget is to achieve financial break- even (subject to set-asides for capital reserves, discussed later in this article.)
Basic Requirements Applicable to HOA's
What are the major things HOA's must do? Here is a short list:
(1) The HOA must have an annual meeting to vote on the budget. State law governs timely notice and voting rules at such meetings.
(2) The HOA must have Bylaws that explain in detail how the organization is governed.
(3) The HOA must have a Declaration as a part of its founding documents that physically describes individual units and common areas.
(4) The HOA is generally responsible for repairs, maintenance and upkeep of common property, and other property as provided for in the Bylaws.
(5) The HOA must handle surplus funds as follows (Section 1603-114 of The Act):
Unless otherwise provided in the declaration, any surplus funds of the HOA remaining after payment of or provision for common expenses and any prepayment of reserves must be paid to the unit owners in proportion to their common expense liability or credited to them to reduce their future common expense assessments.
Are Your Bylaws Clear?
Imagine an HOA has 16 units with one vote per unit. Some unit owners want to build a solar panel array that will benefit all members of the HOA and qualify them for a 30% income tax credit. The Bylaws of this HOA require at least a 90% vote to approve such a proposal.
The problem here is fractional votes. 90% of 16 means that at least 14.4 votes must be received to approve the proposal. But fractional votes are absurd because they are physically impossible. In this context, fractional votes don't exist. If only 14 votes are received to build the solar array and 2 vote against then the proposal will likely fail because 14 / 16 = 87.5%. Some owners may find this result inequitable because of the fractional vote issue.
The problem of how to handle fractional votes when applying voting thresholds is important because most Maine HOA's are small (total units and total votes are frequently a two digit number.) And many key voting thresholds are usually stated as a multiple of 10 such as 50%, 80%, 90%, etc. Thus, it is mathematically likely that fractional vote issues may arise for many small HOA's.
It may be possible to clarify the Bylaws and impose rounding on all fractional votes. If a rule of reason is adopted then all fractional votes would be rounded to the nearest whole number. Thus, if 14.4 votes are needed to satisfy a 90% threshold, then 14.4 would be rounded to the nearest whole number: 14.
Section 1602-107 of The Act may facilitate such an approach (particularly the wording applied to "formulas.") Sometimes law respects reason.
Close votes are a common cause of strife and litigation in many areas of life. One extreme example was the case of Bush v. Gore (year 2000) when the U.S. Supreme Court, in effect, decided the outcome of a very close Presidential election. Law is a blunt instrument for resolving disputes and lawyers are expensive. Prevention of future disputes is a wise policy.
Achieving Good Communication During Meetings
Unfortunately some annual HOA meetings can be raucous and divisive where rival factions engage in shouting matches. Or an important meeting could be dominated by an obnoxious bully who cuts people off mid-sentence. The best practice for avoiding these situations is to adopt Robert's Rules of Order (or any similar set of rules.) Robert's Rules are designed to create and maintain an orderly structure for important meetings that allows everyone to have a fair hearing while facilitating courteous and efficient communication.
Here is a great summary of Robert's Rules, slimmed down to its essentials and with a minimum degree of formality:
https://www.boardeffect.com/blog/roberts-rules-of-order-cheat-sheet/
Use Bundling to Save Money
All officers of an HOA have a fiduciary duty to save money for their organization, and preserve its assets and financial well-being. One widely-used strategy to control major costs is bundling, which consists of hiring a single trusted, qualified service-provider to handle multiple tasks for an HOA. Bundling could be used for repairs, landscaping, plowing, etc. It is very important to confirm that the service-provider has the experience and qualifications to perform multiple tasks. Further, any contract for bundled services should contain an 'escape clause' that allows the HOA to void the contract in case of non-performance or poor quality performance.
Maintenance costs can be the largest expense for an HOA. Bundling can reduce this cost by obtaining a discount from the service-provider. The discount is based on the idea that the more you buy from a single seller the more bargaining power you have on price ("volume discount".) Wal-Mart uses this strategy to great advantage when buying inventory.
Bundling could be combined with fixed periodic payments to the service-provider that average out highly variable maintenance costs. Most HOA's charge a monthly, quarterly or semi-annual fee to owners to cover commonly shared costs. Cash flow deficits could arise when high costs are incurred in between periods when assessment revenue is collected. In other words, if HOA revenue is a fixed monthly amount then it is wise to have HOA expenses be a fixed monthly amount as well, if possible. Cash outflows should be balanced with cash inflows.
Here is further information on how an HOA can save money:
http://wisepropertysolutions.com/6-ways-to-save-money-in-your-hoa/
How Much to Save for Future Major Repairs and Replacements?
One of the most important financial issues HOA's must deal with is figuring out how much to save for future major capital expenses. Almost all HOA's have an obligation to pay for commonly owned property which may include parking lots, fencing, septic systems, roofing, siding, etc. These commonly shared costs are a liability of the HOA.
The reality is that most small HOA's use educated guessing and common sense to estimate the amount that should be accumulated for future major repairs and replacements. If an HOA gets it wrong and an unexpected major repair exceeds the balance in the capital savings account then individual unit owners will be required to make up the deficit. Almost all HOA's self-finance their major repair and upkeep costs. Very few will borrow from a bank to pay for such costs, and few banks will lend to an HOA.
A more comprehensive (and more expensive) way to estimate how much should be saved for future major repairs and replacements is conduct what is called a Reserve Study.Here is a brief summary of the key concepts used in a Reserve Study:
(1) Engineers and accountants work together to formally estimate the useful life and future replacement cost of assets the HOA is obligated to maintain.
(2) Use probability-weighted costing: if an engineer estimates there is a 10% chance a roof will need replacement one year from now, and if an accountant estimates the replacement cost at that time will be $10,000, then the probability-weighted cost is $1,000. This concept is applied systematically to all assets the HOA is obligated to maintain.
(3) Estimate all probability-weighted future major repair and replacement costs out to a horizon date, which may be 5 to 10 years from now, or more. Size matters. Disneyland, with billions of dollars in assets, has a fifty year capital budget.
(4) Discount estimated future costs by the time value of money. If you know you have to spend $100 one year from now and earn 1.5% on savings then you need $98.51 in a savings account right now. This amount will grow at 1.5% (compounded monthly in this simplified example) to precisely $100 one year from now. Even though interest rates today are quite low, the concept of the time value of money becomes more and more important the further out you look into the future.
(5) Totalize all estimated probability-weighted future costs and discount them to the present. The sum total is the amount a HOA should have in its savings account right now to cover future major repairs and replacements.
This example is one of many approaches to preparing a Reserve Study, and is merely a highly simplified illustration. Timeshare HOA's follow a very similar approach.
HOA's Have to File and Pay Taxes
HOA's are a type of hybrid entity that share many features of a non-profit organization. In most cases a HOA will benefit by electing to be taxed under Section 528 of the Internal Revenue Code. This election results in exempting all revenues received to preserve and maintain the common property of the HOA.
Electing HOA's will still owe corporate income taxes on so-called unrelated business activities. For most small HOA's interest income and other investment income will be taxed. Electing HOA's must file IRS Form 1120-H by the 15th day of the fourth month after the end of its tax year. A flat tax of 30% applies to non-exempt income earned by a HOA. The election is made by filing Form 1120-H. For further information see:
https://www.irs.gov/charities-non-profits/other-non-profits/homeowners-associations
A Timeless Question
And now I will conclude with a question that never seems to become irrelevant: Which of the following situations is better?
(1) Law tells Reason what to do;
Or,
(2) Reason tells Law what to do.
Athena, the Greek goddess of reason, arm-wrestles Themis, the goddess of law. Who should win?
(Literary scholars familiar with Hesiod's Theogony will understand that my characterizations of Reason and Law herein are deliberate and necessary simplifications.)
Additional Resources for Maine HOA's:
(1) Here is a great general resource that offers further insights for HOA's:
(2) Another great website with general information:
(3) Here is a website with current events and discussion of a variety of topics affecting HOA's:
https://communityassociations.net/maine-resources/
(4) Legal advice on actual cases and specific questions asked by members of Maine HOA's:
https://www.avvo.com/topics/homeowners--association/advice/me
(5) Best practices and other expert advice for HOA's:
https://www.hoaleader.com/?gclid=EAIaIQobChMI_J-chej55QIVx5-zCh38eArtEAMYAiAAEgIcr_D_BwE
George Adams
Certified Public Accountant Master of Business Administration
Tel: (207) 989-2700 E-Mail: GeorgeAdams@IntelligenceForRent.com
450 South Main Street: The HQ of IQ
Brewer, Maine 04412-2339
©2015 Copyright George Adams CPA MBA. All Rights Reserved.
