By Sherri Hall
Oftentimes, associations find themselves faced with the task of imposing a special assessment to take care of an emergency item that wasn’t budgeted for in the reserve fund. But what if the reserve fund did have enough to cover the cost of the unexpected repairs because it just so happened to be overfunded? How can an association even find itself in such a position with an excess reserve fund?
According to Thomas Engblom, CPM, PCAM, PhD, a trusted advisor with over forty years in the community association industry, a percentage of the association’s income is designated for the reserve fund. The amount the association should budget for is typically determined through a reserve study. Reserve budgets include items that the annual operating budget doesn’t cover including long term repairs and replacements.
So, what exactly can lead to overfunding of the reserves?
Engblom offered an example where a condo association had been budgeting for roof replacement for 20 years but was able to have the work done and paid for as part of an insurance claim after a natural disaster caused roof damage. This situation led to the association finding itself with excess reserves because the funds that had been budgeted for years for the roof replacement were no longer needed for this project.
Another cause of an overfunded reserve is not making repairs or replacements that were budgeted for, said Engblom. “The reserve can be overinflated if a board hasn’t made any repairs or replacements year after year,” he noted.
Engblom explained that overfunded reserves can be detrimental to an association because homeowners and homebuyers might be concerned that the monthly assessment is too high for the association having so much money in the reserve fund. “If the association is consistently overfunding, people may not be able to afford the monthly assessment,” he added.
Additionally, overfunding can lead to other problems such as obtaining bank loans, said Engblom. “If an association is overfunded, a bank may not grant a loan for the desired amount,” he noted.
When applying for an association loan, the bank may not require 100% funding. Typically associations finance 100% of their projects, but in these situations associations find themselves financing less due to excess reserves.
He referred to an example where an association needed to do a $2 million capital project. They applied for a $2 million loan but were only approved for $1.5 million, with the bank requiring them to use their own excess cash to fund the rest of the project. In this situation they were overfunded — or over collateralized.
However, most associations typically don’t find themselves in the position of being overfunded.
“The majority of associations are actually underfunded,” said Engblom.
“But this year, things may be different,” he noted. Enter the Coronavirus (COVID-19) Pandemic.
“Due to the health crisis and the restrictions implemented as a result, many associations have closed their amenities for the past several months, and some may or may not be reopening any time soon,” he said.
He added that many projects have also been put on hold because of the pandemic.
“Many association boards have not been able to meet during this time and still might not be able to, said Engblom, “it’s difficult to get the projects completed during this situation.”
“In addition to boards not being able to meet, some associations may also have trouble acquiring loans they need in order to complete these projects because some states require unit owner approval to obtain a bank loan,” Engblom said.
Since associations haven’t been able to hold unit owner meetings, they won’t be able to get approval for the project loans and if they can’t get the loans, they can’t do the work.
Therefore, Engblom said he believes many associations are going to have excess funds this year due to the Coronavirus Pandemic leading to these amenity closures and pushed off projects.
So, what happens to operating budget surpluses?
According to Engblom, an association’s annual budget should operate at zero — that is, that there shouldn’t be a profit or loss.
In fact, he noted that in the past many associations who have found themselves spending more than allotted for in their operating budgets have taken from their reserve funds in order to balance out their operating budgets.
Because laws vary by state, some associations may not be able to do this, but those who do rarely pay the reserves back, Engblom explained.
“In the event that the association makes a profit, they have one of two choices: they can refund the money to the unit owners or they can adopt a resolution to put the excess funds in reserves for next year,” said Engblom.
Although many residents may be upset and want a refund, especially with amenities such as pools, fitness centers, tennis courts and playgrounds closed until further notice, Engblom believes it is in the association’s best interest to opt for the second choice.
“One reason,” Engblom said, “it doesn’t make sense to refund the money because it is unknown what could happen next year that would require the association to need those excess reserves.”
He noted that associations can choose to lower the next year’s assessments or not to increase them, but doesn’t think many will do so for the same reason they most likely won’t give a refund.
Another reason Engblom believes residents won’t be given their money back for amenity closures has to do with insurance.
Chances are that if an association decides that its pool will remain out of operation for the duration of the summer, residents may request a rebate for the portion of the assessment that goes toward running the pool.
“In this case, if the association does not issue a refund and a unit owner sues the association for paying for a common element that wasn’t open, the board has insurance coverage to deal with such a situation,” Engblom explained.
“On the other hand, if an association decides to open its pool and a resident contracts coronavirus as a result of doing so, the [association] does not have insurance to cover a suit over someone contracting the virus,” he said.
Engblom believes that many associations will find themselves with excess funds this year because of the pandemic-related closures and postponed projects and noted that this can actually help those associations who were in the position of being underfunded.
When associations do find themselves with excess funds, Engblom suggests they ensure that their money is properly protected. He explained that as the FDIC protection limit is $250,000, associations should prepare to put funds in excess of that amount in accounts that would cover them. Engblom explained that there are two national programs, CDARS (Certificate of Deposit Account Registry Service) and ICS (Insured Cash Sweep) that can help associations manage funds in excess of $250,000 while still obtaining FDIC insurance through various types of accounts.