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Low HOA reserve accounts are surprisingly common, and when I asked the HOA expert, Jacquie Berry, about my observation, she said that 75% of HOAs in California have underfunded reserve accounts. This is a big deal for many home buyers, particularly first time buyers and seniors downsizing to a common interest development after living in a house without an HOA.
What is a reserve account?
Homeowners Associations have two budgets and bank accounts: one for operating expenses (right now items, this year) and one for long term costs (anything more than a year out).
To ascertain how much should be in that reserve fund, the person doing the budget estimates the replacement cost of the item, such as the roof, in today’s dollars and then factors in the rate of inflation, often about 3% per year and calculates the total cost needed in whatever year the replacement is expected to happen.
Why are so many HOA reserve accounts underfunded?
I asked Jacquie this question: why are all of these homeowners associations so poorly funded? She replied that many of them won’t save today for something needed in the distant future (with the underlying thought being “when I may not even live here anymore”.) It appears to be a common practice, at least in some homeowners associations, to simply kick the can down the road.
What’s the risk with a low HOA reserve account?
The risk with low HOA reserve accounts is multifaceted. We’ll touch on a few of them here.
Naturally, one of the first risks is the HOA insisting that home owners pay more. They are allowed to raise the monthly dues by as much as 20% of the previous year’s fee annually. Sometimes, though, that’s not enough. The next approach, when a large sum is needed, it to have a special assessment.
Special assessments get voted in when a majority of the HOA wants to get certain important projects done and there are not sufficient funds for the project. Recently we’ve seen these special assessments get levied for $30,000 – $50,000 or more in some cases. But that’s not all!
Home selling headaches if there’s a low HOA reserve account balance
If the HOA reserve account dips under 10% it can be hard to sell a unit in that complex to anyone seeking a mortgage. We recently learned that conforming loans must abide by certain guidelines set out by Fannie Mae and Freddie Mac so that the loans can be resold. One of the minimum standards is a reserve account that is at least 10% funded.
In the last few weeks we’ve run into a couple of condo communities with a current or past history of going under 10%, and the result is that the units become “un-warrantable” and cannot fit the guidelines for a conventional loan. Yes, a loan can still be obtained, but the interest rate may be higher. Our client realized, too, that refinancing in the future, when rates are predicted to drop, may not be possible if the HOA does not fix the problem with the low reserves.
Insurance issues
Special assessments are not always a matter of mismanaged budgeting. Surprises from natural disasters or insurance companies demanding changes to keep insurance can come out of the blue and create an emergency situation. Recently I heard of a common interest community in which the insurance company demanded that they re-roof immediately, and that ended up costing each unit’s owner $36,000. That came with short notice, I’m told.
Speaking of insurance, another risk with low reserve account funding is not having enough money on hand should a large deductible need to be paid, as in the case with severe damage from fires, floods, quakes, etc. Insurance has gotten expensive for all of us. Some HOAs increased their deductible amount. It’s essential that if this is done that there be enough funds in that reserve account should the unthinkable happen.
New laws
Have you heard of the balcony law in California? When there are 3 or more units, if the property has outside raised wooden elements, such as stairs, balconies, or walkways, they must be inspected by January 1, 2025 and then every 9 years after that. There are nuances, of course. In a large development, the requirement is for a representative sample of the balconies, walkways, or other exterior items such as stairs.
After the catastrophic balcony collapse in Berkeley in 2015, it’s clear that these raised wooden elements ought to be inspected to protect everyone. The result will be some level of surprise for HOAs, who may find a big financial burden to repair these items as balconies were not routinely inspected in the past.
When we show condominiums and townhomes now, I pay a lot of attention to things like raised wooden elements, or roofs that may be called by an insurance company (or simply old age) since any HOA expenses will ultimately become costs of the individual homeowner. A low HOA reserve account spells trouble as they condo and townhouse communities need to be ready to absorb both the predictable and the probable expenses down the road.
Where to learn about the reserve account’s funding
When purchasing a townhouse, condo, or other type of home in a common interest development (CID), the seller is to provide the buyer with the HOA documents. These include a wide variety of things, including
- the articles of incorporation
- the covenants, codes, and restrictions (CCRs)
- the bylaws
- the budget (which usually includes info on the balances for both the operating and reserve accounts)
- meeting minutes
- sometimes newsletters
- sometimes the reserve study
- sometimes rules and regulations (in addition to the CCRs, which cover most or all of them)
Often the HOA docs are separated out and you can quickly locate the budget and sometimes even the reserve account study, which must be done every 3 years. Sometimes the listing agent puts them all into one big PDF, which isn’t so much fun unless there’s a table of contents at the beginning with hot links to the various documents in the PDF.
If you are buying into an HOA, or if you already own property in an HOA, it’s important to keep an eye on the finances. No one likes a special assessment, but if they aren’t done as needed, the problems can really mount – and grow – such that it’s very hard to sell a home if that low HOA reserve account dips below 10%. Kicking the can down the road is not a good answer at all.
