Understanding Community Association Budgets

24 Mar

Budget decisions for new community associations can be a minefield. Developers, owners, and board members often don’t realize all the financial considerations they’re supposed to take into account when making early budget decisions. An association should never start out “in the hole,” and there are measures that are required that can protect against an inability to perform necessary projects down the road. This article is to give those dealing with budget issues a brief overview of how to approach the budgeting process.

An association obtains funds through its assessments. The developer of the association (also known as the declarant) has control of the board of directors of a new association (or condominium conversion) until it turns over control to the unit owners. This gives the developer the power to set the amount of the monthly assessments during the period of declarant control. Assessments are comprised of two primary components: (1) The common expense assessments are for funds necessary to maintain and manage of the community; and (2) The reserve funds are those funds required for the replacement of anything the association is obligated to replace (this is found in the association’s governing documents, specifically the declaration – roofing and siding are frequent examples).

The Minnesota Common Interest Ownership Act, or “MCIOA,” found in Minnesota Statutes Chapter 515B, permits a developer to reserve the right to pay a 25% alternative assessment for each unit it owns that is not “substantially complete.” “Substantial completion” means the date on which a “certificate of occupancy” is issued, which is issued by the city in which the home is located following an inspection. A developer may therefore pass the first assessment early so homeowners start to pay a portion of the operating expenses, but delay “substantial completion” on unsold units to take advantage of the alternative assessment. Developers also may take advantage of potentially ambiguous language in MCIOA stating that assessment obligations do not begin until a unit is “created.”

It may sound unfair that a developer would pay only 25% of monthly assessments, but it’s not entirely that simple. Prior to the passage of the initial assessment the developer is required to pay all of the association’s operating expenses. Also, if there are any unpaid costs at the time control is transferred to the members, the developer must pay them within 60 days. The developer’s alternative assessment right is also limited to the common expense portion of the assessments. The developer has to pay 100% of the reserve assessment on the units it owns. Again, however, these assessments are not due until the unit itself or any building within the unit is “substantially complete,” which may lead a developer to delay the “substantial completion” of unsold units to avoid triggering this assessment.

All of this may tempt a developer to set assessments too low in order to minimize its own assessment contribution or to generate buyer interest. Nevertheless, the association’s budget is required by law to include an adequate reserve assessment to allow for the replacement of the required components of the development. The members of a board of directors who are appointed by a developer also owe a fiduciary duty to get this right. The developer and the board it appoints would therefore face liability if they leave the association with insufficient operating or reserve funds on hand. A developer would be wise to set a realistic budget or it and the board members it appointed will risk liability to the Association.

Similarly, it would be wise for individual owners elected as board members to review that budget right away, and each year thereafter. Consider whether a reserve study is necessary to ensure the reserves are adequate. A new association board should also make sure it has all the proper documentation for the construction, finances and operation of the association from the developer. These documents are often not turned over to the detriment of the unit owners going forward.

Assessment issues should be addressed proactively by all parties involved. Failing to discover a problem early can lead to significant financial consequences for all involved that will only worsen if not discovered. Accordingly, resolution of these problems is more likely if they are caught sooner, rather than later. Hopefully this article helps you to reach that goal.

Author:

This blog entry is written by Matt Drewes. Matt is a shareholder at Thomsen & Nybeck, P.A. and head of the firm’s Association Representation Group. He practices primarily in the areas of real estate litigation, townhome and condominium law, construction litigation, debtor/creditor law, insurance litigation and employment law.  For more information on townhome and condominium law, please visit: http://www.tn-law.com/CM/Real-Estate/Townhome-Condominium-Law.asp.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: