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Association Funding: Budgeting, Assessments, and Reserves

Association Funding: Budgeting, Assessments, and Reserves

October 13th, 2020

    Association boards have a variety of responsibilities in administering the affairs of a condominium or homeowner association. Some of the most important responsibilities include ensuring that the association has sufficient funding to maintain, repair and replace items within the community, to carry insurance, and to maintain adequate funding for all of its obligations. To help communities understand those responsibilities, this article will address association budgets, sources of funding for the association, and long-term planning for major repairs and replacements.

    BUDGETING

    Governing documents generally require that the board of directors adopt an annual budget, which forms the basis of the upcoming year's assessment. Because the duty to administer the association rests with the board, it is necessary for the board to thoughtfully consider the association's anticipated expenses, and to establish a budget that allows the association to continue operations. While assessment levels are certainly a concern for association members, the board ultimately owes a fiduciary duty to the association and its members to maintain the community, and must base the budget on actual anticipated expenses. As discussed in more detail below, condominiums, and many subdivisions, are required to maintain a reserve fund for major repairs and replacements in addition to the anticipated expenses for any given year.

    ASSESSMENTS

    In most associations (particularly condominiums), there are three types of assessments that can be levied against the members to ensure proper funding. Regular assessments (often referred to by homeowners as "dues") are based upon the adopted budget each year, although each member's responsibility for the regular assessments can vary based upon the governing documents. For example, in many condominiums the regular assessment rate is premised upon each unit's assigned percentage of value. Alternatively, some governing documents establish equal assessment rates despite varying percentages of value, and others establish assessment rates based upon a different calculation entirely. Governing documents also determine the frequency in which assessments are owed, typically, monthly, quarterly, semi-annually, or annually.

    Despite proper planning and appropriate budgeting, there are times when a budget shortfall or other unanticipated expense will arise. For these types of non-discretionary expenses, many governing documents provide the board of directors with the right to levy an additional assessment. Because additional assessments are generally intended to cover non-discretionary items, most governing documents provide the board of directors with the unilateral right to levy an additional assessment without needing member approval. Although many documents do contain provisions for additional assessments, not all do, and it is important to verify whether this type of assessment exists and to confirm whether there is any member approval requirement.

    While regular and additional assessments are generally intended to fund non-discretionary items, there are also times when an association may want to add to their existing community or otherwise incur expenses that are more discretionary in nature, such installing a tennis or basketball court that did not previously exist. In these instances, associations may be able to levy a special assessment. Although not always true, most governing documents require that special assessments be approved by the membership. Because special assessments are most typically used for discretionary items as opposed to items that are required for the proper upkeep and administration of the community, requiring membership approval is logical. As with levying additional assessments, it is important to verify whether your community's documents authorize special assessments and whether there is an approval requirement.

    RESERVES

    Association budgets are generally intended to project expenses that an association will incur on an annual basis. Of course, not all items can be planned and accounted for on an annual basis and so associations typically fund and maintain a reserve account for future repairs and replacements.

    Pursuant to Section 105 of the Michigan Condominium Act (MCL 559.205) condominium associations are statutorily required to maintain a reserve fund. While this Section of the Act does not specify what amount must be held in reserves, the Administrative Rules established under the Act require that Michigan condominium associations maintain a reserve fund which is equal to at least ten percent of the association's budget on a noncumulative basis and which may only be used for major repairs and replacements of the common elements (R 559.511). This Rule also clarifies that the minimum standard may not be adequate for all associations, and that the association should "carefully analyze their condominium project to determine if a greater amount should be set aside, or if additional reserve funds should be established for other purposes."

    Mortgage underwriting guidelines generally also require that condominium associations maintain an adequate reserve fund. While the statutory requirements in Michigan do not require an annual contribution to the reserve fund, most underwriting guidelines require, in addition to maintaining the statutorily required minimum balance, an annual contribution of at least ten percent of the association's budget, unless the association's reserve fund is "fully funded" in accordance with a professionally prepared reserve study (reserve studies are addressed in more detail below). .

    Although there is no similar statutory requirement that homeowner associations maintain a reserve fund, some governing documents impose this requirement. Even when the documents do not require a reserve fund, associations should consider establishing one for major repairs and replacements to avoid the need to levy a large additional assessment when the time comes for a major repair or replacement.

    Because most directors are not engineers, companies exist which specialize in reserve funding and can complete a "reserve study." These companies will utilize information gained from the association and on-site inspections to help determine the remaining useful life of the major elements of the community (such as roads, roofs, siding, and the like) as well as the anticipated costs of repair and replacement. Reserve studies can help association boards determine the appropriate amounts to deposit into their reserves so that the board can avoid levying large additional assessments when a major item fails in the future.

    CONCLUSION

    Proper planning and management of the association's funds are important measures to ensure that assessment levels are maintained, and to avoid the need to levy massive additional assessments for major repairs and replacements that could have been planned years before. Associations should work with their professional management company or with other qualified professionals to ensure that they are properly budgeting and planning to future repairs and replacements.

    * Evan M. Alexander is a Michigan Condominium Attorney and an associate at Makower Abbate Guerra Wegner Vollmer PLLC. Mr. Alexander focuses his practice primarily in the areas of Michigan Condominium Association and Michigan Homeowner Association law. Mr. Alexander is a member of the Real Property Law and Young Lawyers sections of the State Bar of Michigan.

    Author

    Evan M. Alexander
    Evan M. Alexander

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