By Broderick Perkins
Buying a condo is a lot like buying a share in a closely held, publicly-traded, non-profit real estate holding corporation, yet many buyers spend more time researching a used car purchase than they do before buying a condo.
Without scrutinizing a condo association's financial status, especially its reserves, you may not know until it's too late that your homeowner's association can't afford to take care of itself.
An estimated 30 percent of all homeowner's associations are considered "poor," unable to meet major repair and replacement obligations because of insufficient reserves, according to Association Reserves, Inc. a Calabasas, CA-based firm that studies home owner associations' reserves in 37 states.
"It is amazing that people don't spend much more time on a condo purchase, when they are becoming 'business partners' with strangers in a multi-million dollar real estate development partnership," said Robert M. Nordlund, president of Association Reserves.
While an association's reserves isn't the only factor to consider when buying a condo, it is a crucial and telling document revealing how well or how poorly the association is managing its budget to make ends meet.
"Because inspecting each building is not cost feasible, the only way buyers can currently determine the condition of the common area buildings and capital reserves is obtaining the association's reserve study," said Frederick L. Pilot, president of Sacramento-based Common Interest Consumer Project, a non-profit education and research group concerned about the risks of condo buying.
Condominiums and townhomes typically are developed as what's called common interest developments (CIDs) -- you own everything in your unit, at least everything on your side of the walls. You are a shareholder in the remainder of the buildings, grounds and other facilities. As a shareholder you are a mandatory, dues-paying member of the CID's home owners association (HOA), the organization responsible for the upkeep and care of buildings and grounds.
Those responsibilities include managing an operating budget of hundreds of thousands of dollars with a crucial component called the capital reserves. The reserves is money set aside for repairing and replacing common area components -- the condo buildings and all of its common elements, other structures, landscaping, walkways, paving, swimming pools, decks, etc.
"About one-third of associations out there don't have enough money to take care of themselves. Pretty sad news, but not really surprising," said Nordlund.
The American Institute of Certified Public Accountants recommends associations conduct annual reserve studies to determine how financially fit they are. Only a few states, however, mandate the studies, but less frequently than CPA's recommendations.
The reserve studies reveal how much cash is available for upcoming obligations, how much an association actually needs to meet those obligations and a financial plan to come up with the difference, if any.
Nordlund says depending upon the level of available reserve funding, you can use the information to help you determine the relative risk of being dinged for more cash after you buy into a given condo community.
- With a reserve that's zero to 30 percent funded there's a 26.6 to 53.5 percent chance that an assessment or other action (deferred maintenance, loan, higher dues) will be necessary to overcome the shortfall. The lower the funding the higher the risk.
- When a reserve is 30 to 70 percent funded, there's a 3.4 to 17.6 percent chance of an assessment or other action.
- When a reserve is more than 70 percent funded, special assessments or deferred maintenance are unlikely, with only a 0.5 to 2.4 percent chance.
Broderick Perkins, has been a consumer journalist for 20 years. Experienced in print, electronic, and consulting journalism, he is chief executive editor of San Jose, CA-based, DeadlineNews.Com, an editorial content and consulting firm.