Tips to Create and Communicate a Sensible Budget for your Community Association.
How To Establish An Association Budget With Proper Reserves
Most individuals that serve on a board of managers of a condominium or community association appreciate the importance of establishing a sensible budget with sufficient reserves. After all, Section 9 of the Illinois Condominium Property Act and Section 1-45 of the Illinois Common Interest Community Association Act require boards to adopt budgets on behalf of the association each year. That said, establishing a “sensible budget” is subjective and may cause intra-board turmoil during budget season. This occurs because one board member may be focused on immediate association financial needs and another on long term financial planning. The personal relationship board members have with money also impacts their view and opinion. One board member may be fiscally conservative while another fiscally liberal. Such differences can cause meaningful disagreements.
Further complicating the budget adoption process is the reality that each owner’s assessments are directly tied to the budget. An increase in the annual budget will cause an increase in each owner’s assessment obligation. Most association members do not take kindly to increased assessments – regardless of the reason – and are not shy about expressing their disapproval. For some board members, making an unpopular decision is extremely difficult to do even if in the best interest of the association.
How can a group of three or five board members establish a sensible budget with proper reserves without destroying board and association harmony?
The short answer is strong communication and reviewing historical facts and figures. Boards that appreciate and embrace the importance of communication, both internally and openly with members at large, usually diffuse the potential for conflict. A good starting point is for the board to review the previous fiscal year’s budget. The budget may be compared to the previous year’s expenses to identify budgetary shortfalls and surpluses. After all, a budget is not an exact science but rather an estimated guess of anticipated future expenses. Reconciling the prior year’s budget with actual expenses may reveal a $15,000 surplus for snow removal services. In light of this surplus, the board may choose to lower the figure it included for snow removal in next year's budget. This budgetary analysis may be conducted for each line item within the association budget. If the previous year was an anomaly, the board may review multiple years to gather more financial figures and data.
Once this budgetary reconciliation has been completed and a new budget established, it is important for the board to communicate its thinking to the unit owners. Boards have a legal obligation to provide a draft budget to all unit owners before its formal adoption. The board may wish to include a cover letter with its draft budget that touches upon the board’s rationale for each line item. Including such a letter demonstrates transparency, reduces membership speculation about certain line items and answers membership questions before they arise. A cover letter also signals to the members that significant thought and time went into creating the new budget and reduces membership concern about financial mismanagement.
A key component to any budget is reserves. Both the Illinois Condominium Property Act and the Illinois Common Interest Community Association Act require boards to provide for reasonable reserves for capital expenditures and deferred maintenance for repairs or replacement unless the membership elects to waive this requirement in whole or in part, which is uncommon. Determining the necessary amount of money to set aside for reserves is unique to each association and must be evaluated on a case-by-case basis.
The law provides five separate factors a board should consider when arriving at its reserve amount. Those factors are: 1) the repair and replacement cost, and the estimated useful life, of the property which the association is obligated to maintain, including but not limited to structural and mechanical components, surfaces of the buildings and common elements, and energy systems and equipment; 2) the current and anticipated return on investment (ROI) of association funds; 3) any independent professional reserve study which the association may obtain; 4) the financial impact on unit owners, and the market value of the condominium units, of any assessment increase needed to fund reserves; and 5) the ability of the association to obtain financing or refinancing.
Many associations elect to hire an engineering firm to conduct an official reserve study and prepare a written report detailing the findings. This type of report helps serve as a financial roadmap for boards to follow. Boards are not required to strictly follow a reserve study down to the penny; however, using it for general guidance may prove useful for boards looking for assistance. The basic concept behind establishing reasonable reserves is to set aside sufficient funds that will prove adequate for short-term and long-term maintenance, repairs and replacement. It sounds easier than it is. A board that reconciles its budget with prior expenses, considers short-term and long-term association goals and invests time articulating its rationale increases transparency and its likelihood of adopting a sensible budget.
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