Posted April 6, 2003
By Lew Sichelman
Baffling
and bulging documents hold the key
to
the financial soundness of association |
WASHINGTON -- Annual sales of condominiums
and cooperatives surged again in 2002, setting a record for the seventh
year in a row. But buying a condo is different from buying a house, and
too many people don't take the extra steps necessary to make sure their
purchases don't turn into nightmares.
A condominium isn't a type of dwelling
at all. It's a form of ownership in which you take title to your particular
house, town house, villa or apartment and share ownership of the community's
common spaces and amenities with your neighbors and fellow owners.
In other words, buying into a condo or,
for that matter, into any community in which an association of owners collects
fees and contracts for services is like purchasing a share in a privately
held real estate company. You own your unit. But with all else, you have
partners who have an equal say in how things are run.
Sometimes, unfortunately, the property
isn't operated as well as it could be. And that could create problems.
For example, one out of three associations
doesn't have enough cash on hand to fix the roof, patch the sidewalks and
meet other major repair and replacement obligations, according to Association
Reserves, a company in Calabasas, Calif., that has completed more than
12,000 financial studies for community associations in 43 states.
Worse, most people who buy into a condo
or community association don't do the research necessary to determine whether
the places they are considering are financially sound.
Most states require that buyers be given
all the condo papers -- the governing documents, or the codes, covenants,
conditions and restrictions (CCC&Rs); bylaws; budgets; balance sheets
and profit and loss statements, among others -- often at the time they
sign a sales contract. And most jurisdictions give buyers three days to
pore over the papers and change their minds.
All too frequently, though, the inches-thick
stack of documents isn't handed over until well into the process. Sometimes,
buyers don't receive the papers until a few days before closing. And sometimes,
they don't get them at all.
Even when the papers are delivered on time,
however, few purchasers know what they should be looking for or are experienced
enough to determine quickly and accurately whether the condo is in good
financial health. And their real estate professionals aren't providing
much help along those lines, says Mitzi Romiti of Jobin Realty in Alexandria,
Va.
"Many agents fail to point out the importance
of the condo documents," says Romiti, who has sold more than 75 condos
over her career and is currently president of the condo association where
she lives. "And most don't explain to their clients what they should be
looking for or what could happen."
What could happen is this: If your association
is underfunded, you could be hit with a major special assessment over and
above the monthly or quarterly dues you already will be paying. Romiti
recalls one condo in which all the balconies had to be replaced, resulting
in an assessment that owners didn't expect.
First, read the
rules
So what should you be looking for to guard
against such surprises? For starters, obtain a copy of the codes and covenants
and read them. These are the rules and regulations by which your new community
will be run, so you'll want to understand what's required and what's prohibited
and be sure you can live within these parameters.
"I have only been here six weeks, but I've
learned that much," says Frank Rathbun, the new vice president of the Community
Associations Institute, a group in Alexandria, Va., representing all stakeholders
in the nation's nearly quarter-million condo, co-op and homeowner associations.
Beyond that, though, you'll want to take
a hard look at the "financials," particularly the association's operating
budget and its reserve fund. If you don't feel qualified to assess these
records, you might find it worthwhile to spend $89 for a Risk Evaluator
Report from Association Insights (ainsights.com or 1-888-527-1700).
The one-page diagnosis delivers two key
pieces of interpreted information:
-
An overall rating, from a high of "A" to a
low of "F," that allows you to determine whether the property is financially
sound.
-
A prediction of whether a special assessment
will be required over the next 12 months to cover shortages in either or
both the operating budget or reserve funds.
Know the risks
The Risk Evaluator also covers three other
important risk factors:
Percentage of reserves funded. This is
an indication of the association's willingness to plan. If it doesn't,
the place is either primed for a special assessment or necessary maintenance
will be deferred.
It won't do you any good to look at how
much money the community association has on hand because every community
has different amenities in different condition. But there is a generally
accepted standard percentage.
Ideally, the reserve should be 100 percent
funded. But if it is more than 70 percent, that's OK. An assessment is
"very rare" when the association has that much money on hand, says Association
Reserves president Robert Nordlund. If funding is less than 30 percent,
though, look out. "That's a very weak position," the condo association
expert warns, "and it means you are heading right for a special assessment."
Percentage of 60-day delinquencies. This
shows how the association handles its business. According to Richard Thompson
of Regenesis, a consulting firm in Portland, Ore., that specializes in
owner associations, if a higher than normal number of owners are allowed
to be behind on their dues without aggressive collection, the board probably
isn't doing its job. Moreover, if people aren't paying their share, there
won't be enough money to pay the bills.
If no more than 5 percent of the members
are two months late, that's a sign of a well-run shop and strong cash flow,
says Nordlund. If 5 percent to 10 percent are late, the place is in "fair"
shape. But if this key benchmark is above 10 percent, it's a sign of poor
management and an under-funded association.
Percentage of owner-occupants. Generally,
the higher this figure is, the better. For one thing, owners tend to take
better care of their places than absentee landlords. For another, lenders
may balk at granting loans to purchase in a community that has many tenants.
"Since a lender has a share of the common
area liability, they want to be sure a majority of residents have a high
motivation in caring for the property and are willing to ante up the money
to do it," consultant Thompson explains. "Homeowners have a greater likelihood
of doing that."
If owners inhabit 75 percent or more of
the development, the financial risk is low, according to Association Insights.
But Thompson says that if the percentage drops below 67 percent, financing
options start to disappear and property values may decline.
The Risk Evaluator also sends up a red
flag for these other indicators of financial risk: the association's history
of special assessments, tax and legal filings, financial audits, insurance
coverage and whether a professional manages the place.
Finally, one more item worthy of looking
into is how the association invests its money.
"Just keeping it in a bank account is not
good enough," says Nordlund. If it has more than $200,000 in reserves,
an investment manager specializing in reserves planning should handle the
money. If it's less than $200,000, the money should be placed in a local
or regional bank that has a community association program. |