 Aloha ladies and gentlemen, welcome to this week's edition of condo insider brought to you by think tank Hawaii. This week we will be discussing operating budgets for your associations. It is that time of year where associations start to process and prepare for their next fiscal year so it is a busy time of year. And if you have not already started to do so it's probably a good time to start thinking about your 2022 operating budget and reserve study. That being said, we will be diving into the operating budget side of your association a little bit today so we will touch a little bit on the basics of a reserve excuse me of a budget. What is a budget. First of all, well, a budget is an estimate of income and expenditures for a set period of time essentially generally speaking for associations that set period of time is 12 months or one year. The associations in Hawaii have a calendar year or a fiscal year that starts on January one. However, there are other associations out there that do have fiscal years that may start on September one or July one so there are some associations out there that do have different fiscal years, but I would say a large majority of the associations in the state of Hawaii the fiscal year matches your calendar year where it starts in January one. That being said, in the association world, we utilize the zero base budgeting process when preparing association budgets. So zero base budgeting is a method that has you essentially allocate all of your money to expenses and savings and sometimes some debt service depending on your association. And the goal is that your income will essentially offset all of your expenditures so essentially your income minus your expenditures will equal zero or will balance out to zero at the bottom line. So whatever amount of money you are collecting on a monthly basis, essentially is designated or designed to cover your monthly expenditures. That being said, when we look at a reserve, excuse me, an operating budget, we look at a couple of different aspects. We look at our revenues, and we look at our expenditures. So we'll touch on revenues briefly first. So in the association world we're kind of limited on the different revenue sources that are available to different associations. Obviously most associations collect their revenue through monthly maintenance fees that they assess to their home ownership on a monthly basis, either via a payment coupon or a monthly billing statement. So a large, the largest portion probably almost close to 100% of revenues is collected through maintenance fees. However, depending on your association, you may have some other sources of income. For example, your association may have a resident manager unit that is not utilized by your resident manager, and therefore your association is renting that manager's unit out on a monthly basis to some other resident. So that is a potential source of income or revenue above and beyond your regular maintenance fees. So a potential source of income depending on your association is your parking income. There are a number of associations out there that have parking lots and units that actually don't have a parking stall designated to the unit. When that occurs, oftentimes those entire parking structures, those parking lots are rented out on a monthly basis to the residents of that association. Having said rental income through your, your association own unit, your parking income or a couple sources of revenue. Another source of revenue that many associations utilize when they install some meters for either electricity or possibly water and sewer, and therefore becomes a billable event because their individual electricity usage and possibly water usage is being metered. And therefore, the amount that is being utilized on the residential side, or portion of the budget, budget is basically reimbursed from the homeowners based on their submitters. I would probably say most associations don't have actual water submitters because it is difficult to submit or water depending on the makeup or infrastructure of your building. However, it is becoming more and more common that associations do some meter electricity. It is a green approach to try and minimize the amount of electricity that associations are utilizing. Some other sources of revenue that some associations are able to benefit from our rooftop rentals. For example, we have these major cell phone companies that will go around and they will basically lease portions of rooftops of different associations in order to basically provide cell phone service throughout the state. We have actually seen quite a bit of increase or modernization to the cell phone tower equipment with the implementation of 5G. So that is another potential source of income depending on your association. And that is something that you may want to investigate if that option does come your way. Some associations do have some other minor fees that they may implement, such as a fee to utilize the barbecues or a fee to reserve the elevator for move-ins, move-outs. Generally speaking, these fees are very minimal and really don't provide a significant difference in the amount of money the association needs to collect through maintenance fees. Another source of income for associations is interest income. That being said, though, it's important to understand that your interest income, you need to really take a look at your reserve study because it's most likely that your reserve study is already factoring that additional revenue for your reserve fund. That being said, I do see on a somewhat regular basis where associations make that mistake where their reserve study basically is budgeting the interest income that will be allocated or deposited into the reserve account. They also budget the interest income under the operating side, and therefore they're essentially double counting that revenue source. So you really got to keep a close eye on the interest income because most times your reserve study is already factoring interest income rate. So considering the Hawaii administrative rules section 16, associations need to basically make an assumption when they're preparing the reserve study about what the interest income will be. So take a close look at your revenue line items and take a close look at your reserve study and make sure that you are not double counting your interest income, because again, your reserve study is likely already factoring or counting for that interest income. Make sure you are not adding the interest income to cover operational expenditures because it is a fund or as a amount of money that should be deposited into your reserve account and not into your operating account. As I said, those are pretty much the main sources of revenue in the association world, the association world essentially are nonprofit organizations so you're essentially collecting as much maintenance fees as required to cover your operational expenditures and to cover your reserve contribution. Moving on to the expense side of your operating budget. There are essentially two classes of expenditures, number one, you have discretionary expenditures, and number two, you have your mandatory expenditures. Let's first touch on your discretionary expenditures. So discretionary expenditures basically you have a little bit more flexibility on whether or not you really need that expenditure, or whether you can kind of control the amount of money that you're spending in those discretionary line items. Unfortunately in the association world the discretionary expenditure line items. They're not that many most associations have more mandatory expenditure expenditure line items rather than discretionary line items. However, a discretionary line item can be controlled. For example, maybe the number of employees that your association hires, maybe you guys will decide to hire eight employees rather than nine, or maybe you will decide to hire nine rather than eight. So you have some flexibility and how much money you expend on certain line items for example like your employees, the benefits that you offer to your employees do you offer a 401k matching program or retirement programs. Those are discretionary items that are really up to the board and whether the board will decide to include those discretionary expenditures in your operating budget. There are some service contracts or maintenance contracts that they may not be discretionary but you still have some flexibility in regards to the frequency of services. For example, I happen to know of an association that they have a semi annual roof maintenance plan with their roofing company. They have two roofing systems on a semi annual basis because essentially they have two roofing systems they have the residential tower roof, and then they have a roof that essentially covers the commercial unit on the ground floor. So the top of the ground floor roof is very visible when looking down from the residential tower. And if it's not maintained on a regular basis power wash on a regular basis maybe coded on you know in the areas that need coding on a regular basis. It tends to be aesthetically unpleasing when it builds up with dirt or debris. So that's kind of a discretionary expenditure that association may choose to spend more money to have the frequency increase due to aesthetic reasons. Maybe some on the flip side they may decide to have an annual service once a year rather than twice a year similar with window washing. Again that's kind of a line item that's a little has a little bit more discretion depending on your building, maybe rather than doing a quarterly window washing you may go to three times a year or a semi annual. You're really going to have to understand your ownership and what the desire is what the complaints you may be hearing are from your ownership so window washing might be another option or possibility where you can increase or decrease the frequency of that and that basically has a direct correlation on the amount of money that you need to spend for that line item. Another one that I see on a regular basis in regards to ownership classes in an association is the temperature of your pool. You know I hear there are groups that like hot or warmer water than those that maybe do lap swimming. But again that is kind of an expenditure or a component of a line item that you can control. You may either slightly decrease that expenditure line item or possibly increase depending on the path that you take. So again the discretionary line items are more, they're more flexible you may or may not need them in your, your operating budget, or you just, you know, you tweak the frequency of the the currents on those service contracts. So that's discretionary expenses, and now you have your mandatory expenses, and you really have no option in regards to paying your mandatory expenses. For example you have to pay your utility bills you have to pay your electricity electricity your water your sewer, you don't pay those items, your water gets shuts off, or your electricity gets turned off. So those, that's an example of an mandatory expenditure that you have to pay. And you will find through your governing documents and state statute for that matter that associations are required to carry insurance. So insurance is another mandatory expenditure that associations need to budget accordingly. You do, we did touch on some service contracts under the discretionary side of things like the window washing the roof maintenance will he things like that. And those are also service contracts that are absolutely mandatory. For example, if you live in a high rise or if your association has an elevator, you need to make sure that elevate that elevator is on a maintenance contract. In order to make sure that that elevator remains operational all the time. It would be very difficult for homeowners. If you live in a 20 story building and, unfortunately, you did not maintain your elevator properly. And therefore it was broken down making people walk up and down so that is a service contract that in my opinion is a mandatory service contract. Another example of a mandatory service contract would be like your refuse service that you have, or utilize to pick up your refuse on a daily basis or three times a week basis so those are some examples of a service contract that are considered to be mandatory. Another item that is mandatory and is determined by reserve study is your reserve contribution through Hawaii statute associations are obligated to fund your reserves to meet your future financial obligation. And so you do have a mandatory expenders expenditure basically a transfer from your operating account to reserve account that you need to budget for accordingly. So those are basically the two different types of expenditures your discretionary expenses and your mandatory expenses. That being said, we're just going to take a short break. Aloha, I'm Mitch Ewan, host of Hawaii, the state of clean energy on think tech Hawaii. Hawaii the state of clean energy is about following the many clean energy initiatives in Hawaii Hawaii the state of clean energy appears weekly on think tech Hawaii at 4pm on Wednesdays. Thank you so much for watching our show. We'll see you then. Aloha. Great. Welcome back to condo insider brought to you by think tank why my name is Jonathan Billings and we're talking about association operating budgets. We've touched on the basic basics of your operating budget. We've touched on the zero based budgeting process that we follow. We looked at your revenue sources and the two different types of expenditures that you have in your operating budget. Now that being said, there are some other expenditures that you may want to consider adding to your reserve study. I'm likely aware. The association industry is being hit very hard currently with insurance premiums insurance rates. There's been a tremendous amount of loss or payouts at the associates, excuse me insurance companies have had to pay over the last number of years and it directly affects the amount of premium that your association pays for your insurance coverage. That being said, in my position, when I go out to solicit insurance proposals from different companies. I am finding more and more often now that insurance carriers are requiring property managers are managing agents to fill out questionnaires. And in those questionnaires they will have questions like how often or what is the frequency that you clean out your way stacks. What is the frequency or how often do you inspect your rooftop. What is the frequency that you are cleaning your electrical equipment. So, and the insurance companies basically are doing more due diligence or they're doing their homework more in regards to what kind of maintenance programs does your association have in place. That essentially should minimize the amount of loss that your association has. So that being said, considering that insurance companies are asking managing agents to complete these questionnaires. You may consider being proactive and get some of these components on maintenance programs so when you're managing agent is filling out these questionnaires. Answer yes we are on a regular maintenance program for your way stack cleaning or yes we are on a regular maintenance program for your roof coding system, or yes we are on a regular maintenance program for your electrical distribution system. So those are some maintenance programs that you may not currently have in place that you may want to consider putting in place in order to hopefully improve your insurance premiums. So just a little food for that little food for thought there just to consider. Just moving on so you know like I said we're entering the budget season and a question I get someone on a regular basis, you know who should be involved in regards to your budget and what do we really need to look at in your budget. So that being said, it's a zero base budget. So what you're going to want to do a committee, the treasurer you're managing agent on site management, you don't want to review your different contracts you have in place your refuse contract your elevator contract your security contract things like that, because oftentimes you will see in those contracts that they have escalation clauses or they have clauses that they can increase a certain percentage on an annual basis. So when you're doing your budgeting, you have basically already know what the cap will be for the increase on those specific components or the specific maintenance contracts. So you're really going to want to take a close look at your your contracts when you're doing your budget. You don't want to look at your historical usage of your electricity, your water your sewer. You don't want to pay attention to the dollar amount necessarily, for example, electricity it goes it fluctuates up and down with the price of oil. You really want to look at the actual kilowatt usage that you have been utilizing and use that as your average when you're contracting your associations expense line in for your electrical expenditure line. So you're going to want to look at your utilities look at the historical peaks and valleys obviously in the summertime, oftentimes I see that the electricity usage peaks in the summer because everybody's running their air conditioning, where in the wintertime the electricity is not as high as the because people have stopped using their air conditioning in the wintertime. You are going to want to reach out to some of your contractors and ask them what do they anticipate any kind of a potential increase, reach out to your insurance agent. Use them as a source so when you're doing your budget and you're trying to factor basically estimate what your insurance premiums are going to be, reach out to the resources that you have available to you reach out to your insurance and reach out to your vendors, pick their brain on what they anticipate the potential increases will be over that next fiscal year. Take a look at your reserve study. Does your reserve study schedule an increase for fiscal year 2022. I do know that a lot of associations did postpone a 2021 increase due to COVID-19. But you know, you need to make sure that you pay attention to reserve study and what the required reserve contribution will be for 2022. It is likely that you will be required to increase your reserve contribution if you did postpone an increase in 2021 to basically lessen the financial burden or ease the financial burden on your homeowners during COVID-19. You really should be looking, not only should you be doing an average of let's say 12 months, but you really should go back a couple of years, because sometimes you will see that there's patterns where there might be in every other year expenditure. For example, in fiscal year 2021 Association were required to complete the biannual kind of registration through the DCCA. Now that's not an annual expenditure, so that's not going to hit every single year. So in 2022, you do not have to factor for the biannual kind of registration. However, in 2023, that is something you're going to have to remember to put into your operating budget. That being said, also when you're preparing your reserve study, you're really going to want to tap into your onsite. Your onsite management really understands the details really understands ins and outs of your different components of your association. They have a better understanding of the current condition, let's say of your booster pumps or some of your mechanical equipment and whether or not those pieces of equipment will need some kind of repair or upgrade during that next fiscal year. So if you don't want to tap into your onsite management, pick their brain to better understand what the condition is of the components. In addition, that you really need to tap into your onsite management to determine wages for the next fiscal year. He or she have an employee that has been an old star and is deserving of a decent increase versus maybe another employee that has been doing subpar work. So you're really going to want to tap into your management to basically understand what kind of merit increases should be factored for your different employees at your association. In my mind, association or boards will sometimes brag that they have an increased maintenance fees in three or four years. In my opinion, that's not something to brag about. And the reason being is because we know costs are increasing. You can see the news right now that the expectations of inflation are going to be skyrocketing or they're going to increase a fair amount in the foreseeable future. So I am of the opinion, and I always recommend to the association that I'm involved with that at a minimum, you should be increasing your maintenance fees at the rate of inflation. Again, costs are increasing cost of labor goes up cost of oil fluctuates inflation is going up. So, in my opinion, it's not something to brag about if you have not increased your maintenance fees for a number of years because then you're falling behind in the rate of inflation. That being said, another consideration about not increasing maintenance fees is there are basically restrictions about exceeding your budget by 20%. And if you see your budget by 20% essentially you the board or the association will need to get a resolution adopted by the ownership that basically authorized that that variance in your operating budget. So who should be involved in the operating budget process. I look at it as a two phase process where the first phase the managing agent is involved or your property managers heavily involved, your onsite management is involved because they know the association, the ins and outs of the association. Phase one tends to include the board treasure and board president of the association. I do see those associations on a somewhat regular basis also form budget committees. So I again I look at it as a two phase approach that the phase one is more of getting into the details really getting to the nitty gritty of your operating budget with a select number of people. And once you're past that point and you basically have a draft operating budget available for review. From that point I goes into the phase two process in my opinion where the treasure presents the operating budget either to a committee or to the budget or excuse me or to the board of directors for review and consideration. Phase two is where the entire board gets involved. They may have some questions for the managing agent or the treasure and basically ask how they came up with certain expectations. I would say that it is important that an association and a board understand every single line item. So if you have time on your operating budget, generally speaking, I would recommend that you actually present the operating budget, let's say in August or September, not approve it. That will basically give the board members a month to review that document. And then at the following meeting in September or October, actually have that budget approved by your association. It's meaningful of statutory requirements and requirements that are explained in your governing documents. For example, statutory requirement basically states that if you have an increase in maintenance fees. You need to provide notice to the ownership 30 days in advance of a maintenance fee increase. There are several governing documents out there by laws that even put a more stringent requirement and require a 60 day notice of an increase in maintenance. So make sure you understand what your governing documents specifically say, whether or not you need a 30 day notice per statute or whether or not your bylaws require a 60 day notice. So make sure you review that so you have a clear understanding of what your documents require. I would say, again, just being in the management industry. I would say, don't wait until November to approve your budget. And why is that you have to understand once that budget is approved, your managing agent needs to go back to their office and go back to their accounting department and the accounting department basically needs to import or input the budget into their accounting software in order to produce your, your financials in order, in order to produce payment coupons or payment statements. The process involved on the management level, or at your managing agent that has quite a bit of legwork in order to provide those payment coupons and those billing statements to your home owner so by approving it last minute. You might be late in line, where there are the other association that essentially approved their budget prior to you. I do see sometimes on a regular basis when you are in budget season you are constantly running your printer. I mean it runs all day long for the entire day because you're printing thousands and thousands of pages to send out these operating budgets to your ownership. Like I said, those printers, they have issues, they can overheat they may break down. So if you're approving it in November mid November late November, you might run into some obstructions or obstacles that may delay the delivery of your operating budget to the ownership, and therefore you should be complying with state statute. So, again, I would just highly recommend don't wait until November, if you have a January one fiscal year to approve your operating budget. Make sure you have a couple month buffer in there in order to give your managing agent sufficient time to prepare to print to stuff the envelopes to prepare the payment coupons the billing statements. Make sure to ensure that you meet your obligation through state statute or your governing documents. Again, as I just previously stated I would, I recommend that the initial budget be presented to the board of directors in the August or September board meeting. If you have monthly meetings if you don't have monthly means you may even have to be sooner just it really depends on the schedule of your meeting so if you have monthly meetings. I recommend it at the initial presentation be done in August or September because that will still give you one additional meeting where you can give it the final review and get the final approval from the board of directors. That being said, that's about it. Have a clear understanding of your governing documents. Look at potential other revenue sources if they are available oftentimes or not. Look at your discretionary expenditures and your mandatory expenditures. Engage your onsite management again they are key during the budgeting process. Work hand in hand with your managing agent your treasure. It is budget season. Good luck to everybody. Spend some time on your budget spend some time on your reserve study and good luck and happy fiscal 2022.