 Welcome to Kondo Insider on Think Tech, Hawaii. I'm your host, Attorney Nalan. Joining me today is our guest, Mr. Damien Esparza, founder of Smart Property. Mr. Esparza has worked in the community association industry for over 20 years, specializing in capital reserve studies. He owned and operated one of the industry's oldest reserve study companies, Barrera and Company, before funding Smart Property. His new company provides the first ever cloud-based capital planning platform designed specifically for community associations. A trademark name is Leading Reserve Study. He has been featured in Forbes, Hawaii Business Magazine and San Diego Business Journal. Such a great pleasure to have you today. It's great to be here. Thank you for inviting me. Damien, can you tell us more about this Leading Reserve Study tool for property managers and condominium associations? Yes, the Leading Reserve Study is a asset management system designed specifically for community associations. We focus on the component inventory, as well as the capital planning analysis and the project tracking of the budgets that you're setting aside for these repairs. And it's all in the cloud. So you can access it anytime, anywhere. Our belief is that the information that you have to make decisions on when it comes to funding your repairs and developing plan should be living. It should be accessible and it should be something that you can access and grow with over time, versus what we've really been using in this industry for the last 20 plus years that I've been in it, which are static reserve studies, right? They're paper-based or Excel spreadsheet and that information gets lost. So ultimately the boards have to recreate the wheel and they're left with less information to make really big decisions. And so what that does is it creates a culture of deferral where decisions don't get made. And over time, that creates deferred maintenance and it costs more to get those jobs done. And in a lot of situations, boards as volunteers don't have the tools or mechanisms to ultimately get or garner the trust from their communities. And then that leads them to, again, to this kind of the spiral of deferral. So if my understanding is correct, it is really your utilizing new technology to transform those traditional paper-based reserve study down by professionals. On top of that, you're basically using technology to make this report more accessible that could be updated as you have more data from daily operations. Is that correct? Absolutely. And I think one of the real value adds for associations, at the end of the day, these are nonprofit mutual corporations. So associations are businesses, but these businesses are unique because they're not in the business of making money and they're in the business of really the purpose is to preserve, protect, maintain these common area assets. That's the fiduciary responsibility of these boards. And one of the things that they strive for because they're nonprofit is to keep the fees as adequately low as possible. And this is a struggle in this industry. A lot of people, when they buy and do an association, we call it the self-cleaning toaster of the mindset. They think that the association is just gonna self-clean itself. They don't understand that this is a business and the costs go up to run a business and the primary source for that in many associations is just the assessments themselves. And so that has to come from those owners. And when they don't increase those contributions and those fees, they get in a little bit of trouble. So the real value that we see is how can we help extend the useful life? So if you have good access to your information, what's the information that can help extend useful life for your components that ultimately save them money when it comes to these contribution increases that they have to sometimes absorb? So the better information you have, the better strategies you have, the better confidence you have. And so all it really comes down to is trust and transparency and giving owners more control over that process. Yes, we've already in headline news, locally and nationwide, nothing piss off the unit owners more than getting a letter basically saying, you're about to increase the maintenance fees two times or three times. Or all of a sudden, everybody needs to get a loan. The association needs to borrow from the bank to replace or repair certain major components of the beauty. And as we all know, if you properly found your reserve studies that was property down, so there shouldn't be many occasions of special assessment and borrowing. So really the planning ahead is super important. And the typical mistakes made by certain boards are kicking the can down the road like a deferent. Yes. And that's why we're here today, having a second session in this year talking about budgets, reserve studies for associations. And we are in a very interesting time period right now. As you mentioned earlier, before we started the show, we talked Hawaii, this market, we're having seeing skyrocketing insurance premium increases. At the same time, nationwide, worldwide, actually every price tag is increasing. This is definitely more challenging because we do have a lot of old buildings in town. So what if from your professional point of view from an industry standpoint, like what's the trend you see down the road on capital reserve studies? And is there any way for people to come out of these challenges that are strategized on that? Yeah, that's a really good question. I would say that, not only are we dealing with inflation, and you're dealing with limited contractors and supply and market and demand, supply chain challenges, some recent news came out, I think they feel some stuff is stabilizing to a certain degree. But in our industry, as we were sharing, one of the big canaries in the coal mine is what's not included in the reserve study, the elephant in the room really is looking at plumbing repairs, which traditionally have not been incorporated within the capital reserve plan because it was considered a life of project. But in states like Hawaii, where really these associations, these condo associations, the concept of them really accepted in the 60s, they're now facing that issue and we're seeing it more and more around how do we fund these repairs? So the necessity to develop a strategic plan to address this and then effectively communicate that to your owners becomes more and more critical. The job of a reserve study becomes less about setting the reserve contributions and really about strategic planning. And that really requires some thought, some patience, some deliberation, right? In terms of how we're going to approach this. And that I think those are some of the bigger headwinds that we see right now in the marketplace and what happens when you don't, right? Well, you throw good money after a bad solution, i.e. you're throwing money on plumbing repairs, which really are spiking up your operational costs, right? And then you end up not funding those reserves and then the insurance companies start hitting you with higher premiums. So it's a critical point for board members to really think and remember that they're running a business. And the more information you can effectively communicate to your owners, the better off you're gonna be. In terms of relief, what opportunities are there for relief? The most, I think the most optimistic things that we see really are what are the different technology composites that can extend useful life of an asset? Really thinking aggressively about your maintenance. Ultimately, if you do good maintenance, you can extend life. You're essentially you're buying time of that asset. And those are things that we see, some of the more sophisticated or smarter associations think about when it comes to their CAPEX planning. Yeah, so for the benefit of our audience who are not familiar with a reserve study, those things could be really lengthy over 70 pages. For any late person to look at it, that's like a sleeping aid materials. Can you help us understand? For example, if a unit owner or a new board director is presented with a copy of such as reserve study report, what other key areas they should pay attention to? And are there any red flag signals someone can detect? Just based on information there, you can already diagnose associations in bad financial shape. Yeah, that's a great question. The other besides sleep aid, it's the most expensive paperweight you might ever buy, right? And I say that a bit in just because they're just really hard to understand with all the tables of information and whatnot. Typically when I look at a reserve study, the thing that I'm looking at first, the item I'm looking at first is I wanna look at what the funding plan looks like. And I wanna know is that graph stay cash flow positive over a 30 year duration or does that graph go cash flow negative? Those are the first things that will give me a telltale in terms of what are we working with here, right? Is there a high quality problem where they have some very sufficient funds, a reasonable capital plan over the next 30 years and you have a lot of cushion. And so we're just looking to keep maintain that and maybe put some more buffer or contingencies in that just to keep it at that level or are we really having to think about strategic planning? Meaning they have more work to do than money they have. And we need to think about phasing out some of these projects. We need to think about potentially a special assessment or some kind of contribution plan that's gonna be able to kind of triage the work that needs to be done, maybe punch some effective maintenance plans into that from a dollar perspective into extending some life of some of the bigger components. So that's kind of what goes into my head when I look at it initial reserve study in terms of what are the red flags? I also wanna know what, and this is kind of like a back of the envelope number, I'll ask them what are your assessments and then figure out what are your contributions? For example, if it's an older townhome, we know if, like for example, an older townhome, if they're only putting 20 cents of every dollar into their reserves, townhome 30 doors or I should say 300 doors, we know that that's not enough, right? We know that they should be probably putting about 30 cents, right? Ballpark, maybe 35 cents of every dollar. That's just based on some analysis that we've done over the years, I'm looking at what healthy versus non-healthy associations are. So we kind of can do some benchmarking on that. Another big telltale for me is, is this an association with let's say less than 100 units? If it's an association with less than 100 units, 30 years old and they haven't been putting money away, there's only so much pain that you can spread around on 30 doors, right? So the less number of units, in my opinion, ultimately the higher that special assessment price might be if they haven't been funding at an adequate level for a very long time, because the other thing that we're always thinking about is what's not included in the reserve study, right? Understanding windows, are windows included? What are the CCNR and bylaws say? Windows is a big one. Are there other building envelope issues that might not be included? Ensuring that all the mechanical equipment may be in there. And then at last but not least, like I shared before, plumbing, right? So, cosmetically sometimes those aren't things that people look at when they first look at a reserve study and a lot of people will focus on photos because they understand the photos, but it's not so much the things that you can see, it's the things you can't see within a building that typically drive up the cost a lot when it comes to the capital repairs and or special assessment. I think you just include some technical terms about the funding plan. You mentioned there's percent funding, there's also cash flow methods. Can you give us the explanations on this basic term so that our audience can understand our conversation better? Yeah, so, and I want to make a distinction. What I was sharing was back of the envelope, what we will look at is what are your total assessments and what percentage of those total assessments are going and contributing into reserves, right? So is that a 30% or another number? But that is just a baseline numerator divided by denominator. The other number that's used in our industry though is considered what we like to call percent funded. Percent funded is just an indication of your financial strength today. Then you go about as a snapshot of your balance sheet and the formula there is very simple, takes your total reserve cash as an asset and it divides it by a denominator and that denominator is considered your crude, if you will, liability, right? How much money should you have in the bank today given all of your components, their replacement costs and their current effective age? And that will give you an idea in terms of what their indication of financial strength is. One of the challenges I've seen in my 2020 plus years, 22, 23 years of working in this industry is a lot of boards will focus on that number. The challenge is you can be 60, 70% funded today but if your cash flow plan is going negative in five, 10, 15 years, whatever it is because you have a huge spike of a project coming down the road, I don't wanna live in that association because you're ultimately gonna have to do a big increase, right? So that's something that you really need to look at. So going back to if you're an owner, right? What's our percent funded, right? That's a number that's worth looking at but then how does that relate to the cash flow plan, right? Is that cash flow plan steady going up and up and down, right? Based on expenses coming in and obviously income coming in as well, expenses going out, excuse me, or is that going negative? So those are really important indicators to look at. So that's what percent funded, right? Everyone kind of uses that. That's kind of our hallmark in this industry, understanding your indication of financial strength. Then we have what we call funding plans. So state of Hawaii has two models that you can adopt. One is called your cash flow plan, which essentially just like it sounds, you have to have enough cash in the bank for every year for over a 30-year period to cover those expenses. It can be $1. Now the challenge with that model or that plan, if you will, is it doesn't have a lot of buffer. So if you're off in price in components, right? Included or non-included, any type of assumption and let's be honest, reserve studies are a lot of art and a lot of science, right? It's not predictive in nature. It's a capital planning tool. It is a budgeting tool, right? So it's not going out and getting scopes of work for every single project you're doing. And we don't know exactly what inflation is gonna look like in the future, right? Maybe we can say what we think in the next two to three years, but what's four, five, six and so forth. So that's why we recommend getting these refreshed every year, at least a financial refresh, if you will. So that cash flow plan leaves you really minimal in terms of your buffer for risk management from a perspective. And then the other option in the industry is what they call percent funded. And so at that point, you're basically running a 50% funded level, right? And so that's a huge buffer. And us as professionals that wanna give recommendations, we will always go with the more conservative approach, right? We'd always say go with percent funded. It's gonna give you a larger buffer, better risk management, if you will. But what's the challenge of that, right? Well, in a lot of situations, unless an association has been putting away every dollar from day one of its birth, if you will, which typically doesn't happen at all, you're essentially having to do a huge spike or a huge increase in what that contribution is gonna be and then hence what the assessments are gonna be. And so we don't see that a lot in associations unless they've already kind of started that training, if you will, of their planning from an early inception of those components. The other challenge with that model is if you said, hey, we wanna do that now, essentially all of those other owners that lived in the association that aren't in there now, they got free rent on the component because they weren't putting money into the kitty every year based on usage, right? Which is one of the challenges common interest capital reserve planning, right? You're not supposed to be putting money away based on when it was replaced. They're supposed to be putting money away every year based on your use of that component. So if you don't do that from day one and you do a big spike in terms of wanting to get to a percent funded level, it does create heartburn. And that's one of the challenges, I think, with that adoption of that plan. And why most associations go the path of least resistance which is the cash flow plan. I see. So based on your experience, because I think Hawaii, they just require like a 50% statutory minimum if association choose to fund the estimated replacement reserve assessments, a percent, or if they use the cash flow plan, they would have to fund 100%. Compared with the other states, where are we as a state in terms of the spectrum? Are we on the more restrictive conservative side or we are kind of like lagging behind? I will say, the fact that Hawaii has a requirement to fund your reserves is better than most states. Oh, that's good news for us here. But we also have corrosive air here, right? Components tend to deteriorate faster here. Yeah, true, true. But I would say that I believe the law was passed in the initial, the first law was passed in 92 if I'm not mistaken. But yeah, I would say that Hawaii was on the forefront of this. And I think that's a really good thing because a lot of this is about conditioning people's expectations. It's about conditioning homeowners' expectations. At the end of the day, this is about homeowners and the perceived value that they see of the association and where their money's going, right? And I think in some situations, they don't see a lot of perceived value, right? They only see what they see in front of them. They don't understand that the fact that they're running, that they're part of a business and it's got an ongoing concern and it's got to operate like a business and it needs funds to operate like a business in order for them to get those high property values that they want, right? Everyone goes to Zillow and says, did you see what the neighbors' house went for, right? But there's a cost to that. And when you live into a community association, right? That's part of what this contribution is for, right? So I think that's a critical component of connecting the dots and telling that story. But that being said, I would say Hawaii versus a lot of other states is in a much better situation in terms of requiring either funding model or cash flow, which means you have to have all that money for that specific year in the account or a 50% funded model. Yeah, so talking about the law, we do have a new law passed this year at 1.99. The legislative bill number is SB 855 regarding association budget replacement reserves. So this new law actually brought a lot of positive changes to the existing laws. For example, as all we know Honolulu County, like there will be about 400 buildings subject to that five sprinkler ordinance. Those buildings need to come up either, they're gonna install automatic sprinkler system or they need to pass that life safety evaluation assessment, which are expensive projects. This new law now require association's annual budget, which is the packet all union owner received before every annual meeting. They must include summary with details of the estimated cost of such fire safety equipment or installations that meet the requirements as required by the city's ordinance provided that the reserve study may forecast a loan or special assessment to fund the life safety components or installation because this occurred wasn't on a lot of project minds. It was the law passed because of the 2017 Markov-Bowlfire accident. The new law also make changes, basically emphasizing again, if the association's reserve study was not prepared by an independent reserve study preparer must be reviewed by a professional like that, not less than every three years. It clarified that managing agent with industry reserve study designations does not have conflict interests. They can be the one preparing for the reserve study for associations and also more specifically, they do want additional details be included in the reserve study report, including disclosure of component of association property omitted from the reserve study and the basis for the omission, which is the exact point that you highlighted in our prior conversation. And also plan increases in the estimated replacement reserve assessments over the 30 year plan and whether the actual estimated replacement reserves assessments for the prior year as defining the study was less than the assessments provided for in the reserve study and if so how much and explain the impact of the lesser assessments on future estimated replacement reserve assessments. So hopefully this new law will also bring positive things and also remind all the board directors that you do all the fiduciary duty to property adequately found your reserve study of replacement reserves for your beauty, which is basically protecting the investment for everybody. Not just now, you don't have the mentality of I'm gonna only be leaving this project for a few years so who cares kicking the can down the road but what about your heirs or whoever's gonna take over your projects, your unit, your investment, leading a legacy a good legacy for all the future owners that could be your children, your grandchildren. And before we wrap up, Damien, can you summarize a takeaway plan for our audience today? Be good stewards, right? Be good stewards for your community, for your building. You mentioned legacy, right? I think to sit on a board as a volunteer in itself is, they're not being paid, right? They're investing their time and we all know how valuable all of our time is. So I think those that may not have served on a board think about serving on a board and really practice good stewardship for helping our communities thrive and be safe, right? And protect these common area assets. So that we do have nice places to live and good communities to participate our life in. That's great. Thank you so much for your time, Damien. Thank you so much for joining us today. You're welcome. Thank you so much for watching Think Tech Hawaii. If you like what we do, please click the like and subscribe button on YouTube. You can also follow us on Facebook, Instagram, and LinkedIn. Check out our website, thinktechawaii.com. Mahalo.