 Welcome to Condo Insider. This is our weekly show about association living every Thursday at 3 o'clock on ThinkTacY. They're running a campaign and they're a wonderful nonprofit supporting the public interest and we encourage you to go into ThinkTac and consider making a donation. We've been on this show now like this is over a hundred and sixty episodes we've done about association living and as I've said before about 38 percent of our population lives in an association. Thank you for tuning in today. I've asked a good friend of mine David Simpson to join me who's a director at Associate Hawaii to talk about something at that time of year again whether we like it or not called budgets and reserve studies. Just to kind of review the statutory requirements and kind of current thinking on budgets and reserves and I asked David who I've known for a long time to come in. Welcome David to the show. Thank you Richard I appreciate it. Why don't you introduce yourself to the audience limit who you are, how long you've been in Hawaii. Well I've been in Hawaii now for about I think to say this because it really oldated me but 25 years but I've loved every minute here and I've spent about the last 20 years somehow involved with properties be it association management commercial properties and different types of real estate. Do you like the real estate industry? I do you know every day is a new exciting day. I guess we can sum it up last night. I usually tell everybody I like it because it drives me to drink but then it's a short drive. You're right right and it does do that too. Don't test your patience at the time particularly residential management because boards of directors take a lot of pride and personal interest in the place they live and become emotional a lot of the time so it's not an easy job I've been told. Yeah but I think it's very gratifying because at the same time it is personal for them and hopefully we're helping them out with you know any aspect of their lives and we really can create some good relationship. What is their home and they need to care about their home and we thank volunteers on boards for taking the time to serve in this job that doesn't pay very well. True. The law says they get nothing. Yeah. But anyway we thank them for that and the law is very clear you know the associations every year have to do a budget. Right. What do you think about it? You know I think it's fiscally responsible I think it's you know a good standard. And the law basically correct me if I'm wrong although last time I was wrong was 1964. There you go. No that's not. But anyway the law is pretty clear that there are certain items that have to be in the budget. Let's just assume for the purpose of our show today we're talking about an association with a calendar year budget. January 1 to December 31. There are associations out there that have fiscal year budgets where the fiscal year might end on May 31 or June 30th or whatever. But to keep this simple we're going to be talking in terms of January 1 to December 3. So by law and by their governing documents they have to do a budget. What's included in the budget? Well you know there's several items. I mean they have to have an estimate of the revenues, expenses. We're looking at you know if it's going to be a cash on a cruel basis. We've got a total revenue or the reserve account. Sorry. An estimate of reserves and an explanation of how those reserves were calculated realistically. So we know that we're doing everything in a proper fashion. The reserve contributions you know for the reserve study and a percentage of the funding or if it's a cash flow aspect. You know I've been in this industry 25 years or more. The term I've always hated was maintenance. Because people think of maintenance fee they think of maintenance. More times than not today the fee you pay more of an operating fee. It is. Because you're going to have water sewer that's not maintenance. You may have TV cable or internet in some cases. In some cases you might hire security for your building. You certainly have insurance. If you're a flood zone there's flood insurance, liability insurance, property insurance. Right. The maintenance fee I've never liked that because people seem to think when they get an increase every year that why should why should we have an increase. I haven't seen much maintenance. What's your experience? Well you know when we when we look at increases you know especially here in Hawaii things are going to go up. Prices are going to move forward and we've got to we got to be prepared for it. You know and realistic a budget is proactively looking at the future cost even within that 12 month period. Well the issue becomes to me you know budgets today under Hawaii law and current association thinking of what they call zero-sum budget. We look at how much money we need how much money we need to put in reserves by statute that comes up to some number. We multiply it by the percentage of common interest for every owner and that becomes their association fees. Some clients break it out the reserve of contribution versus the maintenance fee or kind of the law it's called a regular assessment. They break that out and what happens if someone doesn't pay if an owner is delinquent. You know I mean those are the parts that we we are unable to plan for I guess you could say because I think we're always hopeful that everybody's going to pay and they're going to pay on time. But it definitely can create a shortfall. So what's an association to say they have a vigorous collection policy or so they I think it's very important that they set a standard and then adhere to that standard especially when you're talking a larger association. It's just pure numbers right the more the more individual units you have the more likely you could have someone that doesn't pay in the same manner that everyone else. The worst I've ever seen was going back to I want to say 2008 we had the financial project. I had a project on Maui of about 60 units mostly vacation rentals and investor units and that association was leasehold and they had just finished agreement buy from the lessor the fee for around 17 million. On top of that they had deferred maintenance and barred another two and a half for the reserves to fix the spalling and the deck and what happened was because the economy changing and people are not coming to Hawaii and tourism down they weren't getting the revenue and 30% of the condominium units walked away leaving 30% of the units not paying maintenance fees. I hate the word maintenance fees but I'm going to use it in the show. Miles will go with the flow that's what everybody uses. What do you think about that? You know I mean it's detrimental you know especially to the property because costs are still going to be there. We know that as we said if we want to call them operational cost or we want to call them maintenance cost they're still there so then it ends up being troublesome for all the individuals that have made it. In this case we didn't know the financial crisis. Their whole theory was they'd borrow the 17 million each of the 60 owners would go out and borrow the money they needed which is about 300,000 owner I think a little less. But they would go out and borrow the 300,000 pay off the 17 million dollar bank loan. They'd have a fee simple property on the ocean. The problem was in 2008 because of the crisis all the real estate values plummeted. They no longer had the equity unit. The banks wouldn't give them individually the loan to buy the fee which meant the association had to pay the bank loan of 17 but then 30% weren't paying their maintenance fees so believe it or not they were in default with the bank. That was a major crisis. About 10 years to get out of it but understand this even though the banks have no mortgage on the property they have an assignment of cash flow for the maintenance. They didn't want to force those. What are they going to do with it? Right. So they didn't work out where the interest was reduced like one quarter of one percent interest only they didn't work out why the association goes through the foreclosure get the units and resell them and maybe the original lender for the individual owners mortgage got stuck because they didn't get what they should to pay off the balance. Right. But over a few years they worked itself out and now all those units are worth more and now all the people are fee simple and I think it took about 10 years for the last unit to be sold and conveyed but what happened was that the banks were very very coming to find a workout plan to keep the association afloat. Right. What that association did with the remaining 70% of the owners they passed a monthly cash flow assessment that was strictly to cover the 30% of the people who weren't paying and then as they got new units into whatever they would adjust that cash flow assessment that's how they made up the deficit. Although not a recommended budgeting strategy. No. No but definitely a recoverable one. Recoverable. So how often do they do a budget annually right? Annually. And you know offhand what the legal requirement is when they have to have the budget done by? Well so the way that works is they've got to have I believe and correct me if I'm wrong as we said earlier 30 days before their annual meeting is when it's required. That is the statutory obligation but assuming the annual meetings in April and the budget years December 31 most associations would adopt a budget in say November so they give the 30 days mandatory notice of any increase in maintenance. If there is no increase they don't have a 30-day obligation but to use more often that I tell clients all the time is that you want to put a budget out to your owners you can't prove that actually right. If you're getting near the end of the year you have issues on your reserves and funding they'll an IDAC or it may be you have big numbers that are missing. Are you not better off adopting last year's budget with the beginning of the next fiscal year January 1 and then amending that budget in March or April once you have real number. Yeah I think that's a great pathway. So the message on that is by the way is that budgets are not set in stone although not recommended you could amend your budget every year so in the middle of the year I saw association that lost a lawsuit on a I want to say sexual harassment whatever by one of the employees they got a multi-million dollar judgment covered later to borrow money and do some things and what they did is they amended their budget in the middle of the year and they got a loan and they solved it right budgets even though there are do there's nothing in the statute to prevent you from amending your budget or research and do you want to put out a budget reserve study you can't depend on versus taking a couple extra months you really own on the real numbers you know what I think it's imperative really to take those extra moments anyway we're getting close to a time for a quick break here we're going to take a one minute break we'll be back with David Simpson about budgets and reserves hello I'm Mellie James host of let's mona up Tuesdays every other Tuesday from 11 to 11 30 this show is meant to dive into stories of local product entrepreneurs and how they're growing their companies from right here in Hawaii I'm so thrilled to have our show kicked off and so please join us on Tuesdays at 11 o'clock as we talk to local entrepreneurs and hear their stories Welcome back to Kano Insider I'm sitting here with David Simpson a director with Associate Hawaii talking about the basis of doing budgets and reserve studies we're taking on that topic today because we're going into budget season and all these associations out there are going to be pulling their hair drinking more wine whatever trying to figure out how not to raise the maintenance fees recognizing that's an impossible task and a poor choice of strategy because as we discussed early it's a zero-sum budget you're collecting just enough money to pay your bills and fund your reserves and every year things go up like insurance you always want more money medical insurance for your employee all these different costs water sewer so there's always inflationary pressure on the budget and simply reducing reserve contributions is like the old fram oil filter commercial pay me now or pay me later you're going to end up with not enough money reserves ultimately which may require special assessment or a loan we finished up we were talking about the basic obligations of a budget and you have to do them annually and if you're not quite sure the numbers you have until 30 days before the annual meeting before the final budget is due even that final budget can be made the later during the year so that's where we were let's talk about reserves for okay I've said in the beginning that you do the operating costs which are like the monthly cost maintenance salaries whatever it may be what is a reserve study what is basically as perfectly realistically it's to evaluate anything thousand dollars or over generally speaking but over a 20-year period you want to get a good idea of life expectancy of major component I think this goes back and I can tell you some history that when condos are interesting you know some cases people have incorporated because they think they need that additional protection of being a corporation but condos are created by statute and they exist because of that the statute provides those unincorporated condominium association all the protection corporation has just by being a statute but once you get into doing a budget or reserve study what happened in the 70s where developers wanted to sell the units so they made the main disease really low with no money for the future roof for the future painting or anything else excuse me and what happened is the legislature back in around 1995 or 96 passed a law saying that you must do a reserve study and be 50% funded by January 1 2000 and that's kind of where it began because the idea behind it was so many people were complaining they bought in a senior citizen and there was a $10,000 roof assessment that they felt that condos should disclose up front through a reserve study what the future repairs are going to be required an estimate what the costs were going to be require everybody to put in monthly contribution towards that the idea behind it is if the project was banned new and the painting was gonna last 10 years and I was $10,000 or a thousand a year and you live there or five of those 10 years you should have be paying 50% of your prorated reserve because you use in theory half the painting for the building and it was a forced method to deal with that now the problem with that January 1 2 it was amended 1990s know that I wrote you there we go I can speak about air on this and if it was over our legislature they gave you a choice of that time of percent funded is the only method to fund your reserves like cash or a cool accounting there are different techniques you use to calculate and funded versus reserve and if you look at the administrative rules that support the law if you guys don't know there's administrative rules out there there are rules out there to tell you specifically how you have to calculate it's a long story it's a whole show in its own but anyway when they passed the law they said you have to use percent funded failing to recognize one small fact 99.9% of the industry didn't use cash flow funding they use excuse me up percent funded didn't use percent funded they use cash flow funded which is a different calculation technique which is a more balanced technique so anyway making a long story short for my question but it's a little question in here but anyway that they put the reserves of the obligation to make sure the consumer was protected that there was a reasonable opportunity that association's for the owners as they used these components enough money to pay for the replacement there wouldn't be a surprise that's kind of a there you go so from your experience what's your experience no I useful they I think they're very useful you know I think as we move forward with our construction we're seeing you know from years and years ago we don't see it some of the large items that we see today now we've got elevator remods and we do out all these things that are multiple sometimes that we need to be able to calculate and plan for really about the plan and if the plan is wrong as the board responsible they'd be soon person well I think I think the question really becomes is were they doing their judiciary duty did they make a valid attempt that's really more of a question yeah I think yeah they expand upon that is that the statute gives them immunity provided it was done in good faith right so if they really done some work on that they've made a mistake or they forgot something they're probably not going to be soon person I had a case I was in this case as an expert where the board said you know we have to replace the air condition our reserves are in great shape we just the air conditioning system doesn't exist we don't have a question become if they did that which I did not let them do that right if they did that and all of a sudden there's an assessment would they have action under the statute they couldn't be soon personally if they willfully and intentionally excluded a component that they knew was there I would have to think that you know they're gonna hold some responsibility for that I think that they would yeah that's not what happened but I was involved early in this case and in trying to correct them prior reserve study issue and the issue was they were like well we were in great shape we got lots of money if we don't have to take care of the air conditioning well what if you do have to take care of the air conditioning well you're gonna have to take care eventually by the way it's not working now so I don't know how you say it's gonna have a long life you know and it's funny because I was recently in another case and they had me in my deposition they were saying well why do you think this reserve study is an example I gave with one but many examples was that the building was 40 years old when they did a condo so the components were already 40 years old they had wood fire door and their old reserve study not mine well we're gonna replace one fire door every five years there's 52 fire doors that means it's gonna take 260 more years or total of 300 years to replace all the fire doors now is that something you can say a good faith yeah I think they might the life expectancy on a door was not gonna be 160 or 300 years no it's not so I think you have to say the board look when you get these reserves that you have a degree of immunity but you have to put some good faith effort into that modern thinking would tell you if you have something like wastewater pipes that has this unknown useful life and there's so many factors and whether the pipes are exposed or buried within the concrete is there's so many factors that affect useful life that at least as the statute and the administrative rule says put it in the reserve study and even if you put a footnote saying we don't know the remaining life of this that we're funding it at $50,000 a year until more data comes in so it can be more appropriately do something versus and that doesn't exist in the scheme of all this so what's your advice to boards so first and foremost make sure it's done make sure it's done timely properly I think the time you put into your budget it will pay for itself you got it like you just said a few minutes ago it's all about making sure everything's there because those are the knowns and what we can't do sometimes is budget for the unknowns you know if I had one of the statutes says you have to hire a professional to the diverse to the reserve study and the board do it so I'll be very transparent here and say I'm not positive but I would have an expectation that you should have some type of professional training be able to conduct something that's so important that's interesting because the statute itself does not specifically require the board to hire a third-party professional although it's recommended for all the reasons you just cited because you have to understand a condo world you have two unit condos and thousands of condos a board of a ten unit condo with maybe it's a single-family homes have been CPR'd all they have is street lights in a road it's not that complex that they say have to hire a professional the statute the statute typically is a broad brush it doesn't carve out the versus thousand-unit project although there are issues in the statute where they talk about it's less than 20 units but the reality of it's nothing the statute requires you to but the question is how do you do a good job planning if you don't have a reserve you with the best part of hiring a professional to reserve study is I would say if you if it's wrong it's their fault that's right you've transferred the liability even though that professional is not liable to the still a budgeting tool it's not science you don't know exactly how long it's gonna last but you know if you get a good professional and they work with you while you're doing your operating budget you can put together a very high quality product that gives you a reasonable chance of having money when that when the money is due and I would tell you I've been doing this a long time it's not perfect under any assessment but what makes it more perfect most of them is a board will simply put time energy with their management company and other hired professionals to think about every component every issue and try to put some basis in a reserve study and then in that reserve study the most important word I teach my disclosure with some sentence in what your assumptions were right oh you have that base I was actually in another lawsuit recently I guess what went on where the reserve study was done and they projected $50,000 for the falling repair and they had bids of 650,000 that makes sense to ignore the bids from no anyway we're down to one minute in the show I want to tell you it's always great to have David on my show I always do a hangout with you thank you more fun to drink wine with you than to sit here in this beautiful home here and talk about business either way we're gonna have another great show next week you've probably met my other co-host Cheryl Franklin and Jane Sugimura I will not be here next week I'll be going off to California as a guest speaker at a major owner conference of management about an exciting topic I hope it's exciting I better figure out what I'm going to talk about anyway well thank you for watching condo insider we hope you've learned something about budget reserves and and we're gonna plan accordingly if you're a board member and if you're an owner understand why maintenance fees occasionally go up so thank you for watching condo insider