 Aloha, and welcome again to Kondo Insider, Hawaii's show about association living. We've said many times some number between 30 and 40 percent of our population lives in an association, whether it's a condominium or a homeowner association or a co-op. We're all governed by some very strict laws here in Hawaii, and this show is all about teaching board members and owners about the various issues before our industry and trying to give you some helpful advice. We began a very ambitious project three or four shows ago to review Hawaii condominium law HRS 514B, and we used as our resource, the real estate commission came out with a course that realtors were required to take this year for continued education with regard to 514B, and we're kind of using that as our template for this show, and this is Scott's fourth time on the show, I think, in a row, in a row, and you've been on the show a couple of other times previously. We've had fun before, I'm not sure about last week, but yeah, we've had fun before. Well, I appreciate you driving me to drink, it's one of the nicest things you've ever done to me. I didn't have to drive you far though. That's true. But anyway, Scott's director of training for association, I'm not going to go through his background again because we have a very ambitious schedule to get through this class and this 514B, and I'm not going to summarize what we've done before, but I encourage you to go on YouTube and think Tecawai, and look at the prior shows where we talked about government structure, government process, and now we're going to talk about fiscal matters, but before we do that, like we've done every show so far, I've got to go back and review the last thing we didn't get done in the last show, and we're talking about document production. We talked about the law and all the things that you have to do in document production, but we didn't get down to the fact, do owners get document production for free? Well, it depends. Normally no, there is the allowance to charge minimal fees to gather the documents, put them together, copy charge. There are some instances where some of the documents might be free because the association may have it up on a website. They may not have all the documents, but they may have common ones up on the website. So generally speaking, an owner will pay up to, in one instance, up to a dollar a page for copy fees. I don't think most of the management companies charge a dollar per page, but it was interesting where they came up with that amount at the legislature. Where did they come up with that amount? Well, there's actually a law on the books that says if I go into any state office and request a copy of something, they cannot charge me more than a dollar per page. And so they sort of took that same idea out of that statute and moved it over into the condo statute so that there was at least a cap on what you could charge for copy fees. Yeah, I would caution owners about that because the law is patently clear that they want owners to have documents, specifically ones that aren't going to harm the association. There might be some legal opinions or executive session material. They're not entitled to enter the statute. But they want to make it affordable so they have this one dollar per limit which I think most management companies don't charge for. However, it says, say, another administrative fee. Exactly. And when I see owners get into trouble, they get who-who, get really angry about something. And they write the management company, they say, and they take the exact list of the document. I want all the invoices. I want all of the letters. I want all of the diverting documents, all the financial statements, all the check registers for the last 10 years. And they're angry. They don't think through it. They just want everything so they can sift through it. And not realizing there may be 20 or 30 boxes of material in a warehouse somewhere. That's right. They're going to have to pay to have it picked up, brought down there. And then if they wanted a copy of everyone of those things, it could be 20,000 pages if they said 10 years. And I've seen 10 years. Oh, I have as well. And the other thing to consider in there is I don't think, I think you said it correctly, where they're not thinking it through. If you're asking for all these documents for the last 10 years, maybe only in the last two or three years have they been digitized. But going back 10 years, those documents are not likely to be digitized. That means putting them on a truck from the warehouse, bringing them over to the office, start making the copies. And remember that dollar for pages for copy, not administrative fees to do all this. Because here's the other point. You call and you want all those documents. You bring them down to the management company's office. Maybe you have litigation going at the management company. They're not going to give you access to those documents for you to go through before you copy them. And unless they have an administrative person sitting there to make sure you don't add a document that didn't exist before or take a document that's harmful to your case. So when you go in and you take huge amounts of documents and you want to look through them, they may decide to put an administrative person there to protect the association that someone can't take something they shouldn't take and or add something that wasn't there in the beginning. So it's not a cheap process. And the best thing I can advise owners to do is think it through what you're really trying to get information on. And narrow it down to something reasonable. Even to the extent, take some initial information, which may be minimal, before you even ask for additional information, try to work through the process, then just get who-who and say, I want everything for the last two years. That's an extremely good idea. Also, we have to realize that your typical owner normally isn't asking for all those things. So they're asking for things like recent financials and stuff like that. But you and I both have experienced the, yeah, we want the 10 years worth of this. And they're also allowed to come down and review them. Right. You can make them available to them at your office or a convenient location, so to speak. And again, that same issue comes up. Somebody may have to be there to watch this entire process to make sure that something isn't taken, that shouldn't be taken, and things like that. Well, we actually, one time, caught an owner trying to take a document because he was involved in litigation. And the administrative person caught him trying to, because he had his papers and notes and he's moving papers around, but he tried to take a document with adverse to his position and kind of hide it with his papers and we caught him at that. And so we told him we're going to doubly administrative people now because of this and we put a note in the record because of that. And then the owner pays for that cost. Yeah, but before moving on to the fiscal thing, I'll just say one more thing. It's important that boards give owners access to the documents they're entitled to see. Don't put roadblocks up. Just make them available and remember we have to be cautionary about the quantity and what we do to protect the association in that process. And as the world becomes more digitized, it becomes much easier to provide documents. So anyway, let's move on to fiscal matters. Fiscal matters usually means budget assessments and reserves. And reserves. Your specialty as a matter of fact. That's what I've been told. Or what you've led me to believe. Let's keep it in simple terms for the owner. What is the budget? Well, the budget is just like a household budget where you're budgeting how much to pay for groceries and the electric bill and things like that. That's the same thing a board's got to do every year is budget and plan what the expenses are going to be for the next fiscal year or calendar year depending on how they're set up. And based on that, they will know what to collect in monthly maintenance fees or assessments. For the coming year. That doesn't work in my home. That doesn't work in mine either. My wife says you get a dollar a week and you can do whatever you want with it. And the rest of it, I'll take care of everything else. She actually gives you a dollar. Boy, she's more generous than mine. Yes. But anyway, the condo side, the condo world, the budget is basically an estimate of your expenses. And at the same time, you're going to have to balance that with income, which is assessments. That's kind of what a budget is. It's a forecast. And my experience on budgeting with associations, nobody wants to raise, I hate the word maintenance fees, because you know it's more than maintenance because you have insurance, you have all sorts of other costs. It's an operating fee. If you're too unrealistic about it, you're not able to collect enough money from the owners to pay your bills or fund the reserve, which is another statutory issue that you have to do. But in simple terms, budget is an estimate of expenses and income. And an assessment is what you charge the owners. And I think you hit the nail on the head. It is an estimate. Can a board be wrong in their estimate? And we have emergency situations that pop up that we're not planned for even in real life. And so boards can make mistakes and not be held liable for those mistakes because they were using their good business decision at the time. But you and I both know and we've seen it happen. Well, let's see what we can do to reduce the maintenance fees. And sometimes you end up cutting so tight that you create more problems than you can fix. Well, for clarity, you know, we always talk about maintenance fees, and that's the word we all use. But the reality is, in a statute, they're called regular assessments. Yes, they are. And that's where the term special assessment comes when there's an additional charge during the year, either on a one-time or monthly basis, because of typically some unknown condition that's come up, and that's why it's a special assessment. But in a statute, when owners and board members talk about maintenance fees, they're really talking about regular assessments with respect to what it is, you know, with respect to that. And the problem I see is that, and typically this was true in, I want to say 2008, but what happens is, boards got so conservative with budgeting that they didn't see the sudden rise in utility costs. Yes. And so all of a sudden, they budgeted, let's say, 10,000 a month for utilities, and they were running 14 or 15,000 a month in utilities. And so what happens? They're short, 4,000 or 5,000 a month, right? Yes. So what happens? The reserve fund doesn't get funded, and that's the problem. Well, and we see that from time to time. Say a board in January of this year, based on previous year's estimates, have determined the electricity is going to, say, run $10,000 a month. Tomorrow, a barrel of oil could go over $100, and that does affect your common area electric bill. And the next thing you know, you're running short every month. So you can have a problem if you are too conservative and not taking certain things into effect. Well, I think realistically, in the last couple of years anyway, because the price of oil has gone down, and utilities are at a much lower level than normal, that associations have been able to minimize increases or avoid increases because they've had a savings in utilities because of the price of oil. And I would caution everybody out there, that's going to change someday. It is. Everything goes up and down, and there's going to be eventually pressure again on associations and their budget because of rising utility costs at some point in the future down the road. Well, I've recently had this discussion in regards to whether or not maintenance fees need to be raised, and a very good CPA told me one time that a good association should be raising their maintenance fees about maybe three to four percent a year just to keep up with the cost of goods. Because you do run into boards at cut, cut, cut, and then four or five years down the road, now they've got to pay the piper, and so instead of having, let's say, a three percent increase every year, they now have to do a 15 or 20 percent increase. So the idea behind that is, do you pull the Band-Aid off slowly or do you just rip it off and do it all at one time? Yeah, because I hate to say, show me the money. It's all about the money, you know. I was talking to a board that had problems because they had a $10 million cast iron pipe problem. And so it's like, well, someone else is to blame, but me, we have to fix the pipes, but I want someone else to have to pay for it. Well, government's not going to pay for it. Let's hold the board of directors responsible. The statute gives them immunity in the sense that they do the best they could. And even if they don't do the best they could, they're really limited to the cost of forcing them to do a correct reserve study. They're not responsible for the $10 million that they're short in the budget. And it's the owner's property, so they have to find a way to pay for it. There's loans and other ways to deal with it, but more times than not, reserves don't get funded because they don't put enough energy in a reserve study. And two, they have increases in operating costs or surprises, and they don't fund their reserves. And so then they're not even meeting the reserve study they originally anticipated. And it's probably no different than our state government. You look at the hundreds of millions of billions we're short in funding University of Hawaii improvements and all the rest of it. It's all about the money. Yeah, it always is. And that's what you've got to deal with. So we talk about the basic definitions. Let's just review briefly the mandatory disclosures that must be included in the budget. So when the board puts out a budget, there are mandatory disclosure that should be in writing as a part of that budget when it's mailed to the owners. Because they have to provide it to the owners every year. They do. And what are those mandatory disclosures? You threw me. You do this, do you wait until to the show? You know what we're going to do, because I need time to think about it, even though I wrote them all down on a piece of paper for you, and look at them and not miss any of them. Because we're on the verge of a break, we're going to take a one minute break and you can read the 472 items and study how to do them in 90 seconds. Thanks for watching Think Tech Hawaii. And look forward to seeing you at Education Matters on Tuesday with me, Carol Manly. Aloha. My name is Justine Espiritu. This is my co-host, Matthew Johnson. Every Thursday at 4 p.m. on Think Tech. We do a lot of research at 4 p.m. on Think Tech. We host the Hawaii Food and Farmers series. We like to bring in folks from the whole realm of the local food supply and agriculture, anyone working on these issues, any organization or individual that has plans or projects. What kind of people have we had on? We've had farmers. We've had chefs. We've had people from government, institutions, everyone who's working to help make Hawaii's local food system that much better. So you can see us every Thursday and join the conversation on Twitter and we hope to see you there. Welcome back to Condo Insider. We're sitting with my buddy Scott Shirley talking about 514B in fiscal matters and I was giving him a lot of heat that we want to talk about what the statute says. You must have disclosure on your budget. Before you answer that question I would say 90% of the condos I see the budget fair to include these statutory disclosures. There ought to be a cover page that answers these basic issues. Yes, there should. And they should be clearly defined for their own protection and even though some of them are within the budget itself some of them are not. So back to my original question that I gave you a hint that warned me when you're going to give me a test. But there should be an estimate of revenue and expenses. Of course, where are you going to start from? Of course, what are you going to get in revenue and what are the expenses going to be? Is it done on a cash or on a cruel basis? The total for that particular year that's going to go into the reserve account an estimate of reserves to maintain the property and explanation of how reserves were calculated reserve contributions and whether it's percent funded or cash flow is used when creating that reserve. So let me just add a little bit to that. It's pretty hard for you to say something about me wanting to interrupt and add something. Obviously, estimate of revenue and expenses is pretty common. Here's how much we're going to spend on these various components and we're going to get the money from you, the owner, through assessments. Cash or cruel basis. There's actually several fundamental methods of accounting. Cash and accrual are very different. Only accrual is generally accepted accounting principles. For some small associations, it's expensive to do accrual. You wouldn't do it on accrual. But if you want to know the difference between that to go back to YouTube, Think Tech of Why, when I interviewed Rodney Harano, great CPA who talked about the difference between cash and cruel accounting. Total amount in the reserve account. You need to say at the end of that fiscal year prior to this budget, we had $50,000 in the reserve account. Then you need to say we've done a reserve study and we're going to need X dollars over a certain period of time to maintain the project. Usually in the millions if it's a big project in 20 years. Then you need to determine how and tell them exactly how you calculated this contribution amount. Because the statute requires to say based on a reserve study we've determined we need to collect from you this amount of money each month for the year to meet these future obligations. The way that's calculated is not up for someone else to decide. There's national standards in the administrative rules of Hawaii. Then you need to say what methods you choose to do your reserve study. The percent fund that are cash flow. If you don't understand that, go back to Think Tech of Why and I did Kim Becker and Polly Wong. We talked about different types of reserve funding and I think I had Jonathan Billings on one time. Let me throw one out at you then on that. What do you think is the most common type of reserve funding? Is it percent or cash flow? There's no question in the United States of America and Hawaii that 98% of all condominiums use the cash flow method of doing reserve studies. As much as you may not believe it because it's back to different methods of calculation if you were to purely calculate on a percent fund that we have to calculate each component separately, not on a pool like cash flow. 50% is actually more money than doing full funding with cash flow. It's a statistical anomaly in quoting the great Mark Twain who stole it from Benjamin the Israeli. There's lies, damn lies and statistics. And statistics. I would just encourage boards to know you need to have these disclosures in the budget. Make sure you have a sentence that answers these basic questions. We did this on the cash flow method. Our budget is based on the accrual method of accounting. We have determined we need this amount of money over the next period as of December 31. We had this amount of money in the bank. Just because it's on a report, having a summary sheet answering these basic obligations will only protect the board from any protection. You will see on a lot of when owners want to resale and things like that. A lot of the documents that the realtors use are questions like how is the budget prepared and is the reserve study done on cash flow or percent funded. They want the buyers to know already. When they're thinking about buying in that complex how certain things are done. Well, this year we're going to review some of this in more detail. Especially once the legislature is finished and some of the laws have changed a little bit. But it's topics that we just need to say to the owners these disclosures must exist on the budget you send to the owners. The budget to the owners people often think it has to be done fiscal year December 31 January 1. So you have to have the budget out in November or December. Technically that's not true. You have the ability to adopt an interim budget amend your budget later during the year. But the actual budget has to be out 30 days before your annual meeting. So you have a chance to say look this year we haven't got the final bids in on this. So we're going to adopt last year's budget for the first three months of this year until we have better data telling your owners you're taking it more seriously before your raised fees are adjusting. But you don't really have to have the budget out by year end. You have to have it out 30 days before the annual meeting. The statute makes it clear too that if your budget is going to cause an increase to the monthly assessment you need to notify the owners at least 30 days advance. That's correct. Absolutely. So a major component of the budget is the reserves. So what is the reserve study? Well, I particularly think the reserve study law is terrific because I came from a generation early on in real estate where you bought a condo and a couple years later the board sends you a letter saying it's time to replace the roof. Can you send us your portion of the roof is $20,000. Can we have the check next week? And unfortunately that was the common way that a lot of condominiums operated. You just wait until something broke and then assess the owners. Now they're projecting each component of the building the roof, the parking lot and all the small other items in there as well what life is left on it how much is it going to cost later on to fix or replace and then start saving for it. Wouldn't that be great if we did that on our own homes? No one does. But the reality of this is that the argument going back when the reserve law came in place was that developers intentionally kept the maintenance fees low to sell their units and there wasn't a reserve study. So now there has to be a reserve study. There has to be a part of the budget. However if you look at the current law the association doesn't have to do a reserve study until the first year following the developer turning it over to the board. Which means that the numbers in those estimated maintenance fee exhibits in a public report really are not based on a reserve study. It's based on industry estimates or wild guesses. And so another industry the real estate commission recently has looked at amending the rules with regard to developers and looking for ways that maybe require more from the developer to have a reserve contribution. And I think that particular issue that you're talking about comes up as well when you're taking let's say a 20 year old building apartment building and converting it into a condominium. You have other issues there but it's still viewed as a new condominium. As a condominium it's new but it was still a 20 year old apartment. So there's some fine tuning that needs to be done there as well. So let me just summarize the reserve study of the Culliana. That number one you have to kind of determine what your life expectancy of those components. So you may look at our elevator and there's tables and manuals and say that has a useful life of 35 years. And then you say well my building is 20 years old so I only have 15 more years left. That's the remaining life. So you know the life expectancy is 35 years remaining life is 15 years. And then you have to look at the estimated cost based on 2017 since it's 2017. Then apply inflation to it over the life of your plan which is usually 20 years under Hawaii law. And then that comes back to calculate a contribution that each owner has to make to the reserve study as a part of the budget. And that includes some earnings of the investments of that money although today investments are negligible to say the least. That being said the components within a reserve study you actually by law have to identify every item over $1,000. But you can assemble those into a component like pool equipment. And say that's $10,000 that includes the filter that includes the pump that includes things. So you do have the ability to take smaller items and consolidate them into a component and put them into your account. Then there's 50% funding versus full funding which is full funding is not 100% funding. The two differences between the cash flow or a lot of detailed technical terminology which I'll say again go back to my prior videos and we're going to do one in the future too. But if you think about it if you have a component that comes due under the statute of money that all of a sudden by using money you're aligned for something else and so your reserve study now becomes less than 50% funded. In that theory the law says you have to assess and make up the difference that year. You can't just phase it in the law says if you borrow from the reserves to pay for this when you meant it for that if you're using the component method which is the reserve study it becomes a difference. There's a lot of risk and liability if they don't think it through and unfortunately Speaking of that since you are the expert and you've done numerous reserve studies I think there's a misconception out there that once the reserve study is done that's all we need to do for a while. Should that reserve study be revisited from time to time and re-looked at and some of the components may actually be in a requirement of the part of the budget so every year they should take that reserve study and if they did the painting that costs $150 instead of $100,000 they should be adjusting in that study or they're looking at the elevator and saying we have ten more years but our technician is telling us it's only the last five more years you should be a part of that annual budget every year reviewing that reserve study and making adjustments because you may not have made all the contributions you require so you've got to every year do that. Now if the customer does make a mistake heaven forbid but they do, we all do are they personally available for the mistake? Not if they've acted in good faith they're not trying to hide something and I would say for the most part they do hire a professional to do this form because again they're volunteers. This is not their area of expertise to know how long the elevator is going to last or how long the roof is going to last so a lot of times they would do to ask them about preparing a reserve study. Well we didn't get this all done as I thought we wouldn't we're at the end of this portion of the show. I do want to summarize by saying that the reserve study and the budget are very important parts of the whole finance most of the problems in the associations are money directed. I wanted to talk about owners rights and withholding assessments but we're going to do that next week if you're willing to come back I bet you can twist my arm to come back you know you're fired if you don't other than that other than that I want to thank you again for being here and I want to thank our viewers for listening to us talk about budget reserves probably one of the most important parts of an association. We'll be back next week same time with more about condominium HRS 514b aloha