 Welcome to condo insider and maybe a belated happy new year to all of you right now the industry is getting very busily ready for the legislature which is going to open here shortly and as usual we probably expect another 30 to 50 bills to be introduced to affect condo living. If you don't understand how the legislature works, it's a biennial legislature. So the bills that were introduced in 2021 that did not get a hearing. Maybe nothing happened, but those bills are considered all still active today. Doesn't really worry us because rarely do we ever see those bills come back to life. And many of them were kind of duplicative of bills that did get a hearing so the subject matter was very similar so. But we have to be prepared and we have a list of the 50 or so bills that didn't get a hearing and we'll expect another 50 bills on some new topic or redundant topic we've dealt with for years and. Well I guess the wine consumption and beer consumption America will double or triple during the next two or three months, and rightfully so I may add. Well anyway it's a new year and by now you should have adopted if you're a calendar year basis condo, you should have adopted an annual budget for 2022. It would be helpful to go through what the requirements are, and you can ask yourself whether your association budget passes or fails a test on how the budget was prepared and how that includes reserve study. And what the basic requirements are under the condo statute. Now I tell you I've been doing this for years, and I have a very bad view about the subject because very few condos and the state of Hawaii. But forth the proper disclosures, they may give the owners of budget and may have income expenses etc reserve contributions. I have a statute when all the requirements are for the budget to be proper. I find most associations don't pass this test, and it'd be so simple to have a one page summary that says, here's the answers to these questions and comply with the statute. I'm not sure how scared that makes me because I'm not sure what the results would be. If someone tried to push that claims. Sorry, the budgets there they were right to set the main disease and, but the reality of it is the truth be told. I typically comply with all the requirements of the statute so we're going to go through that just briefly today and give you kind of a overview and then you can ask yourself, did your association passed the test. Let's begin first with the general concept of preparing a budget. The question I asked is, are you an up bottom up or bottom down kind of a budget, but that I mean as follows. You say my goal is not to raise maintenance fees so I'm going to plug the numbers, so that I don't have to raise maintenance fees or if I do they're very nominal, or you say here's my realistic look at the expenses. Okay, so raw sir, here's what we're really going to deal with. And that's what the main is fees are. I see too often that association boards think it's their duty not to raise maintenance fees, and they do things to create lower operating costs. The number one thing they probably do is push the reserve contributions down to make the numbers work and fudge the reserve study to try to make this all balanced which is kind of like the old fram oil filter which is a commercial, pay me now or pay me later. These types of things are only going to hurt the association, and it'll hurt them bigger and more effective in the short run when these real expenses come do. It makes no sense to say these are operating expenses, knowing they're going to be higher, knowing you won't have the money to put in reserves, and then someday down the road you don't have enough money reserves so you have to do a special assessment and or alone. I would caution everybody to tell you that with that collapse of that condominium in Florida, there's a great deal of legislative pressure, including Hawaii on tightening up the requirements on the reserve study and putting potentially punitive measures and if you don't follow certain basic rules on the reserve study, it's kind of been lightly enforced. There's been lawsuits on this matter but I'm expecting there to be some onerous bills out there, trying to prevent that from happening under the concept that owners, whether they live there, should pay their share of the capital costs or the depreciation as we say for the roof and things like that. So let's go through the basic questions on this show. It's a 30 minute show about, and we're going to talk in the first part of the show about the operating costs, and then the second part of the show about reserve contributions. Let's give you the test. The first test is, first question is, what are the requirements under the statute to do a budget. And the first thing you have to do is you have to estimate an income or revenue or regular assessments. And we think that that's maintenance fees, well it is maintenance fees, but the test statute refers to the income you charge in a monthly basis to quote maintenance fee unquote, as a regular assessment, a special assessment would be to deal with some like a roof for some other economic problem that your association has as an effect, but the correct terminology is called regular assessments with regard to the income you receive. And one question is, what do you have to put in the budget to say, and what do you have to disclose to make it a valid budget, according to 514 b. Okay, the first thing is you must estimate revenue and expenses. Revenue is going to be regular assessments maybe sub metering of electricity. Maybe you have some incidental income from vending machines or parking income or things along that line that you can make as revenue. You might even have a special assessment over a period of years that you're counting on to help pay the load or just to pay the cost of what you're planning to special assess for. So the first thing is you have to estimate revenue expenses, and probably every budget does that. You probably all get a for that particular portion of budget. The next thing is the budget needs to disclose. So it's prepared on a cash or a cool basis of accounting. I find very few budgets would be very easy to add a little footnote the bottom prepared using your cool method of accounting, prepared using the cash method of accounting. Probably most people prepare their budget whether they're doing their books this way but on a cool basis they say well, insurance is $12,000 a year at $1000 a month over 12 months. And that's basically a cool accounting where a cash accounting would say, well, yeah, within just 12,000 a year we pay the premium quarterly so we're going to be charging $3,000 a quarter on in one month specifically with respect to that but at the end of the day the budget is annual basis. Although a lot of management companies give you a monthly projection. It's, it's, it's basically a requirement to disclose with cash or cool accounting. A good example would be the auditor fee how many times you do the auditor fee, usually once a year for that the tax returns. You're going to have more money going out that month and if the auditor fees $2,400 that's $200 a month. If that's what you're putting in your budget that you're doing on a cool basis. If you're saying it's 2400 we pay it in November, then it's cash basis. But the real bottom line is the statute says you have to disclose it so if you don't have a sentence in there somewhere saying, this is prepared using their cash or cool method of accounting. And I would say probably 90% of you get enough because you don't do that. And I don't understand why because it's such a simple thing to put a footnote at the bottom of how you prepare it. The other statutory requirements and your annual budget. I missed nowhere I'm going to deal with more of this after the break is is the reserve contributions, the reserve contributions you aren't spending you're saving the money for something in the future. I've often said that when you look at, you only had one component of a million dollars every 10 years, you had every year's assess 100,000 to all the owners, and then you would get a million you spend a million to fix the reserve, and then you'd be back to zero and just start all over again. But what the law says is you must disclose in your annual budget, the total amount of money you have in the reserve account. It seems to me very simple to say the total estimated reserve because you're doing this kind of in September October. You would be projecting what your balance is going to be January one so it seems easy enough to me to say the projected beginning balance for January one 2022 and our reserve account is $1 million. And be done with it. And, but I give probably most of you an F in the sense you may disclose it to the extent you provided a reserve study with your budget but it just seems so easy to me for you to have a one page disclosure on your budget. And it deals with the statutory requirements to say the estimated reserve beginning balance as of January one 2022 is $1 million. We've taken into consideration expenses, but for the balance of the year and income received for reserve and our projected balance on January one is 2022. If you don't think that's important, but let me tell you that ideal all year long as an expert witness on lawsuits, where the attorneys to get a hold of this stuff. They basically say well that's what the law says we're well where is it. Well it's on this page in the reserve study, but it doesn't seem a lot easier just have a one page disclosure for the budget. Anyway, the next thing is, you have to have an estimate of reserves to maintain the property in that Hawaii law and its administrative rules they call that the estimated replacement reserves. That always angered me because of the fact when you look at national standards and the language we use from CAI and other national reserve study organizations, they caught reserve contributions. And they thought in Hawaii, estimated replacement reserves. I don't know where that came from in 1995 when they wrote this thing. I have often debated and argued that you should have a situation where in the national standard, we should amend administrative rules and they can say estimate replacement was also known as reserve contributions, so people don't get confused because when they get the reserve study they get confused. So anyway, there has to be an explanation on how the reserve study was calculated. They have to have what the reserve study says the contribution should be. There's not leftover cash flow that here's all the operating expenses and if they're higher than they should whatever's left over we're going to put into reserve study, you have to do a reserve study that says to maintain the property this is the contribution amount. And then you have to find this goes that you do your funding plan under the reserve study using a cash basis or cash flow or a percent funded method of analysis. It comes to me as a reserve person, you can vary or the budget person or association, you can very easily write a disclosure that addresses all of these issues up front because there's some penalties. If you don't do it right. And on that note, because that's kind of a brief summary of the operating side, we're going to take a one minute break. I'm going to go get a beer or a glass of wine because this is probably going whoa what do I get myself into. Anyway, we'll be right back in one minute. Hi I'm rusty Kamori host of beyond the lines on think tech Hawaii. I was the head coach of the Punahou boys varsity tennis team for 22 years, and we were fortunate to win 22 consecutive state championships. So is based on my two books beyond the lines and beyond the game, which is about leadership success character and creating a superior culture of excellence. Please tune in and watch my show every Monday at 11am on think tech Hawaii and on YouTube. Aloha. I'm Prince Dykes, the host of the Prince of Investment, the financial literacy and business show that comes to you live every other Thursday at 4pm Hawaii time. Make sure you subscribe to us on YouTube and wherever you can catch podcasts. I'll see you there. I'm back. Hopefully you got a quick break. And we're going to talk more about the budget but just to review the basic disclosure under the statute. You have to provide an estimate of revenue expenses, whether the budget was prepared on the cash or cool basis accounting, the total amount of money in your reserve account, the estimated reserves reserve contributions required pursuant to reserve study to maintain the property. In the description of how you calculated that contribution, and whether that was done on a percent funded or cash flow funding method, as far as the funding plan and how you came about those conclusions. I want to tell you that there are sorts of penalties within the administrative rules that if in fact you use statistics to manipulate the results every year. There's a popularized Benjamin, the Israeli statement that there's lies, damn lies and statistics. And the law has putative measures in there for you or against you if you use the different funding techniques off and on different ways in an effort to avoid the requirements of a reserve study. And so there's all sorts of kind of penalties that exist out there, but let's talk about the obligation of the reserve study, which is a part of the annual budget. The question I always get and people get confused is that when you look at CAI, Community Association Institute, they actually define reserve studies into three categories, level one, level two and level three. What is the most onerous in the sense that you've got to call contractors you've got to get numbers from people on occasion you may have an architect or an engineer look at the spalling. We really do a lot more retail detail, as far as how you came up with your numbers. The industry recommends that about every five years. The lowest level is a level three. And a level three is, you're basically taking your prior reserve study and saying, well, we didn't do the roof this year we're going to do it next year, or we did do the roof and we projected 200,000 cost 230,000. We're basically updating the data within the, within the reserve study without a site visit. The level one requires a site visit and independent analysis or, or numbers from a vendor or architect or somebody. Level two is kind of in between where you've done a site visit you've updated the numbers, but you haven't gone to the effort of contacting the vendors of the architect. Level one, as I said is recommended every five years or so. Level three, which is recommended or required every single year at a minimum, because the reserve study the law says the budget shall include a reserve study. If you just use a two or three year old reserve study, you've got to update that every year based on what you would believe current information, because you're postponing or doing and things are costing more or less and it needs to be updated and doing those things. That's a really good work product. Level two is they say every two to three years. Some people don't know there's another study called a level four, which is for developers for new projects that are under construction or admin bill yet. We have some bizarre laws here in Hawaii that developers don't have to do a reserve study. When they estimate the reserve contributions and do their initial public report that I am confident you'll see in the legislature this year. They also try to force them to do a level four reserve study. The rationale behind that is all these new projects. All these owners are complaining to the affordable housing owners. At the end of the day, as soon as the board takes over, he's made the fees are going up 50 60 70%. I've seen developer public reports that shows zero for reserve contributions and estimate the mainest fees under the concept that the association doesn't have to do a reserve until the first full fiscal year following the formation of the board. That's not really what the law says we look at 514b. I forget the numbers either nine or 38 but they have to do an accurate estimate of mainest fees. And it's not the current year it's it's kind of what you can expect to pay it's kind of a common thing you'd want people who are buying to know what they're really getting into. I hate to think of the, I've seen it with some cases I'm involved in where owners all of a sudden walked in they got a 70% increase in mainest fees, and it's an affordable housing project of new first time buyers. Does that seem fair that they didn't do some work to figure out what the real numbers are and, and so anyway, but back to the reserves and the requirements in the wall. You have to do a reserve study every year, it has to be a part of the budget, and you can pick a level one two or three or you can do it yourself as a board, but you should put some time in it because you need to define all of the components over. Are you ready $1,000 in value. So if it's a common element over $1,000 in value it has to be included in the reserve study. What most people do is the law provides for those components less than 10,000, you can bundle them together. So you might see a whole bunch of fire doors that $1,000 of fire door bundled as as all components with a total of less than $10,000. I typically put a one item in of X dollars a year every year for those components without going through the arduous task of defining ceiling fans and light fixtures and things like that I basically set up a single line item. For all of those items with a disclosure so people know what they're getting. So, other thing that's commonly misunderstood, there's another lawsuit I'm aware of right now that people say that we have always components to roof the painting, the parking lot. You have to have a separate reserve account for each one. No, you don't. There certainly have to have a separate account. It's not a bank account. Think of it like a chart of account or a puka that you're going to say okay I'm counting. I'm accounting for the money coming in, some of that's going to go to the roof. You know we the law is very clear and the DCCA has published information on that that you don't need a separate bank account, but you do need to have a separate accounting for every component within that reserve study so each year when you do your reserve and you have a million dollars in the bank, you should be able to say 150,000 for the roof, 100,000 for the parking lot, or whatever it may be so you need to have an accounting of that, and a definition. Those of you who use reserve specialist, their software does all that for you so you don't really have to put too much time in that. But then we said you know that we have to define as a matter of law, whether you did cash flow funding or percent funding. I do a whole show on that subject, but the reality of it is just like cash in a cool accounting. There's two methods to do reserve studies is the component method and the pooling method, the component method measures the funding status as a percentage. The pooling method measures it as a cash flow of 20 years in Hawaii. Now the national standards by the way is 30 years. And I think you'll see legislation this year to make the requirements for the pooling method to be 30 years instead of 20 because it's helpful to actually plan and have more time to collect and being able to steal or hide things because it's a newer project just intentionally or unintentionally, the press, the amount of money you need for reserves. And then all of a sudden, but if it's a 30 year component now it's a 20 year component left. All of a sudden you have a big push to have to raise the reserve contributions significantly to make up for the 10 years you didn't fund so, but under the statute you have to do reserve study annually. And it has to meet certain criteria where you've defined the components. They're useful life. That's how much life they have when they're brand new. They're remaining life. That's how much you think they have left before you have to replace it. You have to estimate a replacement costs in today's standards 2022. And you have to then ask yourself whether you have either method criteria for percent funded and or cash flow funding. I would tell you that in America and Hawaii 99.9% of all condos use the cash flow funding method under the pooling method of doing a reserve study, because it's been proven over and over again that the the program of using reserve funding brings very erratic results as far as having to change your contribution amounts over time, typically we have larger associations with so many components that these variances have impact or, or swing on all of that. And that's the requirement. And you have to ask yourself now did my budget meet those requirements. Do I have a reserve study that's been updated for 2022. Those would have stung on a percent funded or cash flow method of accounting the funding plan. Have I defined all the requirements of all the components or liars and planning. You know the statute administrative rules also requires you when you project that 20 years you got to consider inflation and interest earnings on your money so a little more complicated but I would tell you clearly. You can do it yourself or smaller associations without much hassle. And so long as you've made a good faith effort to statute gives you a safe haven that you can't be sued and actually if you could be sued, you did you intentionally breached the duty. It really limits the board's liability to forcing the association to do a proper reserve study, and that cost of the owner forcing you to do a property reserve study is refundable to the owner and could be assessed by an arbitrator judge against the directors I have not seen that happen. I have so actually it's not happened in one case where a association board president did some not so good things that he ended up being put in a situation where you had to make a contribution to the owner for the for the cost. So in that note I'm kind of going to summarize now that if you've done your budget reserve study you should go back and look at it because the magic word about reserve reserve study I shouldn't say the budget which includes the reserve reserve study is it can be amended at any time. It's very easy to take a budget you've approved and amend it, because you have new information, or because you want to make sure the disclosures are properly known everybody. And so I would caution you and advise you to go back and look at it. If you're a law review with your managing agent, and try to do the best you can to get proper disclosures to your owners, and whatever you do use real numbers, so that you're not just suppressing the maintenance fees, because you just don't want to realize that, as reported today I think inflation is 7%, and I'm not sure associations don't get the same inflationary pressure as everybody else. So on that note, thank you for watching condo insider. I'll be back in three weeks to talk about fraud. And I have a great guest so it was a great CPA on all the different types of fraud that have occurred in condos, and you'll find that quite interesting on ways and means to help you protect yourself against that. And thank you for dialing into condo insider and we're here every Thursday at 3pm. Aloha.