 Aloha, and welcome to another edition of Condo Insider. Our show is about association living in Hawaii. I've said many times before more than 30% of our population lives in some form of common interest realty association. So the purpose of our show is to educate board members and owners alike on their responsibilities and their opportunities to have a really great association. Today we have with us one of the industry experts, a long time leader in the association industry, a good friend of mine, Steve Farago, who is a professional community association manager. That's the highest designation one can learn from community associations institute and a director of association Hawaii. Welcome to the show, Steve. Thank you, Richard. Good to be with you. Take a minute and tell us about you personally first. Well, I've lived about 25 years in Hawaii now and love all the islands and I have a daughter who's 12, a son who's 27 and a wonderful wife and I enjoy working in the condo industry. And how about you professionally? What about your professional background? Well, for about the last 22 years I've worked as a community association manager for several different companies, been very fortunate to work on all the neighbor islands and in many of the major issues in our industry that's happened over these years. And a PCAM professional community association manager, what's it take to get that designation? Professional community association manager has to take about 10 different courses on maintenance and legal issues and budgeting and a great many other topics that are very pertinent to being in the community association industry and in the end you write a case study on a major property in Hawaii that gets sent to your evaluator and hopefully you pass, which I did. And there's certainly some tenure requirements, how many years in the industry as well I think. Yes, you have to have worked at least five years in the industry to get a PCAM. And do you know how many PCAMs are there in Hawaii or can you guess? I would guess about 20, about 20 out of a very large industry. So it's a great honor. Congratulations on being a PCAM. You know, having been in industry a long time, I constantly hear about repairing the building. And all of a sudden they'll have some surprise come up. The most one that's dominating the conversation in the airwaves today is, uh-oh, we have to replace our cast iron pipes for $10 million for a very large association. And they're shocked, they're sticker shock obviously because of the effects that made these fees and the reserve contributions to deal with that. Let me begin by asking you a question. Basically, does the board have an obligation to maintain a repair of the building? Absolutely. I would say that's one of their primary obligations is to preserve and enhance the asset of the property. Part of why I think that it pipes and such things didn't make it into reserve studies is that the window for that is 20 years. And when these buildings were new 40 or 50 years ago, people didn't really consider it. So boards have sort of forgotten about it, but now these buildings are aging. So it is very important that boards budget for this. Yeah, that's a side note on the cast iron pipes. You know, I did some research on this and we had a couple of great guests on our show regarding cast iron pipes. If you look at all the architectural reference manuals, they say that the cast iron pipe will last 100 years or more. So even if you're budgeting those things due in the next 20 years, even these 40 or 50-year-old buildings, those boards wouldn't have known that they were going to have pipe failure as early as it happened. So in some way that the hidden condition or something you shouldn't plan for or you couldn't have planned for it. But how do they plan for these capital items? I know the term called reserve study, you know, how does that all fit into this? Well, a reserve study is required by the Hawaii State Condo Laws 514A or B. And this is something that needs to be done annually where all the major assets of the property need to be evaluated. It needs to be a proper lifespan, remaining life, and dollar value to repair for each of these items. So it's very important that this be prepared and that every item that should be evaluated is in the study. Yeah, one thing I learned is that, you know, if you look at the national standards with regard to reserve studies, they call a budgeting tool, and I emphasize the word tool because you look at a reserve study and you're asked to, first of all, identify all the components. Identify the replacement cost. Project what that cost will be 10, 15, 20 years from now and project what earnings you'll make and what interest you'll make on your savings to... And I always said to people because I'm a reserve specialist was if I could accurately do that as a science, I could be the head of the Federal Reserve. You know, it's really a tool. It's not perfect. And that's why reviewing it every year as a part of the budgeting process is probably really critical because there will be new things on the surface or things that come up that weren't originally thought about or you put in a budget to replace the painting or do the painting for 100,000 and you just did it with 150,000. So that update process is very critical to establish good historical records for the future, from my point of view. True. So I mentioned cast iron pipes. Is that an issue and what other issues have you seen in the industry? Well, I think windows is another issue that we see that come up a lot because a lot of associations aren't even aware of. Who owns the window in the building? Is it the homeowner in the unit? Is it the association? If so, who's going to pay for it? How will it be paid for? If it is a common element or belonging to the whole association, it's similar to the pipes, very expensive. So how are you going to budget for this to be repaired or replaced? Another declaration theoretically defines whose responsibility it is for certain components of the building. And I have seen with windows you have, well, you have the whole window. Then you have some declarations. Well, the frame is the association's responsibility, but the glass is the owner's responsibility. So really, this gets into an interesting aspect of budgeting because it's probably unlikely you can use the old glass in replacing the windows as a whole and how you budget that and include that. And I've always said that you just need to logically think it through, put it in a reserve study and disclose what your rationale was because at the end of the day, even though it's the owner's responsibility in my example to replace the glass, the paint itself, you may be saying, well, that's not feasible. So in fact, we're just going to budget the entire window replacement as a common expense, which is provided for in a law. The board can take high-risk components and make them a common expense. Would you agree with that? Yes, absolutely. Because the other aspect of windows, and we had an association with this problem, was that the declaration provided for the window scheme. In fact, you managed that project. And the fact was that the new building code prevented them from following that window scheme. They had to go and spend, I think, hundreds of thousands or maybe not quite that much, but certainly tens of thousands, if not 100,000, getting an architect to design a new window, then going out and get the written consent of the owners to put the new window type in. Right. And in your case, I think, also, it was the owner's responsibility for the windows, but the board needed to give them the solution. They couldn't get a permit for the old windows, and they needed to say, okay, this is the approved window in the future. So it's a complex subject at the best. So all of a sudden you get the association. Let's go back to Cast Iron Pipes as my example. They need the biggest association at 300 units. They need $10 million to replace the pipes. But you know what? They don't have the money. What do they do? Well, they're between a rock and a hard place. So the basic choices that they have are to special assess, which is some authority, it's an authority that the board of directors has under the bylaws. It's a form of assessment, to specially assess this amount to each owner, or they can get a loan or a combination thereof. Now can they get a loan without owner approval or do they have to do some processing to the owners to agree and buy into this? Oh, it definitely takes owner's approval. It takes over 50% of the owners to approve the board getting a loan. And to special assess, does the board need approval from the owners to special assess? Generally not. The provision in the bylaws usually refers to it being an emergency or an urgent matter. You don't special assess just to raise money. But if you've identified that your windows or pipes need to be replaced, certainly that is an urgent matter. So the board has the authority to make a special assessment. Yeah, I've actually seen examples where insurance companies have given notice to boards where we're not gonna ensure your property or we're gonna have to go in the non-standard market because your windows are so defective they could fall out and kill somebody. And if you're not gonna replace your windows or 40 years old, it's gonna affect your insurance premiums. So certainly boards who allowed that to happen when someone maybe unfortunately died because the window fell out probably creates great liability and increased future premiums down the road. So I'm not sure ignoring this problem is a good idea. Well, I agree with you. Lots of boards when they hear of some major expense requirement for things like windows, pipes, elevators, the tendency is to say, well, we just can't afford it. And they may decide not to put it in the budget at all. The problem with that is that you're creating a situation when it does become an urgent matter. You don't have the money. You don't have anything about it in the plan. And you have a hard time explaining to owners, why haven't you taken any precaution or at least acknowledge that this is an issue? Then you potentially have liability. Yeah, because I think the interesting thing to me, let's go back to it alone as a method. What I've always said to boards is to think about it this way. You now have a problem. You have a cast iron pipe problem. You have to replace it now. Fairly replace it could result in higher insurance premiums or higher deductibles because insurance companies don't want to keep paying claims for pipe breaking. Number two, you could have an issue where if you ignore it so long, the entire pipe system collapses and you have a black water environmental disaster. If you hate the cost of 10 million, the picture of pipes is bad. Look at an environmental cleanup and the problems related to that and the fines and $10 million might be chump change. So ignoring it has certain risks to it as well. But the advantage the loan had in my view was you need a million, $10 million next year and you assess the owners. It's like $40,000 an owner in my example. Well, if you get a loan for 20 years, they may have to pay another $300 a month or so for maintenance fees to cover the cost of the loan. You've at least given them a way to work through this because a lot of owners may not have a $40,000 cash reserve to pay for a sudden assessment. And then if you assess them and they don't have the money, then you foreclose them and you're in worse shape. Have you seen that kind of situation or? Sure, no, I've definitely seen that situation where a special assessment is very hard for people to pay. I was also thinking of if you identify this need, say to replace the pipes, but you have your pipes analyzed by a mechanical engineer, for example, and they say you're in relatively good shape. I think you've got 10 years actually. If you start under regular maintenance fees, reserving money for the pipes, not only you're showing due diligence, but when you do have to get a loan, for example, the loan amount will be less because you've saved 10 or 20 or 50 or whatever you might be able to put aside against that rainy day. Okay, well, we're gonna take a short break. We're gonna come right back. We're talking to Steve Ferrigo about board's obligations to maintain the property and I have a lot more questions for him, but you're doing a good job so far. We'll be right back. Hello, this is Martin de Spang. I wanna get you get excited about my new show, which is Humane Architecture for Hawaii and Beyond. We're gonna broadcast on Tuesdays, 5 p.m. here on Think Tech Hawaii. Hi, I'm Marianne Sasaki and I'm here today to tell you about the Women's March on Washington on January 21st. It's an incredibly significant march in which both men and women are gonna stand up for women's rights, women's reproductive rights, and all the rights we've accrued over the past 40 or 50 years. There's also gonna be marches in each city, on each island, there's one in Oahu. I urge you to join a march and stand up for women's rights. You're watching Think Tech Hawaii, Citizen Journalism from Hawaii, finding the intersection of our sense of place and our place in the world, right here at home. Great content for Hawaii from Think Tech. Welcome back to Condo Insider. We're talking about the board's obligations to repair and maintain the building. We're sitting here with Steve Farago, a professional community association manager and director of Associate Hawaii. In the first part of the show, we just briefly said that a board has a legal obligation to maintain the building. They're supposed to do a reserve study in preparation to save the money for repair in the building. But if they have sudden surprises, they need to look at ways to either assess the owner or to borrow the money to make the repair. So we were talking about that. And so what are the risks if they do nothing? What if the board just says, we don't have the money, I don't give a damn, I'm not gonna do anything? Well, boards of directors have a fiduciary or trust responsibility to each of the homeowners. So a failure to act in any way or to at least acknowledge the issue is a violation of that trust. When you violate that trust, then there's several potential negative consequences. One is that you've increased your liability as an organization of the association of owners, also your individual liability. The law envisions that when you do the best you can, then you have some degree of protection. If you ignore something important, then you're increasing liability. Also, we've seen the real estate market is extremely competitive. If your building is seen to not be addressing important issues or conversely, if a potential homeowner can see that you're addressing issues, you're doing proper maintenance, your building has more value in the market, which means that units will have a better marketable value. One thing I've seen is lenders now, since 2008 in the, what I'm gonna call the economic crisis that began in 2008, I see now lenders have custom questionnaires. So if a borrower is trying to buy your unit, there's these custom questionnaires by the lender. And one of the questions is, is there any deferred maintenance? And so management companies have an obligation to disclose what they know. And frankly, sellers in their seller's disclosure have an obligation to disclose what they know. And it seems to me, if you put down yes, I have deferred maintenance, you have the risk you may not be able to buy and sell your units anymore. That because of the fact that it's not gonna meet the lender's requirements, because as a lender, they're taking as collateral the unit, but they want the unit to be well maintained. They don't want a unit that's got problems. Have you seen that in your experience, or? Well, I have, and board of directors, I was dealing with dealt with this very issue. There were people who wanted to accept the idea that it needed to be in the disclosure that the windows were going to be replaced and the pipes in a few years. Other people felt like it shouldn't be disclosed. But in the end, the argument that, to say we don't know the precise price or the precise date that we're going to do it at this point, but we do acknowledge that this will have to happen in the future, we actually found that people responded well to that information. So I think we all agree that in the fairness and the lo-ha and honesty that you need to disclose things, but there are risks if you disclose things that you know are a problem, whether the lender's gonna approve the mortgage. And so in theory, I guess an owner could sue the board since they have a legal obligation under the statute to maintain the building, that they can't sell their unit and they're being harmed because the board has failed to maintain the property. Absolutely. Maintaining the property and managing the financial issues are two of the most important obligations the board has. Yeah, it's interesting under the reserve law and the current condo statute that there really isn't a lot of ability for an owner to demand the board to do certain things. However, the statute does give the right to an owner to force them to do a proper reserve study and then implement the reserve study. In fact, there's been arbitrations on this case where owners were upset the board wasn't maintained the property and arbitrators have done like rule they must do it and force them to do a reserve study and follow it. The arbitrator demanded regular accounting on the board's actual actions and what they've done to accomplish that goal. So I don't think it's something we should look lightly at. It's a very important thing and while we're on the show I do want to mention everybody that if you have a question you can call our hotline at 415-871-2474 and we'll do our best to answer your questions. So back to the basic reserve study. So if they have a surprise or an issue should they put it in the reserve study? Absolutely. They should put it in the reserve study and at least acknowledge that this issue is there. Put some degree of funding there. Some boards take the stance of they'll increase funding each year to show that they're progressively moving forward even if they can't pay the entire amount knowing they will get a loan in the end but they still must disclose it. I think it's interesting to make it. I've had people in the legislature as well as owners say look we need to tighten the reserve law. We need to make mandatory. Maybe all reserve studies have to be done by third parties and the board if they don't properly reserve it they have some level of personal liability and they've asked me what at Richard do you think of that? First of all what do you think of that? Well I was just thinking I was chuckling to myself that having done this for over 20 years in a way Richard can't tell you how many boards have said something to me like well if we put that in we'll have to raise fees and the owners will be mad at us. But in my experience it's exactly what you said. I've never seen a board sued for putting out money to take care of valid processes but on the other hand if they do nothing which they think somehow is better they think that that's gonna be a better outcome but they can be forced into mediation or potentially sued for not maintaining the property. So a lot of people have it backwards. And in this example I gave where some people suggested a stiffer legislation. I've always said think of it this way. Let's begin with having a legislation for the state of Hawaii that they have to do a reserve study for all of their property and they have to 100% fund their property. So that means the alleged 60 to 100 million were short in the University of Hawaii for building maintenance where the billions were short for sewer maintenance. All these different things they would have to say oh we have a law now to make us funded which means our taxes would go through the roof. Boards have a similar problem. They have to balance the affordability of an association and how they plan and bring into fold repairing a building. It's not a black or white thing. You can say well we have to do this but there are financial consequences that affect the owners. And so oftentimes boards are forced to make into judgments and they're phasing things in and planning things in but as long as it's in the reserve study as long as they've identified it and are making some effort to fund it they're better off that they stick their head in the sand. I agree. I like to think of a community association as a triangle. It's a business. It's a government. It's also a community. So the business side of it is what we're talking about is budgeting and financing. The government side is legislating in the condo whatever needs to be done but there is the community side which is communicating with people staying open to owners input and acknowledging important things that need to be done like the reserve study. I had a project many years ago I did a reserve study for them that the board I remember them clearly saying to me he says, you know, the declaration provides for a central air conditioning system. If we just take that out of the reserve study that reduces the funding requirement. We don't have to raise maintenance fees. What do you think of that? Well, if it's in the declaration then it's something that's required. What I often say to boards when they say they don't like something like that in their documents then I say, I mean your documents. If you get the proper percentage of owners that agree with you, whether it's 67% or whatever percent is required then you can change the document. Otherwise you have to adhere to it. Yeah, it's interesting in that particular case because that board thought of that. They said, well, let's go amend our documents and take the air conditioning, essential air conditioning out of the declaration. Well, of course that then begs the question, well, what do you do with the essential air conditioning when it's failed? Which there has failed. But the lawyers in that particular case said, you know, under the old law 514A was 75%, the 514B is 67% of the owners have the right to make declaration changes. But there's also a little another paragraph in there that says, and any affected owner. And so the fact you bought in there you were expecting essential air conditioning made you an effective owner. So in that case, interestingly enough, the attorney's opinion was it took 100% of the owners to approve taking out the central air conditioning system because of the fact affected owners had to approve and when you bought in there you were expecting a certain level of building and amenities when you bought in the property. So it's a lot harder than one might think. But I guess the question comes if a board just said, screw it, I'm gonna do it anyway, does that potentially pose personal liability on them? Well, it does. It kind of reminds me of something I told the board once. I said, well, when you leave tonight, each of you give me a credit card. They said, what do you mean? I said, because if you take the action you're contemplating, you're personally liable. So if that is, we have to charge back the cost of all this, I need each of your credit cards so we can charge it back. It was just a funny way and I got their attention to realize when you do things according to the documents you have a degree of protection. If you're doing things against legal requirements then you're losing that protection to the degree to which you're going beyond what you're required to do. So you made a very good point which is that owners buy into a property with certain kind of amenities, certain kind of conditions and to radically change those creates a liability for the board so they have to be careful. Well, another term is often used in our industry is called the business judgment rule. And that is the boards rely on independent professionals that they mitigate their liability because they're relying on a professional. In our industry there are independent reserve study professionals who prepare reserve studies and management companies often have on staff qualified people to prepare reserve studies. Do you feel it's best to have the reserve study for a board done by a third party? Meeting the management company or a third party professional? I think so because at the different management companies you have people that are fairly highly trained and experienced both in the technical details of reserve study and also the practicality of it for a layman or just a mere board member to say take on doing a reserve study entirely on their own. They are inviting again a certain level of personal scrutiny. It is better to have a professional in the industry do the study for you. Yeah, I kind of agree with that. I would say this that our industry has so many diverse types of condos and so many diverse sizes like from four units to a thousand units. I happen to own a condo and the only common element is a common road and the maintenance of a small park. So do, because the board themselves can do a reserve study. So you really have maybe one or two components, the street lights and the overlay or eventually resealing of that one roadway. It may not be such a big deal that they do it on their own because it's something within reason that the effect is small in the sense of the scheme of the whole thing. However, you get these newer buildings that have bowling alleys, swimming pools, gymnasiums, wake workout rooms, large elevators. In those cases, it might be better to have a professional who regularly works with these reserve studies who has a better idea of the replacement cost, the useful life, although there's manuals and tables for all this and relying on that for the board's protection because they can say, retrusted this professional. But that being said, I would have to go back and say to you and everybody else that even reserve study providers have indemnity because like I said in the beginning, predicting the exact life, the exact cost, the inflation. You know, inflation may be, consumer inflation, they might be 2% but because of the heavy construction and why it might be 10% on glazing or roofing, it doesn't always just match up. So it's still a budgeting tool and you can't totally rely on it but the best way to deal with it is to review it every year and make your best estimate on the whole thing. I would agree. Also, board of director members need to be aware of the fact that they really need to study that reserve document. All right, well, you know what? Our time is up. This went very quick. Thank you for being here today and Aloha, thank you to all for watching Condo Insider.