Before one examines a condo budget, especially as it relates to a board’s primary legal directive, i.e. operations and maintenance, it all needs to be put in context. If it were truly full and honest disclosure, what fundamentally would a board be telling their investors? Well, two key things:
1. They’d underscore structural life cycle and the reserve study. Fact is, high-rise structures especially were designed to be torn down. No matter your love and commitment, there comes a time when fixing an old car isn’t worth it, i.e. maintenance becomes a matter of diminishing returns. Of course, you could put the old gal in heated garage and put a blanket over her, but she’s no longer a utility. Point: If the full life cycle is estimated to be a 100 years, ownership as an investment is musical chairs. And,
2. An honest board would then stress its commitment to “intergenerational equity.” Intergenerational equity is the concept of the idea of fairness between generations. In the case of a condominium, during the course of its structural life cycle, no investor would bear a greater burden thus countering the potential for musical chairs and special assessment shock.
Unfortunately, you’re not going to hear that. According to Deborah Goonan, publisher and managing editor of the nationally recognized Independent American Communities, “Not all associations are irresponsible, but, in my observation, most are. The industry has many perverse incentives for failure to fully fund reserves.”
Goonan provided a few examples:
– Management companies and vendors who provide services for major renovation projects make more money when the association defers maintenance. The HOA industry now has its own HOA banks, HOA lending, HOA collections, etc. When associations fail to fund reserves for many years, they also tend to defer maintenance. One or several major projects must be done. At that point, the management company steps in to “save the day” with referrals to engineers, contractors, lenders, insurers, reserve specialists, etc. Each link in the management-contractor-financial services chain gets a piece of the action. It inflates the cost for owners.
– In communities with a high percentage of investor owners, which is becoming more common, lower HOA or condo fees reduce the cost of doing business, which results in a higher profit margin. High rent minus lower carrying costs equals more net revenue for the investor.
– Conversely, you have some investors who target under-performing communities with profit potential. They buy up units at low prices, gain control of the association, then force the long-time owners to pay for massive renovations and capital improvements to increase their potential for future rent payments.
Goonan concluded: “The dirty little secret is that the HOA industry actually benefits from the dysfunction it creates. The stakeholders in the industry don’t care, because they are making a lot of money as a result of irresponsible management, dysfunction, and corruption in HOA-and condo-ville.”
2020 BUDGET ANALYSIS
Aligned with management’s incentives, in its Letter to Homeowners, the board intentionally mischaracterized the state of the association’s affairs. Here Michael Novak, Chicago-area noted condo financial expert, points out specifically those areas, and sets the record straight.
111 Condo Board: “The Board’s goal in developing the budget was to balance our condominium Association’s assessment needs with the operational and capital demands of our building.”
Novak: “This statement is inconsistent with the board’s repeated waivers of reserve contributions since the 2017 Full Reserve Study was prepared.”
111 Condo Board: “The proposed budget includes $900,000 in funding to our reserve account, which covers capital projects and any operating overages. Large reserve expenditures in 2020 are expected to be continuation of the concrete facade project and replacement of rooftop make-up air units.”
Novak: “The Reserve Fund is not to be used to fund Operating Fund shortfalls. In fact, the IRS will tax the full reserve fund if it’s not being used for its stated purpose. Meanwhile, the board neglects to mention the amount of reserves waived in the 2020 budget, again effectively deferring assessment increases beyond 2020.
111 EC’s 2017 Full Reserve Study, approved by your board of directors, conceals the fact Reserve Advisors recommended a 190.17%, or $1,053,833, increase in the minimum recommended reserve contribution; and, in order to minimize assessment increase shock, Reserve Advisors recommended the full $1,053,833 increase ($554,167 in 2017 to $1,608,000 in 2024) in the reserve contribution, which is inflation adjusted, be phased in over 7 years beginning in 2018 through 2024. With a budgeted reserve contribution of $900K in 2020, your ass’n needs to increase this by at least $708K, or 78.67%, if not much, much more, by 2024.”
111 Condo Board: “Note that the Board believes that no special assessment will be required now or in the foreseeable future.”
Novak: “Not true. Keep in mind that your ass’n’s reserve contribution is currently 23.58% of total assessments, which means the reserve contribution line alone will cause assessments to soar by at least 42.14% by 2024, and/or the board will pass one or more special assessments.
If you recall, your ass’n’s percent funded as of the 2017 Reserve Study Update was just 5.315%. Reserve Study Professionals consider a percent funded under 30% to be poor and at significant risk of a special assessment.
The 2017 Reserve Study has phased increases of $94K for 7 years (2018-2024) and annual inflationary increases beyond that. 111 EC should be phasing in MASSIVE increases in the reserve contribution. Bottom line: your association has failed to maintain intergenerational equity.
I guarantee you the next reserve study won’t be pretty. Your ass’n has major expenditures planned between 2023 and 2033, and again between 2038 and 2042. The ass’n will pay a heavy price for deferring recommended reserve contributions and not earning anywhere close to the modeled investment income. They all add up!”
111 Condo Board: “We believe that the expenditures included in this budget will improve our building’s value and appearance.”
Novak: “With uninformed buyers maybe. The problem is prospective buyers don’t know what they’re buying, especially if the condo interior appears to be well maintained.”
Forget the milk analogy. Apparently, Kool-Aid spoils… and drinkin’ it too can make ya sick! Who knew?! Well, for one, The Board.
Simply stated, the 111 East Chestnut Condominium Association’s 2020 draft budget rises to fraud. It begs for a sell-by date. It completely ignores the tremendous burdens that will be put unfairly on present owners and future buyers. Factoring in structural life cycle, owning at 111 is akin to musical chairs. When the music stops, and it will, some suckers are going to be left holding the bag. And that’s just plain wrong.
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EDITOR’S NOTE: The Homeowner Meeting to discuss the budget is now scheduled for Thursday, December 12th at 6 PM. Out of 444 Units, there will be maybe 2 or 3 owners there. The meeting will last about 10 minutes tops before Board President Santogrossi brings it to a close. Innocuous and laudatory homeowner comments will be heard. The more poignant homeowner questions will be ignored. And immediately thereafter, Santogrossi will gavel in a board meeting, and the Board will rubber stamp its thinly-veiled scheme.
UPDATE 12/7/19: 111 E Chestnut St Unit 20A Chicago, IL 60611, 2 Beds 2 Baths, 1600 Sqft, MLS #: 10485058, CLOSED $562,000.