Your condominium owners’ association (COA) and what you need to know

As an owner in a condominium, it often remains a mystery as to how the association operates; particularly in associations where owners use their condo as a second home or investment. Because it’s not the owner’s primary residence, they are not there to observe the day to day operations. Hence, most owners only understand that their requirement is to pay the annual, quarterly or monthly assessments, and their right to vote annually on members (owners) of the board of directors.

The word condominium often abbreviated to “condo” is a Latin word formed by adding the prefix “co-“ (together) to the word “dominium” (domain, property, ownership). Its meaning therefore is “shared property.” The common elements, such as the parking garage or lot, elevators, the building structure, roof, grounds; all have undivided shared ownership among homeowners.

Of what I would consider the most important factors of ownership in a condominium, below are four considerations necessary for an owner or prospective buyer to know and understand:

Annual Budget

The fiscal priorities and strategic planning are the most important emphasis of a COA because it affects everything, to include the reputation of the condominium. The budget has two parts: the operating and the reserves. It’s developed by the board, shared with the members and approved at an association meeting after members have been given the opportunity to provide input. The annual assessments will be determined after the board concludes the total annual estimated expenses and necessary reserves. The assessments are derived from the annual budget and are generally paid quarterly.

Operating Budget – The operating budget outlines the fiscal priorities of the association and establish how income will be used to perform maintenance and repairs for that year.  Some examples of items covered in the budget are: utilities, administrative and management fees, repairs and maintenance, taxes, major repairs and replacements, accounting, legal and insurance.  The operating budget covers the day to day operations and these expenses should remain fairly constant from year to year provided the association doesn’t add a new service, or the cost of utilities doesn’t rise significantly.

Reserves- The question is how much is your association saving, and how much do they already have in the bank for anticipated future maintenance and replacement of items such as elevators, parking lot coverings, building and common area painting, the roof and the pool?  It’s important for the management to invest in a professional reserve study that will accurately determine the amount of reserves needed.  The Board of Directors must then decide what percentage they will set aside. For the prospective buyers who are looking to purchase in a condominium, the reserve funding is an area necessary to review prior to making your investment decision.

Special Assessments—those are dirty words to the ear of a condominium owner.  Operating budget shortfalls and lack of reserves force the COA to institute a special assessment to all owners. Each owner will be required to pay a certain amount to fund the action. Sometimes the COA doesn’t have a choice about spending money. Only so much trimming of the budget and increasing quarterly assessments can occur before tough decisions have to be made. Should it be necessary that items such as, new elevators need to be installed or the roof needs replacing, the board in cooperation with the CAM, will determine the cost and divide it among the total number of owners.

Real Estate Values and Lending

Whether an owner plans to own for a short term or a long term, the marketability of the condominium remains paramount. Banks see second home and investment properties as riskier loans contrary to the loans used for a primary residence. Banks will issue a questionnaire to the COA prior to approving a buyer’s loan. They are looking to see if there’s replacement insurance in event a catastrophe occurs and the building is no longer tenable. They also look to see if any party owns in excess of ten percent of the total number of units in the building. This proves risky in the event those condos are foreclosed and/or the party stops paying their assessments, which ultimately places a strain on the COA’s budget. Lenders set rules about what proportion of owners can be delinquent on their assessments. If it rises above the limit, they won’t finance. One other main concern banks have is litigation. Banks tend to veer away from condominiums involved in lawsuits.

It’s imperative that banks are willing to make loans in a condominium. Real estate values can quickly descend if banks choose not to lend. Most purchases, historically, have occurred through the assistance of banks making loans. Very few buyers have the ability to purchase their condo with cash. We’ve all heard the saying, “Cash is King!” It makes for a quick transaction, but ultimately cash buyers drive the harder bargain and press values down.

Counter to a cash buyer is the seller who owns the property outright. Owner financing is optimal when banks aren’t making loans in the condominium. Although, the number of owners who have the advantage of offering financing are a nearly as few as the number of cash buyers.  One of the benefits of owner financing is that the owner can demand a true market value on the purchase price.

Owners who have existing mortgages are not privy to owner financing unless their property has an assumable VA mortgage. Conventional mortgages have a “Due on Sale” clause, which means the lender can call in the mortgage to be paid in full in the event the owner chooses to attempt to owner finance. This is referred to as a “piggy-back” loan.

Rules of the Association and the Board

Are the rules established in a fair, consistent and equitable manner?  Associations can be negatively portrayed if the rules are established to only satisfy the few as opposed to the majority. They regularly carry the stigma as badly-run, inefficient organizations that take advantage of homeowners.  Owner involvement in quarterly board meetings and annual meetings is essential to maintaining harmony and having their voice heard. Take time to research your board candidates and vote for those who are most qualified to make sound decisions regarding your investment.

In a vacation rental market, do they make renting easy for guests? Most owners rely on rental income to offset the carry costs of ownership. So, it’s essential for the rules to be “renter friendly”. At the same time, are there protective policies established to punish the owner who rents their condo and fails to pay their assessments? Many associations today prohibit the delinquent owner and guests from using the community amenities until the outstanding assessments, interest and penalties are reconciled.

Legal Issues and Liabilities

Are there any lawsuits against the association? As an example– A few years ago, a local COA was named in a lawsuit with other vendors because two girls were badly injured in a parasail accident. The COA was sued because the girls launched from the resort’s beach. COA’s carry liability insurance, but the cost of paying the deductible can be exorbitant and negatively affect the budget.

Is the COA having to sue? During the downturn of the economy, it’s not uncommon for investment properties to be the first to suffer. The COA must continue to operate, and when an owner stops paying the assessments, the COA must implement legal proceedings and possibly foreclosure action, to recoup the losses while the owner is in default. The cost of initiating a number of lis pendens can prove to be costly to the association.

Also, is the physical structure of the building sound? On occasion, an association will have to deal with building defects, whether it is from faulty materials or the builder’s poor craftsmanship. These issues can require years of research and litigation and the attorney expenses are usually paid upfront and during the proceedings.

In closing, often there are critical decisions made that will affect your investment whether short or long term.   It’s critical that you as an owner stay engaged in the events of the association should you already own a condominium or if you have future plans in buying one.

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