As real estate agents representing buyers of condos, stock cooperatives, tenancy-in-common shares, or similar properties, we have a duty to help our clients understand the obligations, assumptions, and health of the governing body, typically called the homeowner’s association (HOA). Reviewing the hundreds of pages of documents given to buyers during due diligence can be overwhelming and lead to misunderstandings. That’s why our expertise is of great value to buyers.
Show Me The Documents
California law requires condo sellers to disclose all material facts and provide buyers with all governing HOA documents and one year’s HOA meeting minutes. A typical document package for a San Francisco condo, coop, or tic share will include the documents that set up association governance, any rules and restrictions, the current budget and budget-related documents for the HOA, and one year of meeting minutes.
Governance: Bylaws & Articles of Incorporation
Bylaws typically spell out how an HOA runs, who the officers are, how many votes exist, and the basic purpose of the HOA. Some HOAs integrate their bylaws into a section of the Covenants, Conditions, and Restrictions document, so not every HOA will have them as a separate document. Articles of Incorporation will confirm the type of HOA you are joining by virtue of your purchase. An HOA does not have to be incorporated, and those that aren’t won’t have Articles of Incorporation.
Rules, Restrictions and Financial Responsibilities
The Covenants, Conditions, and Restrictions document, known as CC&Rs, is written at the time of the development’s creation. It contains the language that allows for financial assessments against owners, important information about how “worst-case” scenarios are to be handled, as well as the rules and restrictions that impact everyday living for residents.
Shared ownership of a condo building comes with shared costs. This document will detail how responsibility for finances is allocated among owners, how often assessments are levied, what happens if an owner can’t pay, how and what collected assessments are to be used, and other pertinent financial obligations and expectations.
Worst Case Scenarios
This section will detail what happens in case of flood, fire, or foreclosure, giving all parties, including lenders, assurances about the value of the collateral for their loan in the case of unexpected events. Typical questions such as what happens to a home loan and insurance proceeds if your home burns down will be addressed.
This section will outline the rules governing the right to lease, smoking, pets, window and door signs, noise, floor coverings, quiet hours, sound transmission, remodeling, and anything else that you can or can’t do as an owner. Use restrictions often include a broad clause that gives the HOA power to create and enforce additional operating or house rules.
HOA Meeting Minutes
Meeting minutes provide condo buyers with an idea of what has been on the minds of the owners and board members, as well as recent or recurring issues. If there are concerns about a section of the building, meeting minutes will provide insight. If there is a perpetually unhappy neighbor or other issue caused by someone in the development, information will often be in the minutes if the HOA has been or will be involved.
A condo association keeps track of and collects funds for daily operations and long-term reserves. Operating accounts handle day-to-day operations and expenses, while reserve accounts store money for future replacement or maintenance of building systems or structures. Information about these accounts may include current balances, bank statements or activity ledgers, and reserve studies. Current budget documents track monthly fees and how they are spent or saved to help you understand how the property is cared for currently and identify trends in how the organization assesses and utilizes any money collected.
Is the association collecting enough money to pay its regular bills and what are those regular bills? Are the other homeowners making their association payments or are other owners delinquent? Is the money being spent appropriately?
Questions about the current financial status of the association are answered by these documents. But what about future financial obligations? Is the association saving enough and properly budgeting for replacement and repairs? Future financial health is typically addressed by a budget document known as a reserve study that may or may not be available, based on the association’s size.
The Reserve Study
Reserves and reserve studies generate impressive-looking documents, and in my experience, they are little more than a collection of “what-if” best guesses about what might happen to association reserves. Reserve studies make significant assumptions about: How much it will cost to replace/repair major systems in the future? How long building systems and structures will last?
While we can interpolate from current costs and project into the future, it remains a “many variables” projection. The moment a meaningful change happens to the costs or lifespan of a building system, the forecast about replacement becomes quickly useless. A 1% variance in cost compounded over 30 years can quickly invalidate even the most well-planned of reserve studies.
Real World Reserve Study Scenarios
How long will the paint in the entrance, halls, and common areas last? On paper in a reserve study, a diligent HOA that regularly inspects the building, addresses minor maintenance items before they become major items, and takes care of the existing paint will look identical to a lazy HOA that doesn’t inspect, doesn’t maintain, and isn’t meeting their fiduciary obligations. But they aren’t the same. The numbers on a reserve study will look the same, but one HOA is well managed and the other isn’t.
And that’s just the paint! What about doorknobs, elevator buttons, hallway carpet, the roof, windows, building siding, exhaust fans, access control systems and landscaping? A building has so many systems and variables that I find reserve studies to be ineffective bordering on useless. Additionally, reserve studies come with no liability – a buyer has no recourse if assumptions used for a reserve study are incorrect.
Why Are There Reserve Studies Then?
State law requires them, is the short answer. A longer answer about state law requirements is from our friends at the Community Associations Institute. On a quarterly basis common interest development boards of directors must review reserve accounts and compare reserves to the previous year.
At least once every three years, boards must conduct a competent and diligent visual inspection of the property that the association is obligated to repair, replace, restore or maintain as part of a study of the reserve account requirements.
The board is to annually review this study to consider and implement necessary adjustments to the board’s analysis of the reserve account requirements.
The required reserve study shall at minimum include identification of the major components that the association is obligated to repair, replace, restore, or maintain that, as of the date of the study, have a remaining useful life of less than 30 years, identification of the probable remaining useful life of the components identified in the study as of the date of the study, an estimate of the cost of repair, replacement, restoration, or maintenance of the components identified in the study, an estimate of the total annual contribution necessary to defray the cost to repair, replace, restore, or maintain the components identified in the study during and at the end of their useful life, after subtracting total reserve funds as of the date of the study, and a reserve funding plan that indicates how the association plans to fund the contribution identified in the study.
See more detailed information in California Civil Code Section 5550-5520.
There is no statutory requirement to fund reserves.
How To Protect Yourself, Reserve Study or NOT
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