Planning in Uncertain Economic Times

Recently I've been out to a couple of networking events, revelling in the freedom of being around people again. One of the ongoing conversations I hear is about inflation and the economy. Also, in my networking world, the increased concern about how unprepared the majority of condos are to cope with costly infrastructure replacements.

These two factors are coming together to create what appears to be enough pressure to turn coal into diamonds in the world of condos and HOA's. I agree wholeheartedly that condos are underfunded to meet capital replacements. What I'm not hearing is a reality-based discussion about this. The discussion needs to get pulled back a bit in order to define where the problem originates and solving it at that level. A bit of reverse engineering, if you will.

These two factors - inflation and underfunded reserves - are the perfect illustration of why a better model is needed. Inflation is going to kick the daylights out of operating expense projections, and boards are going to be faced with the unhappy decision of raising condo fees significantly. In turn they will be likely to face unhappy owners the next time there's a meeting with them.

If history repeats itself, this means that a hard look is going to be taken at the portion of the budgets going to reserve, and once again those contributions are going to be reduced or perhaps even eliminated in a 'temporary' measure to ease the financial burden on owners. Most of the reserve studies I've seen cap inflation at 3.5% annually, or thereabouts. So the problem of reducing or eliminating reserve contributions will quickly be exacerbated by the actual cost of capital replacements.

Borrowing is always an option. The problem with that option is that condos have no collateral and pay exorbitant rates of interest and incur massive fees and legal expenses when borrowing money. A condo I once managed renewed a loan after five years at 95% of the original loan amount. Unless they special assess, the debt will likely never be repaid.

The major banks could offer condos some relief in the cost of borrowing, but can't take on the high risk that is associated with private lending and high interest rates. They are only willing to loan money that will be repaid long before the need to borrow might arise again. So one piece of advice for condos is to do a bit of research to figure out how to qualify for less expensive loans, and try to position themselves accordingly, if borrowing seems the best plan.

Establishing a five-year plan to reorganize a condo's finances isn't going to cure inflation, totally eliminate cash calls or avoid monthly fee increases. But in the long run it can save tens - if not hundreds - of thousands of dollars. A five-year operating plan will ensure that the needs of the condo are met, both in terms of monthly expenses and reserve contributions. It helps boards take a realistic look at where their finances are today, and establishes a realistic plan to cure any deficits over a five-year period. Spreading the solution out over a longer period of time eases the financial burdens facing condo owners.

Another benefit is that it makes sure that the owners today pay their share of future infrastructure replacement costs, rather than leaving unpaid contributions to the reserve that future owners will ultimately pay. The only alternative to this is to acknowledge that an investment in a condo is a declining investment that will eventually be of no value. That makes no sense at all. Chipping away at the problem over a reasonable period of time makes a whole lot of sense.

In these tough economic times we all need to keep our eyes on the prize. In the world of real estate it's called protecting the equity. The only way to protect the equity is by protecting the asset. It's time for new ways of thinking and new strategies that are clearly aligned with these objectives.