What Happens When the Homeowners Association Runs Low on Cash?

April 20, 2010

Nash Law Firm, PLLC
By:  Stephen J. Nash
nash@nash-law.com

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As a by product of our economic and real estate troubles more and more associations are experiencing money problems.  The first payment that a homeowner will stop paying when they get in trouble are the association dues.  If at some point in time they stop paying their mortgage payment they have absolutely no incentive to pay the association dues.  What is even worse is that when the lender finally recovers the property through a foreclosure they often do not pay the past or current association dues.  This means that in the normal foreclosure situation the association will not get paid until the foreclosure has been complete and the property has been sold to a new home owner.  This means that the association cannot count on receiving any money for at least 18 months.  

With the foreclosure rate at record highs and no end in sight, the danger for all associations is that so many association members stop paying that they become non-functional.  Once an Association becomes non-functional, the value of all of the properties within the association plummet and basic issues like plowing, mowing and maintenance become huge problems.  Not only that but what lender will lend to a buyer of a property that is subject to a non-functioning association?  What buyer would want to buy such a property?    

The following are five things a buyer should be concerned about when buying a property subject to an association:

1. Are the monthly dues enough to pay for current costs and future maintenance?

2. Does the association have cash reserves to protect the association from non-payment of dues and unexpected costs?

3. How many properties subject to the association are in default on their monthly dues?

4. Does one person/company own a number of properties in the association?

5. What attempts are being made by the association to collect dues and assessments?

Monthly Dues

Quite often the buyer is looking for a property with a low monthly association fee.  While this is understandable, if the dues are so low that they do not provide the income to the association that is necessary for the association to properly perform its duties, the low monthly payment is going to result in poor maintenance or a large assessment down the road.  Some associations have few costs and liabilities so the association fee does not have to be very large.  Other associations are responsible for plowing roads and parking lots, mowing, and outside maintenance such as siding, decks and roofs.  When becoming a member of an association you are essentially buying into a joint venture with all of the other members and the associations finances should be carefully reviewed to make sure that the association is adequately funded.

Reserves

Some costs are constant others are not.  While we don't know when a new roof will be needed or the siding needs to be replaced we do know that it is inevitable that these costs will be incurred at some point in time.  If a cash reserve is not created, the owners at the time the major expense becomes necessary will be stuck with the entire cost through a large assessment.  So if you buy into an association that has little or no reserves and a year later the roof needs to be replaced you will be paying a full share of the cost of the roof replacement even though you only got the benefit of the roof for one year.  To avoid this situation, monthly fees should be high enough to build a reserve to pay for the anticipated maintenance, including replacement of components over their expected life span.

Number of Members Currently in Default

The greater the number of members who are not paying the monthly association fee, the greater the burden on the paying members.  Unless the monthly fee is increased, the money received will decline with each default and reserves will decline or services will be eliminated.  In these situations, when a buyer reviews the finances of the association they cannot simply take the monthly fee and multiply it by the number of members to determine if enough money is being generated to properly fund the association but instead, must look at the number of members who are paying to determine if enough money is being collected through the monthly association fee.  If barely enough is being collected to properly fund the association, the buyer must anticipate that the monthly fee is going to rise or there is going to be a special assessment imposed to cover the gap.

It is also important to look at who the owners are and who are members of the association.  If one person/company owns a number of properties the impact is greater upon the association if that person/company runs into financial trouble and cannot pay the assessments.  This generally occurs in two scenarios.  The first is the developer who still owns a great number of the properties in the association.  If the developer cannot sell those remaining properties or otherwise runs into financial problems and stops paying the monthly assessments, the association may very well fail.  The second scenario is where an investor bought a number of properties in the association.  Like the developer, if the investor runs into economic difficulties and stops paying, the impact on the association can be staggering.  Unfortunately, it is simply a fact that developers, builders and investors are facing huge economic troubles that make it very likely that they may have to stop making the monthly assessment payments.

Collection Practices

Many associations have traditionally been slow to try to collect past dues; however, in the present economy that can be a mistake.  Every payment that is not collected affects the other paying home owners. You don't want to join an association that is going to wait until there is not enough money to properly function before they start collection actions.  Remember the basic functions of the association all have costs associated with them: lawn maintenance, snow removal, management company, legal fees, insurance, etc.

Conclusion

The fact is buyers should always carefully look at the finances and the running of an association before they buy or they may find that they have only bought themselves trouble.  The traditional review that focused on making sure the monthly assessment was as low as possible simply was and is short-sighted.  If you want a properly functioning association, if you don't want to get hit with a huge assessment because the monthly fees were kept low and no reserves were built up, you must make sure that the monthly fees are properly funding the association and that they are sitting on a default time bomb that can destroy the association's ability to function and the value of your property.  

NOTICE The foregoing is not intended to constitute legal advice for any specific circumstance, but is intended to reflect broadly applicable principles, under Minnesota law, relevant to a typical situation. Each set of facts and each contract is, or can be unique; the unique facts and specific language of the contract may require a different legal analysis and may result in a different outcome. Before proceeding in reliance upon this or any other general description of law, consult with an attorney competent in the field of practice relevant to your situation. Copyright 2011 Nash Law Firm