Condo Media - September 2010 - 40

FINANCE

by Alan D. Seilhammer

Associations in Need of Cash
Before Borrowing, Consider All the Options
his commentary is colored by the horrible debt-induced recession we have been going through. This recession is the worst and the longest since the Great Depression. Interestingly, both traumatic periods were sparked and exacerbated by speculation and over-leveraging (debt). Debt is a real easy way to get to live beyond your means. Debt leaves you vastly more exposed to financial instability, because a cash flow disruption may cause an inability to satisfy a scheduled debt payment requirement and result in loan default. Debt also is an expensive way to acquire anything. But, a wellconsidered loan can be a valuable tool if there are no other alternatives to solving an immediate necessity.

Funding Options
Most association loan requests are to support the need to make upgrades or improvements to common elements. The most common requests are for replacement of roofs, siding, windows and doors. But, a proper starting place is to build your reserves. It is far smarter to have a reserve study, review it annually and fund it as recommended, which will, in turn, create large cash balances that are earning interest. You are in a lot smarter position to earn interest income and perhaps pay taxes on that interest income vs. borrowing money and paying interest. There also is a certain inherent fairness to building reserves. Every day, all the common elements wear out by some small but measurable amount as defined in a reserve study. The person that owns a unit/home for a time period has the benefit daily of the common elements. That unit/homeowner should be paying

in their fair share of the use of those common elements on a regular basis for the period they are members of the association. A portion of the routine common charges payable to the association by each and every unit/homeowner should be their proportionate share of the amount needed to support building reserves per the recommendation of the reserve study. Sadly, the idea of building reserves is a well-studied, prudent and easy-to-follow methodology that is often not followed. The result is an underfunded association with common elements in various stages of disrepair and obsolescence. As worn out common elements must be corrected, the solutions are narrowed to special assessments and borrowing. A special assessment is a uniquely unfair solution because it requires the unfortunate soul that “currently” owns in the association to pay, in full, for the replacement of a common element that has been used by the owners of the past 20 years. A special assessment is also painful. Essentially, a lump sum special assessment will require unit owners to provide some large dollar amount to be paid into the association over some short period of time so the association can engage in the project at hand.

Bank Loan Considerations
The last alternative is for the association to obtain financing. There are many skilled banks that understand the nuances of lending to a community association. Others without that background will be more challenging to negotiate with, and you might find yourself needing to educate the institution. Loans to community associations have proved to be the safest market to which

a bank could ever lend. Consequently, banks with that experience will provide very good loan rates with nominal fees. The borrowing terms will be flexible. The length of a loan term available is typically up to 10 years, and sometimes 15-year transactions are possible. You should never enter into a loan with a prepayment penalty as these loans are most often prepaid. Banks are very willing to fix the interest rate for as long as five years, and sometimes 10 years. Stay away from concepts like “yield maintenance fee” and SWAP rate loan pricing. These are esoteric loan pricing concepts that can look inexpensive initially but, by the end of the transaction, can have the association paying the bank a financing premium. Banks should never require your cash balances as collateral. You need to have access to your liquidity. The bank’s collateral is normally an assignment of the association’s right to collect assessments. Community associations are not engaging in real estate improvement activities as much as it might appear so. The funds being provided are for replacement of reserve funds. Any bank that wants to handle the disbursement of funds as if this were a real estate development project by requiring site inspections and lien waivers is likely not familiar with the issues of associations. The disbursement of funds should be handled essentially as an open line of credit for the association to draw on upon request.

Structuring the Loan
A typical loan structure is for the loan to be a line of credit with a term that matches the build-out period of the project in which the association is engaged.

CONDO MEDIA • SEPTEMBER 2010

Condo Media - September 2010

Table of Contents for the Digital Edition of Condo Media - September 2010