Investment of Excess Operating Funds vs. Reserves

I'll try to keep this short:

I became chairman of the Finance Committee in February. Our HOA has run a surplus in the operating account for each of the last three years averaging $150,000 per year. Current year (thru July) we are $154,000 under budget. We just had a level II reserve study update done and the reserves are fully funded. The calculated reserve contribution from the assessments will go down by $85,000 for 2012.

All of our investments total $510,000 more than the balance sheet shows for the amount of replacement reserves. These investments consist of laddered CD's and bank Money Market accounts. None of the investment accounts are specifically identified or registered as either "reserves" or "operating funds". In all prior years all of the interest earned on all of the investments has been shown as income in the operating budget. Our monthly financial statements, prepared by the management company are not in "fund accounting" format and they say their system can't produce that format.

I believe that the interest on invested reserves should remain in reserves. Under the circumstances how do we determine how much of the interest earned is from invested reserves when it is not clear which investments are reserve funds and which are invested excess operating funds?

What are our options for applying the excess operating funds? My understanding is that we have three options:

1. The unspent funds can be returned to the association members.
2. The unspent funds can be applied to the following year's operating budget.
3. The excess funds can be allocated to reserves.

It seems to me that there are implications of #2 and #3 that have to be considered.

For #2 - If the following year the requirement for operating funds does not increase and we apply the excess from the previous year, then to have a balanced budget the assessment would have to be reduced.

For #3 - The funding of the reserves is based on the reserve study. If the study says that the reserve contribution for the year should be, for example, $400,000 and we apply $100,000 of prior year excess operating funds to the reserves, then the current year contribution to reserves from the operating account only needs to be $300,000. If we don't reduce the assessments, then the operating account will have a built in excess of $100,000.

It seems that if we continue to underspend the operating budget, eventually we will have to reduce assessments. Maybe there is another alternative I am not aware of.

We have only been under homeowner control of the association for 15 months and are still in the process of addressing maintenance and repairs that the declarant neglected. We are also in the process of renegotiating and/or awarding major contracts (such as landscaping for 91 acres of common grounds). Given those and other uncertainties, I am reluctant to recommend to the board that assessments be reduced and they are unlikely to go along, even if I do.

Given all of the above, in your collective wisdom and experience, what is the best course of action?

What are our options for applying the excess operating funds? My understanding is that we have three options:

1. The unspent funds can be returned to the association members.
2. The unspent funds can be applied to the following year's operating budget.
3. The excess funds can be allocated to reserves.

David,
To avoid tax implications: our accountant told us that we can move operating reserves to any of our reserve funds IF the membership votes on the issue and approves.
I do not know if the vote to move the money around would require a majority of the membership or a majority of those present at the meeting, in your community.

In the past excess operating funds were applied to replacement reserves. This was done by vote of the board. Our governing docs do not require a membership vote on this or to approve the budget.

David,

I'm surprised your association doesn't file an 1120H to claim the tax status of an HOA.

I've just signed up for a tax prep course to become a professional tax preparer. Just think, in a few months I'll be an "expert." (Ha!)

David,

I do not think you are allowed to return the funds to the membership except by way of a reduced assessment.

As you know the assessment is the sum of the operating budget + amount needed for reserves + amount needed for a contingency fund divided by the number of lots.

If there are excess funds perhaps you can look at projects you wanted to get done but weren't funded for. Perhaps extra street lighting. Major trimming of trees in the development, etc.

Tim

I do not think you are allowed to return the funds to the membership except by way of a reduced assessment. (Tim)

These are the owners money. Either way should allowed I think. This is why the vote by the members is so important when it comes to money management.

Only 15 months on your own? (HOA turnover) and still assessing the developer's screw-ups?

Too soon to be worrying about what to do with the "excesses"

You need to re-evaluate your Reserve Fund ASAP. Bet there would be some adjustments that could eat up any excesses.

DavidW5,

You wrote:

We just had a level II reserve study update done and the reserves are fully funded. The calculated reserve contribution from the assessments will go down by $85,000 for 2012.

Would you explain what a “level II” reserve study update is? I am not familiar with that terminology.

DavidW5,

Since you had the same company back to update the Reserve Study, have you independently verified, or gotten a second opinion on any of the larger reserve items, perhaps by checking with a local contractor, to ask what might it cost now, and what might it cost in say 20 years, or whenever?

My concern would be that the study might be on “the low side”.

David,

If you're still assessing deferred maintenance in your common property areas, you can't be 100% sure that your HOA is fully funded. You've not spent the cash to bring all your maintenance up to par. At that point, I think you can assess your savings situation, when you really have zero outstanding needs and a plan to schedule savings for future repairs.

But, a tax professional/accountant is your best source of advice.

I'd plow cash back into the getting my core amenities to their expected standard before refunding money or reducing assessments. Repair bills always come due sooner or later. If you're blessed with the cash flow now, exercise the "sooner" when making repairs.