Why You Should Have a Real Estate Attorney for Funding Reserves
February 18th, 2022
In Ohio, condominium associations and homeowners’ associations (HOAs) are required to maintain funding reserves that allow them to replace or repair major capital items without needing to resort to special assessments. However, unit owners can waive this requirement by a majority agreement.
Real estate funding reserves are used to address long-term needs for the maintenance and repair of common areas of the property. Funding reserves should not be used to pay the association’s day-to-day operating expenses.
But when condo associations or HOAs fail to properly fund the reserve account, the association may impose a special assessment to pay for necessary repairs.
Imposing a special assessment can be unfair to association members who own units when the need for repairs arises. Owners who sold before major repairs were necessary benefit from using the common element without contributing to the cost of maintaining it. In addition, being on the receiving end of a special assessment can impose a significant financial burden.
HOAs and condo associations have two major accounts: an operating fund and a reserve fund. The operating fund is used for day-to-day expenses and to perform regular maintenance on association assets.
The reserve fund is like a savings account that is used to pay for costly repairs and replacements.
Unfortunately, many condo associations and HOAs fail to properly fund their reserves and do not have enough money to pay for anticipated future expenses. To avoid being stuck with a costly special assessment, it is wise to have an attorney review the association’s bylaws and Covenants, Conditions, Restrictions & Easements (“CCRE” before purchasing.
Understand Association Real Estate Reserves Before Purchase
Reserve funds should only be used to pay the cost of expenses that do not occur regularly. These include unusual or unexpected expenses that are incurred due to:
Major landscaping projects
Construction of a playground, pool, or another community amenity
Replacing the roof of common structures
Major maintenance or repairs on the clubhouse or other common property
Construction projects or repairs to common areas such as sidewalks
In addition, reserve funds can be used to pay for major unexpected expenses like damage caused by a tornado or flooding, or if the swimming pool pump breaks at the beginning of the summer.
These repairs can affect the quality of life for the entire community, and residents have a right to expect that these problems will be addressed quickly.
Before purchasing a home or condominium unit, you should have a lawyer review the purchase and sale agreement and explain its terms. Your attorney should also review the association bylaws and CCRE, paying particular attention to the sections that address reserve funds. This will help you understand your rights and obligations as an owner and avoid being hit with a costly special assessment.
You should also ask about the remaining useful life of common elements, such as roofs in common buildings or structures with a shared exterior, sewer and water pipes, parking lots, garage doors, elevators, and other major components of the building’s infrastructure.
Depending on the type of unit you are purchasing, association fees often include payments for utilities, hazard insurance, or real estate taxes. But the fees should also allocate a certain percentage to the association’s reserve fund.
Finally, you should ask about the current state of the reserve fund, how it is funded, what it is used for, and whether there are any pending assessments or anticipated major repairs that may exceed the reserve fund.
If the cost of a major repair exceeds the cash available in the reserve fund, the association may impose a special assessment to cover the cost. Before purchasing, ask whether the association has a history of special assessments and, if so, look into the details.
Proper Use of Reserve Funding
Association fees that are set aside for funding reserves should not be used to pay for everyday operating expenses or association needs. These expenses should be paid for out of the operating account. Instead, the reserve fund should only be used to repair or replace major capital items, including common elements that the association has a duty to maintain and repair.
When the association incurs a major expense, it may need to increase contributions to the reserve fund so it can be adequately maintained.
Minor and regularly occurring repairs should be part of the budget and paid for out of the operating account. The association board will determine whether a repair is major or minor and whether it will be paid for out of the operating or reserve funds. However, as a unit owner, it is important to oversee the expenditures to ensure that the reserve fund is being used properly.
The association should not borrow funds from the reserve account to cover items that should be paid for out of the operating account. Borrowing from the reserve fund can have negative tax consequences and lead the association down an unhealthy financial path. To avoid improperly taking funds from the reserve account, board members and unit owners alike should monitor the operating budget and account to ensure that any deficits are addressed, that fees are adjusted appropriately, and that the association is drawing from the correct account to both pay for day-to-day repairs and plan for inevitable major expenditures.
How an RKPT Attorney Can Help
The real estate lawyers at RKPT have extensive experience advising and representing clients in residential and commercial real estate matters. If you are considering purchasing property that is subject to an HOA or condo association or already own property and are concerned about how your association is managing its funding reserves, our attorneys can help.