Recently we have received an increasing number of questions regarding community association budgets, their development and distribution, and their relationship with assessments. Here are some points for consideration.
Annual Budgeting is Mandatory
Some associations do not publish a budget on an annual basis, instead choosing to rely on a past year’s budget, informed by the previous year’s profit and loss report or variance report. Other associations use no budget at all, simply paying invoices from available funds. These approaches are incorrect.
For condominium associations, the Michigan Administrative Code requires an annual budget. R 559.513 states:
Rule 513. The bylaws shall set forth detailed information concerning assessments. The method by which assessments are to be made shall be included and shall provide that the board of directors of the association shall establish an annual budget.
For homeowners associations, the Declaration of Covenants, Conditions, and Restrictions or the Corporate Bylaws will similarly require an annual budget.
The association must then distribute the budget to each co-owner or homeowner by mail, or by an electronic communication method to which the co-owner or homeowner has consented. However, the failure to deliver a copy does not affect the validity of the budget or the assessments levied under it. The budget is subject to inspection by any member under MCL 450.2487.
The Budget Determines the Assessment
Some associations set a target assessment amount, and use that to determine the budget, or determine what projects can be done in the next year without exceeding a specific assessment amount. This is incorrect. The system is top-down, not bottom-up. The board of directors determines the association’s needs and uses that to set the budget. Standard governing documents language may state:
The Board of Directors of the Association shall establish an annual budget in advance for each fiscal year and such budget shall project all expenses for the forthcoming year which may be required for the proper operation, management, and maintenance of the project, including a reasonable allowance for contingencies and reserves.
The Board then divides that among the total units or lots to determine the assessment. Depending on the type of project, the assessment may or may not be equal between different units or lots. Some associations use unequal percentages of value based on differing square footage or number of bedrooms.
Planning for Annual Increases
Many associations attempt to avoid increasing the assessments each year. This can be shortsighted. The average annual inflation rate in the United States since 1978 is approximately 3.8%. Many multi-year service contracts for management, lawn and landscaping, or snow removal have built-in 2% annual increases. Attempting to hold the assessment at the same amount over several years results in a budget that is progressively more inadequate. This eventually causes the budget and the assessment to jump abruptly, frequently 25% or more in a single year. It is better for members’ own household budgeting if the association’s budget increases 3-4% per year, rather than significant periodic increases.
Contributing to Reserves
For associations with maintenance responsibilities, it is essential that the budget include contribution to the reserve fund for major repairs and replacements of common elements or common areas. For condominium associations, the Michigan Administrative Code requires the associations to maintain 10% of their budget. R 559.511(1) states:
Rule 511. (1) The bylaws shall provide that the association of co-owners shall maintain a reserve fund for major repairs and replacement of common elements in accordance with section 105 of the act. The co-owners’ association shall maintain a reserve fund which, at a minimum, shall be equal to 10% of the association’s current annual budget on a noncumulative basis.
“Noncumulative” means only for a single year, meaning that an association need not contribute every year if it is maintaining the minimum. However, mortgage underwriters frequently require that the association contribute a minimum of 10% each year, without regard to the amount on hand from any previous years. Therefore, we recommend that associations contribute to reserves in every annual budget.
A 10% contribution to reserves will frequently be inadequate. R 559.511(4) continues:
(4) The following statement shall be contained in the bylaws: “The minimum standard required by this section may prove to be inadequate for a particular project. The association of co-owners should carefully analyze their condominium project to determine if a greater amount should be set aside, or if additional reserve funds should be established for other purposes.”
For associations which are required to have a reserve study, or have elected to complete one, it is essential that each annual budget fully funds the contribution goals in the reserve study. For associations without a reserve study, the board must make a realistic assessment of the association’s future needs for major repairs and replacement. This is important for any association which is responsible for road replacement, and particularly for attached projects which are responsible for roofs and siding. We are aware of associations contributing 40% of the annual budget to maintenance reserves.
Additional Assessments
Most associations have provisions allowing for additional assessments over and above the budget. Standard governing documents language may state:
If the Board of Directors at any time determines in its sole discretion that the assessments levied are or may prove to be insufficient:
-
-
- to pay the costs of operation, management, maintenance, and repair of the project;
- to provide replacements for existing Common Elements;
- to provide additions to the Common Elements not exceeding ten percent (10%) of the annual budget, or
- in the event of emergencies,
-
The Board of Directors shall have the authority to increase the general assessment or to levy such additional or special assessments without member approval as it shall deem to be necessary.
Additional assessments should be the exception and not the rule. They often indicate that the base budget is inadequate and should be increased.
Some associations, to avoid increasing the base assessment and appeal to prospective purchasers, have implemented a 13-month assessment schedule. One additional assessment is due either in a specified month, or at the members’ discretion throughout the year. For prospective purchasers, this is counterproductive. The mortgage underwriter’s status letter will require disclosure of any additional assessments, and the reason for the assessment. In this case, the reason will be that the base budget is inadequate. Any additional assessment, not earmarked for a particular project, and which continues from year to year, should be rolled into the base budget.
We Can Help
Do you have budget or assessment concerns with your condominium or homeowners association? Our attorneys have decades of experience with these matters. Please call us at (248) 349-6203 or email us using the contact form.
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