By Curtis G. Kimble.
Richards, Kimble and Winn held a brief seminar with Alan Seilhammer, Premier Association Lending, the other night where Alan discussed with many board members and managers the process of obtaining an HOA specific loan. An HOA loan is not the answer to all of an association’s problems, it isn’t even the best choice in many cases, but it can be the best choice in certain situations. It’s an important tool in any association’s financial toolbox. Here’s a brief synopsis of Alan’s PowerPoint and of our discussion:
There are three unalterable truths when it comes to HOA maintenance:
1. The project will not go away.
2. The project will not get cheaper.
3. Whether by reserves, special assessment or a loan, the money comes from the owners.
Because of these truths, when property condition reports and reserve studies uncover problems which require major capital expenditures, it’s important to deal with them. At the outset of any major maintenance project, the scope of the project must be defined, the options available and priorities must be known and understood (is insurance available, ramifications of not addressing entire project, etc.), legal issues must be known or anticipated, and funding options must be evaluated. An evaluation of project funding options depends upon the project budget, project schedule, governing documents, legal review, and current cash reserves, among other things.
- Utilize association’s reserves.
- Special assessment.
What Can be Funded?
1. Most anything you can imagine. Funding tools have become rather sophisticated.
a. Capital maintenance projects are most common.
b. Construction defects are largely the same but are thought of differently.
c. Litigation Expenses: Construct defect, unconscionable leases.
d. Real estate purchases: Units, contiguous property.
e. Buy out of land leases.
f. Emergency line of credit.
g. Operating line of credit for a business need.
2. Operating Expenses are most often not fundable
a. An association with an operating deficit needs to solve that problem internally
b. Insurance premiums can be funded within the fiscal year: 10 months
c. Emergency operating needs depending on the circumstance.
Why You Do Not Want to Wait Until Later:
- Multi-family construction costs increased nationally 37.4% between 2008 and 2012.
- Construction costs are forecast to increase 5.5% in 2013.
- Association investments currently yield less than 1%.
- Loan Rates are about 4.0% – 4.75% & holding steady.
What is Used For Collateral?
1. Assignment of association’s regular and special assessments. Generally an association’s regular deposits should not be posted as collateral since the association needs access to its liquidity.
2. There is no lien or mortgage on the common area or property of the association or any unit (unless purchasing real estate as part of the transaction).
General Loan Parameters:
1. Term. 1 to 15 years.
2. Points. A fee of .5% to 1% (can often be negotiated away).
3. Rate. Interest you pay on the loan. Fixed and variable interest rate programs available.
4. No prepayment penalties for paying before the term ends. Because of this, there is inherent flexibility allowing the association to payoff the loan when it suits them. HOA loans are often for a 10 year term, but most are paid off after around 6 years.
5. Typical Structure. Initially a “non-revolving” line of credit during construction phase of 6 months to 1 year. Converts to a variable or fixed rate term when construction is completed.
6. Interest rate may be reduced if association maintains its other accounts with the bank.
Loan Parameters to Avoid:
1. Pre-payment penalties of any kind.
2. Interest rates that are hard to understand (SWAP rate, etc.).
3. Yield maintenance fee.
4. Changed financial statement requirements.
5. Approval of contractors.
6. Control of deposit accounts or a requirement that operating accounts are to be held at the bank.
7. Balloon payments.
8. Payable on demand.
9. Loan default if delinquencies are over some number (know all the events of default).
10. A debt coverage ratio.
There’s no question a reserve fund is the funding option of choice for major maintenance projects. But when that’s not an option, a special assessment could be inevitable. Unfortunately, special assessments are fraught with risks and are fundamentally unfair because only the owners at a specific date have to pay for improvements that benefited past and future owners. A bank loan is definitely a viable option for funding a project. While evaluating your possible maintenance project funding sources, make sure you understand the association’s options, including the possibility of a bank loan.