Stock Market Is No Place for a Condo Association's Reserve Funds

In our example, at the least the board must include $17,666 into the calculations for the next year's budget to reserve for anticipated major repairs. That means that every owner would pay his percentage share of the entire budget and a portion of the condominium fee would be earmarked for reserves.

Obviously, every association has different needs and different concerns. But the bottom line is that to properly plan ahead, the association must include money for reserves in the operating budget. This money should then be deposited in a separate, secure, interest-bearing investment, such as a Treasury bill or other government insured fund. It cannot be commingled with the association's operating account, nor can it be invested in high-risk stocks (or even "blue chips," where there is even a remote chance of risk).

No magic formula determines how much is adequate. However, a reserve analysis study -- performed at least once every five years -- will guide the board.

If reserve funds are not available when money is needed, what can the board of directors do? Oversimplified, there are three other ways to raise money in a community association:

• Increase monthly assessments. However, if the association needs the money immediately and it is not there, the regular assessments may not come in fast enough.

• Levy special assessments. In most associations, the governing legal documents authorize the board of directors to impose a special assessment on all owners. In our example, if the board immediately needed $90,000 to replace a defective roof, and if there are 150 owners in the complex, this would require each owner to pay $600 immediately. Keep in mind that assessments are usually calculated based on the percentage interest that each owner has in the association. While the amount of the special assessment will vary, the fact remains that each owner may be required to pay up immediately. Wouldn't you rather pay a few dollars toward reserves each month instead?

• Get a loan. Many associations are taking advantage of this approach, and banks have started making loans to associations. However, there are a lot of legal and financial hurdles, and it takes time for a bank to commit to a loan.

There are two additional reasons why adequate reserves are important. First, if you want to sell your unit -- or refinance it -- most lenders will want to review your association's reserve situation. If reserves are inadequate, the lender may reject the loan application. Second, as I discussed earlier, if you ever go to sell your unit, potential purchasers, if they care enough to carefully review the association's budget, may be turned off if the level of reserves in the association does not appear adequate.

According to the CAI report, "Owners are often reluctant to contribute to reserve funds because they think the funds are costing them extra money. To convince these owners of the need for reserves, the association must make them understand that a reserve fund is not an extra expense -- it just spreads out association expenses more evenly. Equipment and major components must be replaced, whether the expense is planned or not."

Boards of directors have a fiduciary obligation to the owners who elected them to make sure that the budget they prepare is adequate, which includes appropriate reserves. This also means that your board must make sure that these funds are available when needed. Investing in the stock market is completely inappropriate.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, Suite 1100, 1050 17th St. NW, Washington, D.C. 20036. Readers may also send questions to him at that address.