In The Black Explaining Common Condo and Co-op Budget Terminology

In The Black

Taking care of a condo or co-op building’s budget and finances is a big job. Handling such large sums of money is an important responsibility, and not every shareholder or unit owner has the expertise to do the job well. Sure, most people know the that the amount of money going out shouldn’t exceed the amount of money coming in, and people with even a small amount of financial experience know the difference between the capital budget and the operating budget.

But it’s much more complicated than that. And because it is so complicated, running a community's books often becomes a joint effort, involving the board, manager, accountant and others. In addition to solid help, another key part of the process is knowing some basic terms and concepts that apply to multifamily communities, whether condo, co-op, or HOA.

First Things First

First, let’s look at some of the main components of a typical co-op or condo building’s financial profile. According to Richard Montanye, CPA, a partner at the tax consulting and accounting firm of Marin & Montanye, LLP in Uniondale, New York, these include working capital position, available cash, capital reserves, long-term debt and budget status.

Put another way, “Associations generally follow the principles of fund accounting,” says Jules Frankel, CPA, MBA, a shareholder at Wilkin & Guttenplan, P.C., a certified public accounting and consulting firm with offices in East Brunswick, New Jersey and Manhattan. "The best way to think about fund accounting is to think about the 'envelope system' your parents or grandparents used. One envelope was for rent, one for food, and one for utilities. Instead, associations' envelopes are operating, replacement and deferred maintenance funds."

Each of these 'envelopes,' major funds, are set aside and represent certain expenditures. For example, monies in the operating fund are set aside for items such as landscaping, property management, and insurance. "The deferred maintenance fund is money the association may not spend every year, but is for repairs," says David Ferullo, a partner at The Curchin Group, an accounting firm in Red Bank. "For example, perhaps the association is planning on painting the building in three years’ time that will cost the association around $30,000. Accordingly the deferred maintenance budget is $10,000 each year in the fund. When the association is ready to paint the building in three years, the monies will be available."

The replacement fund is monies set aside for the major repair and replacement of common elements. "Condominium associations have replacement funds, but co-op boards tend not to include a replacement fund in their budget," says Ferullo. "Co-ops have a stronger ability to borrow money from lending sources and repay them."

Budgeting for co-op, condo or HOA communities actually involves not one, but two budgets, each covering a specific range of expenditures. Recurring (and more or less predictable) expenses such as taxes, utilities, staff salaries, insurance and maintenance are the line items most frequently found in the operating budget. Major projects, and long term plans, and emergency funds are budgeted for in the capital budget and those items will vary, depending on the individual community’s needs, wants, and means.

“You have to be realistic about what those fixed costs are going to be,” says Amanda C. Brady, CPA, a manager at Wilkin & Guttenplan. “You need to look at what your replacement fund is. You know that you have to have insurance, you know that you have to have certain items, that you have to have a managing agency. You have to look at what those fixed costs are in order to be very realistic about how you're going to come up with what your maintenance fee is going to be for the year,” she says.

Much of the information needed to formulate a sensible budget can be found in a co-op or condo development’s financial statements. These include the balance sheet (reporting assets and liabilities); a statement of revenues, expense and accumulated surplus or deficit; the statement of cash flows (a reconciliation of the balance of cash at the beginning of the year to the balance at the end of the year); notes to financial statements and more.

There are also important differences between a co-op’s finances and those of a condo or HOA. Abe Kleiman, CPA, managing partner with the accounting firm of Kleiman & Weinshank, LLP in Manhattan, gives a good rundown of how things work in each type of development.

In co-ops:

• A corporation owns the property.

• Tenant-shareholders own stock in the corporation, with a “landlord-tenant relationship” between the corporation and the shareholders.

• The corporation is governed by an elected board of directors, and transfer of stock requires board approval.

• The corporation usually has an underlying mortgage on the property.

• Maintenance charges include operating expenses, debt service on an underlying mortgage and real estate taxes on the property.

• Tenant-shareholders are able to deduct their share of mortgage interest and real estate taxes paid by the corporation.

In condos, on the other hand:

• The association manages the property on behalf of all unit owners.

• Unit owners own the individual condo units, which are real property, along with a portion of the common elements.

• The association is governed by an elected board of managers, and transfer of units does not require board approval, although the board may have a right of first refusal.

• Condo associations cannot borrow as easily as co-ops (because the condo association does not own the property), and common charges cover the operating cost of the condominium.

More Basic Concepts

Let’s delve a little further into the subject. As we’ve mentioned, one important difference is that a co-op may find it easier to get loans because it has the buildings and the land on which they stand as collateral.

In a condo, on the other hand, its ability to borrow is based on cash flow, according to Carl Cesarano, CPA, a principal with the accounting firm of Cesarano & Khan, P.C., in Floral Park, New York. “In condos,” he says, “getting financing is a whole different ball game. You are budgeting a surplus.”

Whatever type of building you have, there are several basic budgeting concepts that the average board member should understand in order to effectively manage that community’s finances. Again, the pros say, it can be broken down into several basic points.

• The annual operating budget must be balanced. Operating costs must be covered by maintenance or common charges from owners and other regular sources of income.

• The development should establish a long-term capital budget (5 to 10 years), and should budget for future repairs and replacements.

• Capital budgeting should also include a funding plan (regular assessments, periodic special assessments, earmarking specific sources of revenue such as transfer fees, borrowing, etc.).

One financial pro adds that, in his opinion, accrual budgeting is a better system than cash budgeting. “In a cash system,” he says, “you wouldn’t see bills unless you had paid them.” You also wouldn’t see payments until they are actually received.

In an accrual system, on the other hand, income is counted when the sale occurs, even if you haven’t received it yet, and expenses are counted when you receive goods and services, even if you haven’t made a payment yet. In addition to how much you have on hand, an accrual system also includes how much you owe and how much you’re entitled to.

The Budget Process

How does a board begin their budget for the coming fiscal year?

To begin with, they don’t start from scratch. They use the past year’s budget as a starting point. Then, they typically factor in predictions and expected changes, such as changes in real estate taxes (for co-ops), union contracts (which affect the wages paid to building or association staff), fuel costs, changes in assessed value of real estate and changes in water and sewer rates, and insurance premiums, for example.

Expected expenses should also be factored in. Repairs, wind or storm damage, painting, roofing, pool resurfacing and other restoration projects are paid from the capital budget. When a board is underfunded (as many were in the recent recession) special assessments may be required to fund capital projects, however, most boards will take a proactive stance to avoid special assessments whenever possible. So who is best qualified to help determine future cost for big projects in the budget?

All the pros we spoke to stress that predictions are just that—predictions. Projecting a budget is not an exact science. "Things happen after the budgets are completed, and even though you want a financial cushion, some events are beyond our control,” says one financial professional. “For example, often blizzards force associations to exceed the snow removal budget and a special assessment has to be made. Unfortunately, we don't have a crystal ball when we do a budget.”

According to Cesarano, a typical operating budget worksheet, and all sorts of expenses, both past and projected, are represented: Wages, payroll taxes, employee benefits, real estate taxes, interest expense, pre-payment premium, fuel, utilities, water and sewer, repair and maintenance, supplies, insurance, management fees, professional fees, licenses and permits, state and local franchise taxes and “other.”

Expertise

Clearly, budgeting is a complex undertaking that isn’t for novices. Buildings and HOAs definitely need to have a professional to guide their decisions. In most cases, the management company retains outside accountants who are often consulted for important transactions, such as sale or acquisition of units, funding of capital projects or assessments.

Self-managed buildings typically deal directly with their outside accountant. “Self-managed buildings actually need their professional more,” says Montanye, “since they do not have an experienced agent to rely upon.”

Some pros add that in addition to hired accountants, these buildings often also rely on residents who have relevant experience, and either ran a company or were an educator or retired school administrator, for example.

For Cesarano, the budgeting and financial process for co-ops and condos works best as a team effort. A sample “Financial Activities Organizational Chart” typically starts with the board of directors (for a co-op) or a Board of Managers (for a condo) at the top, and goes on to include the managing agent, the treasurer, the assistant treasurer, the finance committee, the CPA, the attorney and the engineer.

“Every co-op and condo should build a team of professionals,” he says. “The budgeting process should start with the manager, then have the team look at it. The accountant should be part of the team—the accountant is also the auditor and he has a lot of expertise. You need the expertise of an engineer. If there’s a tax certiorari attorney, get him on the team. Let your board look at it—they’re the real management. If you have your team in place, then you’ll come up with a good product.”

Everyone Makes Mistakes

What are some of the most common mistakes that boards make in terms of budgets?

Montanye feels that the most common mistake is having unrealistic expectations. “Sometimes boards will ignore professional advice and projections in favor of lower maintenance,” he says. “This makes subsequent decisions more difficult, since they first have to make up for a loss and then fund a much larger deficit which had been ignored previously.”

Many CPAs say that one of the most common errors boards make when it comes to budgets is “reliance on property managers’ internal control structures—those are different at different property management firms. It’s important that the board monitor the property manager, monitor bills over a certain amount and make sure reserves are being used appropriately.

Other common mistakes include deferring or avoiding maintenance increases, budgeting a deficit, failing to establish a long-term capital budget, and failing to fund future repairs and replacements that were identified in a long-term capital budget.

To help avoid these and similar problems, professionals recommend that board members keep close to the process, attend meetings, pay attention to details, don’t be afraid to ask questions, and seek the advice of your management company and your professionals (attorneys, accountants, engineers) whenever needed. Also, make sure your operating budget is balanced, remember to establish a long-term capital budget and have a realistic funding plan.

The Info Is Out There

If you need more information on the subject, there’s plenty out there. To begin with, organizations such as the New Jersey chapter of the Community Associations Institute (CAI-NJ) or the Pennsylvania-Delaware Valley chapter of CAI (CAI-PADELVAL), which serves Southern New Jersey, are specific professional organizations that assist community associations. CAI-NJ and CAI-PADELVAL both publish directories of credentialed professionals that can help to locate a certified reserve specialist, or the chapters can refer an association to a qualified professional in their area.

Resources that can be accessed to help put together your budget are also online. Utilities such as the Public Service Electric and Gas Company (PSE&G) have data on trends in natural gas pricing, with projections. Union contracts are also found online.

Of course, every building should have a CPA that they can rely on. Many CPAs and financial advisors host webinars and have many videos on their website on related topics, such as the “Budget Process for Cooperatives and Condominiums,” “Maximizing Other Revenue in Your Cooperative or Condominium,” and “Funding Requirements for Cooperatives and Condominiums.” Publications like The New Jersey Cooperator (www.njcooperator.com) have ample material on its website as well.

Whether you're professionally managed or do-it-yourself, finance and budgeting for your community means planning ahead, keeping good records, having adequate supervision and being familiar with your building or development.     

Raanan Geberer is a freelance writer and a frequent contributor to The New Jersey Cooperator.

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