Mastering your capital improvement project
Capital improvements are essential for maintaining the relevance of your community and enhancing the value of properties. However, navigating the challenges and expenses associated with significant upgrades, renovations, replacements, and repairs can be daunting for many associations. Discover how to effectively handle a capital improvement project, reserve studies, and funding strategies to ensure a successful management process.
What repairs are considered capital improvements?
A major replacement or repair can be considered a capital improvement project if it increases a component’s market value beyond its original or current state. In general, it is intended to lower future operational costs (such as maintenance or utility costs) or enhance residents’ quality of life.
Capital improvements may initially appear challenging, yet they are crucial for elevating the quality of life in your community. These efforts are designed to enhance service quality for residents, while also aiming to decrease operational expenses over time. Such initiatives encompass various upgrades, including the adoption of energy-efficient heating and cooling systems, roof refurbishments, and the integration of LED lighting. These capital improvement projects are essential for preserving and enhancing property values as well as ensuring the satisfaction of residents.
The best way to know how a capital improvement needs to be defined and, if necessary, approved for is to check your community’s governing documents and involve your association’s attorney. For reference, here is a common definition that applies to many associations:
Capital improvements are meant to last more than a year and usually cost over $10,000. However, they can save your association money in the long run by keeping your property relevant and in tip-top shape, resulting in better resident experiences and property values.
Preventive maintenance: capital improvement’s close cousin.
In contrast to capital improvements, preventive maintenance is generally less costly and performed more frequently. They are funded from your association’s operational budget under the line item “Repairs and Maintenance (R&M),” and they are meant to restore your major components (or “assets”) to their original condition or prevent them from deteriorating further.
Adhering to the preventive maintenance schedule outlined by the manufacturer or installing contractor for a component enhances the possibility of that component achieving, or even surpassing, its projected lifespan—that is, the duration it is expected to function as intended. Extending the useful life of a component means postponing the need for replacement or significant repairs, ultimately leading to financial savings for your organization.
However, there are caveats. “Sometimes, repairs to an older component can get very expensive; in fact, it may cost less to replace the component altogether,” said Christopher L. Pappas, senior vice president at FirstService Residential. “If the repairs cost about the same or are more than a replacement, you should replace the component. The new component may even be tax deductible, or you may get a tax incentive.” New equipment may also come with a manufacturer’s warranty, be more energy efficient, and have a longer life expectancy.
In some instances, maintenance jobs can turn into capital improvement projects unexpectedly. For example, roof damage could appear to require a simple repair, but further inspection might reveal that the entire roof needs to be replaced.
The role of reserve studies.
A reserve study allows you to plan and budget for capital improvement projects over the next 20 to 30 years. A specialist from a reserve study firm (preferably an engineer) should conduct the study, which consists of:
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A physical analysis. The reserve specialist performs a site inspection to assess the condition of common-area assets within your community, such as clubhouses, lobbies and pool areas. Based on this assessment, they estimate the remaining useful life and make recommendations for their repair or replacement.
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A financial analysis. After the site inspection, the reserve specialist estimates the cost for each repair or replacement as well as any additional improvements (like adding a playground or expanding the fitness center). Based on these costs and your current reserves, the reserve specialist recommends a funding plan and calculates the monthly contribution required from each homeowner.
In most areas, the developer would have provided your association with an initial reserve study at the time the property was transitioned to a residential board, but you should get the study updated regularly. “Keep in mind that some states have laws in place that mandate the frequency,” said Karla Chung, vice president of FirstService Financial. “Whether your state does or doesn’t, you should still plan to update your reserve study every 3 to 5 years and after you complete a capital improvement project.”
Additionally, it's vital to conduct an annual review of your study to ensure the suggested funding remains precise. Variations in labor or material expenses, unforeseen occurrences like natural disasters, and a rise in delinquencies can modify your financial requirements.
Given that a reserve study does not offer an exhaustive scope of work, it's recommended to pursue a deeper analysis through a "conditions study" or "conditions assessment" approximately one to two years prior to the anticipated end of a component's useful life. This thorough examination will furnish a more precise understanding of the necessary work and associated costs. For such detailed assessments, consulting with local professionals like contractors, engineers, and architects is recommended.
Paying for a community project.
Once you’re ready to start a project, you need to determine how your association will pay for it. You have several options:
Your reserve fund. The first source you should tap into is your association’s reserve fund. Hopefully, you’ve been following your reserve study’s recommendations and putting the appropriate amount of money aside. Choosing the right type of account for your reserve fund is important, too. Since your board has a fiduciary duty to your homeowners, it’s imperative that you protect the money they are entrusting you with. However, that doesn’t mean putting it in a checking account that yields no interest. With an integrated approach to long-term reserve fund management, FirstService Financial provides multiple products through various financial institutions to ensure that liquidity needs are met while maximizing interest yield and principal protection. “Over the years, we’ve helped multiple associations increase their returns on their reserve funds by moving their funds to safe, high yield accounts like CDs,” said Chung.
What happens when your reserves fall short of covering necessary expenses? Unfortunately, numerous associations fail to put sufficient funds into their reserves. Boards are hesitant to raise assessments due to rising costs, largely due to anticipated backlash from homeowners. Prioritizing the immediate financial demands of day-to-day operations, they often opt to cut costs by decreasing the allocation for future project funding.
Besides leaving you with an inadequate amount of money for needed repairs and upgrades, underfunding your reserves can have other serious consequences. For one thing, it can negatively affect property values. Not being able to replace items like roofs, major equipment, and sidewalks will lower property values. In addition, it can dissuade prospective homebuyers from moving into your community or building, especially those who plan to pay for their home with a Federal Housing Authority (FHA) loan. Even if your association has been diligent in funding your reserves, an unforeseen event or long-term crisis, such as a pandemic, can have a big impact — especially if it is not covered by insurance. Lastly, your association may realize that enhancing amenities is the only way to compete with communities or condos being built in your area. Whatever the reasons for your shortfall, you do have other funding options, which you can use individually or in combination.
Loans. Loans have become increasingly common for funding capital improvements in recent years, a trend that has been mirrored at FirstService Financial. “From 2012 to 2018, the number of loans we helped associations obtain rose from 2 to 78.” said Chung. “And over the past 20 years, FirstService Financial has facilitated more than $2 billion in loans, overseeing the entire lending process – from negotiation to closing.”
One of the advantages of taking out a loan is that you have the money immediately. A loan can also help you fill a gap in your reserve fund or in the amount you’re able to collect up front when homeowners pay a special assessment in installments. You can even take out a loan for the full amount of the project and then use a special assessment to pay it back.
Before determining if a loan is the right option for your community, make sure to consult with your association attorney as some governing documents require a membership vote before securing a loan.
Increased dues. Typically, increasing dues or levying a special assessment are two additional ways to cover the cost of a capital improvement project. Even under the best circumstances, both options tend to be the least popular among homeowners.
Certain communities are fortunate to have remained financially stable, even amid economic downturns and various crises. In such fortunate communities, the option to raise membership fees or implement a special levy might be a feasible method for fund augmentation. On the contrary, communities situated in areas more severely affected by economic troubles may find their residents grappling with the burden of existing dues, rendering any potential hikes in these fees as seemingly insurmountable. Therefore, in times of economic distress or during any crisis, the decision to increase dues or impose a special levy should be approached with careful consideration and empathy.
Remember that for an association to operate effectively and manage ongoing capital projects and maintenance costs, it is critical that you make regular and incremental dues increases. When raising dues, communicate why these increases must occur, so that residents expect them. Work with your management company to draft appropriate and effective communications around any dues increases.
For special assessments, offsetting the financial burden by allowing residents to pay it in installments can make a special assessment more manageable. Keep in mind, however, that since you won’t have the entire balance of the special assessment right away, you may have to either delay work until you do or align installments with the contractor’s payment schedule.
Insurance. Although insurance can’t pay for a planned capital improvement, inadequate coverage can result in unanticipated capital expenses. Make sure you are properly covering assets that may be susceptible to damage from weather or other mishaps.
Capital improvements not only affect your community or building’s health and reputation, but also homeowners’ wallets. That’s why you need to prioritize projects appropriately and communicate with association members from the beginning. It’s also crucial to create a plan prior to starting each capital improvement project, to have a professional managing the project and to communicate with residents about the project’s status as work progresses.
Conclusion.
Capital improvements are crucial for preserving the significance and boosting the market values of community properties. While these upgrades come with their own set of challenges and expenses, it is crucial for board members to grasp the details of these vital enhancements. Understanding the importance of preventive maintenance, undertaking comprehensive reserve studies, and establishing solid funding plans are key steps for communities to effectively manage capital improvements. Through forward-thinking management and careful planning, such initiatives not only safeguard the future of the property but also play a significant role in its continued development and financial health over time.