By Gary Porter, CPA, RS, FMP
Today, the entire country is experiencing an unprecedented challenge. The COVID-19 pandemic has completely shut down major sectors of the economy and is affecting the entire economy. For associations, the impact is significant uncertainty related to collection of assessments, vendor service levels, ability to pay or retain employees, and potentially even the continuity of the organization.
The economic severity will depend for the short term on the duration of the “shelter in place” rules, and for the longer term on the public’s comfort level with returning to a future “normal” that will be different from the “normal” of the past.
The unprecedented spike in unemployment caused by the coronavirus has created a volatile economic climate, placing cash flow from associations’ assessment revenues at risk. In addition, uncertainty remains regarding associations qualifying for a Paycheck Protection Program loan under the Coronavirus Aid, Relief, and. Economic Security (CARES) Act, and bureaucratic delays in the Small Business Administration’s Economic Injury Disaster Loan program. As a result, several associations have inquired about their ability to support operations through “internal financing” in this time of crisis by gaining access to their reserve funds.
Accessing reserve funds
Three possible ways exist to access reserve funds:
- Decrease future reserve funding for up to three years.
- Eliminate future reserve funding for up to three years.
- Borrow from the existing reserve balance.
An association also could combine the three activities over the short term (three years), but you should never consider this unless all other avenues of funding have failed.
Weighing the options
An association’s operating budget takes precedence over the reserve budget, particularly during a crisis. Failing adequately to fund reserves to at least a baseline level can result in increased future costs and, potentially, a complete failure of the association over the long term.
Budgets for 2020 were developed in an atmosphere that did not contemplate the global pandemic we now are experiencing. Given this new reality, associations should consider all means of funding the operating budget at an emergency level sufficient to continue the association’s vital operations.
The reserve fund is not a slush fund, but for most associations it does represent a large amount of cash set aside for future major repairs and replacements, some of which may be decades in the future. This gives the association an opportunity to evaluate the reserve fund to see if any of it may be used on an emergency basis to fund day-to-day operations. Justifying set-aside funding for a roof replacement 20 years from now is difficult when you can’t pay utility bills today.
Avoiding potential risks
To avoid the many potential risks, associations must proceed very carefully.
The first step is to determine the legal authority for taking such an action. The second step is to determine if reserve funds are available to access for emergency operating purposes.
When attempting to determine legal authority for accessing reserve funds you should:
- Consider restrictions in state law.
- Consider restrictions in your governing documents.
- Consult with legal counsel—always.
Don’t even consider going down this road unless you can put all of these pieces together.
Evaluating the reserve fund means comparing the current balance and projected assessments to projected expenditures. Expenditures are the controlling factor, so look at them first. Are any reserve projects scheduled during the next three years that you can postpone without further property damage?
If so, consider alternate funding plans that postpone those expenditures and allow the association to reallocate the budget to decrease reserve assessments and increase operating assessments. To document their due diligence in making this unprecedented decision, the board must obtain a revised reserve study.
Focus on cash flow
The association must make sure cash flow is adequate to cover the remaining reserve projects planned during the next three years and also plan for a “make-up” reserve assessment level for later years. The reserve funds diverted now should be repaid at a future date as economic conditions improve. Remember, the reserve expenses don’t go away; you’re just shifting the timing of when they occur.
In evaluating your reserve funding during this critical period, cash flow is the only thing that matters. Forget the concept of percent funded in this analysis. Percent funded is a crude tool that some use to evaluate the adequacy of the reserve balance, but it cannot take the place of the cash-flow analysis and has no place in this situation.
We always recommend against “raiding” reserve funds for operating purposes, but in times of emergency, exceptions can be made. Consult with your professionals to see if this is an option for your association.
Gary Porter is chief executive officer of Facilities Advisors International, a reserve-study company with offices nationwide that provides reserve-study services and software in the U.S. and several other countries. Mr. Porter holds the RS (Reserve Specialist) and FMP (Facilities Management Professional) credentials and is also a CPA. Porter & Lasiewicz CPAs has offices in California and Nevada and provides audit and tax services to associations in more than 30 states.
Porter has a long record of industry leadership. He is a past national president of the Community Associations Institute (CAI), president of the International Capital Budgeting Institute, co-author of Reserve Studies – The Complete Guide, and author of more than 300 articles. He has been published or quoted in The Wall Street Journal, Money Magazine, Kiplinger’s Personal Finance, and TimeSharing Today.