Kourosh Khoylou Podcast
Navigating Reserve Studies and Financial Planning for Community Associations with Scott Clements
Unlock the secrets to effective community association management with insights from Scott Clements, CEO of Reserve Studies, Incorporated. Discover the essential fiduciary responsibilities of board members and learn how 12 states in the U.S. now mandate comprehensive reserve analysis to safeguard the longevity and financial health of properties. Scott dives into the complexities of interpreting financial reserves, the impact of aging properties, and how modern construction trends necessitate frequent updates to maintain property value and safety.
Pest control management is a critical aspect often overlooked in community associations, especially for wood structures. Our discussion covers the varying needs of different building materials, the importance of regular fumigation cycles, and the financial planning required for effective pest control. Learn from Scott about the impact of environmental factors like ocean proximity on wood moisture levels and pest infestations, and why it's crucial to consult with pest control experts and reserve analysts to craft a tailored maintenance plan.
Financial prudence is paramount for Homeowners Associations (HOAs), and this episode sheds light on predictive funding strategies, the challenge of underfunding reserves, and the ripple effects of inflation on HOA costs. We explore the changes in standards set by the Community Associations Institute (CAI), the critical need for regular updates to reserve studies, and the implications for FHA loans. Scott also shares valuable advice on managing special assessments, understanding the financial health of an HOA, and the broader impacts on property sales and financing. This episode is a must-listen for anyone involved in community association management, offering actionable insights and foresight to navigate the complexities of reserve studies and financial planning.
Unlock the secrets to effective community association management with insights from Scott Clements, CEO of Reserve Studies, Incorporated. Discover the essential fiduciary responsibilities of board members and learn how 12 states in the U.S. now mandate comprehensive reserve analysis to safeguard the longevity and financial health of properties. Scott dives into the complexities of interpreting financial reserves, the impact of aging properties, and how modern construction trends necessitate frequent updates to maintain property value and safety.
Pest control management is a critical aspect often overlooked in community associations, especially for wood structures. Our discussion covers the varying needs of different building materials, the importance of regular fumigation cycles, and the financial planning required for effective pest control. Learn from Scott about the impact of environmental factors like ocean proximity on wood moisture levels and pest infestations, and why it's crucial to consult with pest control experts and reserve analysts to craft a tailored maintenance plan.
Financial prudence is paramount for Homeowners Associations (HOAs), and this episode sheds light on predictive funding strategies, the challenge of underfunding reserves, and the ripple effects of inflation on HOA costs. We explore the changes in standards set by the Community Associations Institute (CAI), the critical need for regular updates to reserve studies, and the implications for FHA loans. Scott also shares valuable advice on managing special assessments, understanding the financial health of an HOA, and the broader impacts on property sales and financing. This episode is a must-listen for anyone involved in community association management, offering actionable insights and foresight to navigate the complexities of reserve studies and financial planning.
Hello everyone. Today is May 29th. My guest today is Scott Clements. Scott is the CEO of Reserve Studies, Incorporated. Thanks for coming on the podcast, Scott.
Speaker 2:Yeah, welcome, thank you.
Speaker 1:So just before we started recording you were mentioning that there are 12 states in the United States that now require some sort of reserve analysis done in communities. Is that correct?
Speaker 2:That's correct, the number is up to 12. Community Associations Institute and the Foundation for Community Association Institute Research. They have put together information as recently as 2023 statistics and 12 states now require some requirement of a reserve study, some required annually, some required every three to five years, some are a couple of years. So they vary from state to state because, of course, real estate is regulated on a state by state basis for the most part. But there are 12 states now that require a reserve study of some kind be available in membership and then, of course, in the resale value. There are also 12 states Most of them are the same, but there's a few variances that require some level of reserve funding. So again, the amount most of them use a term sufficient or adequate. So there's a debatable point on how much that is. Generally that would be considered cash flow and we can go into some of the different terms. But whether they require a percent funded, a dollar amount or these more ambiguous sufficient or adequate amounts, they're requiring that money to be set aside. So clearly they recognize the fiduciary duty of a board in any state to have some money set aside for the future because obviously the age and deterioration is inevitable out there. So they recognize that in 12 states. Now we're up to 30 states that require some level of disclosure on resale.
Speaker 2:So when you go to sell an economy, medium association, you're going to have to disclose. Again, it's a reserve status and it varies by state. So, again, whether it's a dollar amount, percent, funded, adequate, sufficient, any other term you want to use you have to indicate where you are. Most of them are dollar amounts. So, again, whether it's 5,000, 500,000, or 5 million, you're going to know how much is in there comparable to your association, whether or not you have the skills to judge if that means anything like. Okay, $50,000 is a lot of money to me, but for a 30-unit apartment building that's 25 years old, that's not a lot of money at all. So being able to understand how much that dollar amount equates into where they are is a whole nother thing, but at least they're recognizing the idea that you should be aware of what your long-term needs are to maintain the property. Again, the Foundation for Community Association Research put out a lot of statistics and I believe one of them was the age of property.
Speaker 2:So, for instance, uh, in los angeles county it's uh, upwards of 74 years old, I think was the number they gave wow, from that so yeah, the average age of uh properties in some of these uh communities uh, we forget, you know, los angeles is is, uh, you know, decades old and centuries old now. Uh, so a lot of the aging infrastructure out there is coming to a point. You know, reserve studies have always been on that 30-year philosophy, which is a long time. So most components last less than 30 years. If you go through almost any kind of dwelling, most of the components are going to last less than 30 years. There are a few, you know, potable piping, drainage piping, electrical circuitry, those kinds of things that are expected to last longer Now, whether that's 75 or 100 years, almost none of that is expected to last more than 100 years.
Speaker 2:So now that we have a lot of homes in these developed areas, whether it's on the East Coast, the West Coast, et cetera obviously the East Coast probably laughs at our 74 number there are, you know, communities hundreds of years old. So the infrastructure within those buildings is going to have to be dealt with because you're having so many of them get into that advanced 75 to 100, in which case, you know, almost nothing is off limits.
Speaker 2:You know, branch circuitry, other things that are, quote, considered lifetime, are going to have to be included. A lot of that has to do with the expectation. You know, prior to, I'll say, the 1950s and 60s, when they built a residential structure, whether it be apartment buildings, single family, the anticipation was about 100 years, like, well, within 100 years we're going to do that. By the 1970s that expectation was down to about 50. So most of the time when they're building they're assuming that, yeah, within 50 years you're going to do a major reconstruction project, so we don't have to make everything last more than 50 years because you're going to do something different with it anyway, whether it's tear it down entirely or, you know, free wall construction, reconstruction.
Speaker 2:It's just not going to be the same 50 years from now. It's a long time in the process, which has turned out to be, for the most part, true. Obviously there are situations where it's the outlier, but, yeah, most people are severely rehabbing their property much sooner than 50 years. So 50 years is a pretty good long timeline but nonetheless, as the saying goes, it's not made like it's used to. Well, it's not designed to. It's not designed to last as long.
Speaker 2:We're using a lot more plastic, less iron, which of course you know has an indefinite life expectancy as far as degradable, but you know it can crack and it can break, it gets brittle, so it's not an indefinite product in almost any application. So any of these infrastructure items again, plumbing supply, plumage, drainage, gas piping, electrical circuitry, certainly roofing whether it's short-term product and by roofing I mean short-term 25, 30 years or long-term products. We have a lot of slate on the East Coast, a lot of material that's designed to last 50, 60, or more years. That now is 50, 60 years old, so the underlayment and the structure underneath it is probably subject to deterioration. So you have a lot of communities of an age where they look great from the outside, they've been well-maintained, they've been painted, all that, but there's just aging infrastructure that's antiquated or starting to fail, that's going to have to be replaced. So these are some of the costs that haven't always been captured. Community Associations Institute changed its standards, updated them in 2023 to put a greater emphasis on that. So there used to be a lot of discussion about 30 plus. Now, if the life expectancy is predictable, so if for the expectancy we'll just use copper, plumbing infrastructure potable drinking water, copper, plumbing. If your expectation is that it's 50 years long time expectancy, all right. Well, from day one it should be in the report. So you start down 49, 48, et cetera. Don't wait for that 21 years where it comes into the window and is now less than 30 years. California and other states have requirements for less than 30 years life expectancy funding. So that's been a big milestone in the industry. But the idea is well, why do we wait? If it's predictable, then let's start at day one, no matter how long it lasts.
Speaker 2:The other thing is to make sure you get a lot of things in there, even if they're placeholders. So I'll use the here in California and all over the country, but particularly here in Southern California. We use a lot of natural gas, so there are a lot of natural gas systems out there. Natural gas itself is non-corrosive, unless it's in an ocean environment and failed to be maintained. It generally lasts the life of the building, but eventually it's going to wear out, deteriorate and you're going to restructure the property in such a way that's probably going to require it. Not to mention there may be new technologies or in some cases, specifically in California, where they're discontinuing the use of this product natural gas in small appliances because of its climate impact. So nonetheless, there will be changes of some time that this natural gas systems will have to be replaced eventually, but at what point?
Speaker 2:So at this point I would say, if you're in a 20, 30, 40 year old building, probably still not even predictable in the next 30 years, in the next four years, when it's going to happen. So it's fine to put that as a 30 plus no funding and we'll wait till we get more information before putting that kind of liability on the association. But people have always shied away from putting in immediate funding because they think it adds this massive liability. Well, you know, quite frankly, a roof, frankly, a roof that depreciates over 30 years, might cost less than your water heater just because it only lasts seven to 10 years. So you have to look at the cost and how long it lasts when you're talking about the total annual cost and value. So a lot of these components, you can't estimate it. So that's fine, but let's put it in the report, let's put it 30 plus. And so last year the CAI standards were updated to emphasize let's put it in there. If we can identify it, start funding immediately. If not, then put it in as a placeholder because eventually it's going to have to be replaced. So that still will fall through the industry over a few years as evolution takes on.
Speaker 2:But you should start to see more components come into a reserve study, particularly the infrastructure, as I mentioned earlier, those that operate in California and there are some other states that are requiring the use of electrical EV chargers and other things. They're getting very popular in many communities, so they're going to be part of the establishment moving forward. Well, obviously, a lot of these homes, particularly the ones that are more than I'll say 30 years old, they weren't built for the power consumption that these EV chargers are going to need to function. So a lot of these committees are going to have to bring in, you know, updated power sources, rework their power or bring in new dedicated lines in order to service this new generation of EV chargers and e-bikes and all the other things that we enjoy. So again, they weren't built with this in mind, but now they're going to have to adapt.
Speaker 2:Currently, there are standards for a lot of new construction that require it. There's only a few states that are starting to require it for existing construction, but the marketplace will dictate that as well. Right, we work in the rental market here and, yeah, if you want to get, you know, class A rents in the high rent districts, then yeah, you're going to have an F&B EV charger. Right, you know those beautiful Gen Zers, they're not going to pay $4,000 a month for an apartment if it doesn't have, you know, ev parking. That's just. You know their, their consumer pattern. So the market will dictate what a lot of that drives, but nonetheless, that market is moving that way, whether it be market sources or regulatory requirements or limitations that push it that way.
Speaker 1:That's the way that it's moving and then you mentioned structure here in southern california. So there's, so we have termites here in Southern California. So where would the structure in terms of you know, say there's termite damage and it needs to be replaced, or would that also come out of the reserves and do we expect that to be a part of reserves component from now on?
Speaker 2:Yeah, again, that's prudent to budget for. There are, I'll say, varied methodologies to how you would include it. Our company, reserve Stays Incorporated has always just included it as a cycle, generally speaking. If you talk to pest control operators they'll tell you in the environment we work in Southern California about 12 to 15-year cycles. The closer you get to the ocean, you know, the wood's a little softer, the moisture is a little higher. As you get out to the outlying and the desert areas, again a little drier. So the wood's a little harder, so they're less productive, I'll say so the high end 15, 16, obviously that will vary by community, but that's the range. So generally speaking, we'll give an allowance to fumigate on those 12 to 15 year cycles.
Speaker 2:And if you are fumigating a building on a regular cycle, 12 to 15 years per se, then you shouldn't have much additional problems. They're going to come back. They could be back the week after you fumigate but they'll come back. But if you're fumigating on regular cycles you're killing them off at a rate that they can't really colonize and cause a lot of destruction. So if you're fumigating on regular cycles you shouldn't have any other extensive expenses to deal with your pest or termite control. Other associations. You know tenting can be inconvenient. So a lot of associations just put money aside to treat as locally as needed and, of course, to replace wood as needed, because if you don't fumigate on regular cycles, eventually they're going to get to a section right. You know some rafter overhangs and some other, you know low hanging fruit from their perspective. So there's going to be needs out there that you're going to have to spend money on, and so how do you develop a fund for that? So, again, a lot of our clients that don't even fumigate on regular cycles use that as a fund to take care of these repairs and these spot treatments Because, again, while they may not be frequent, when they do occur they're severe in a financial impact.
Speaker 2:A few thousand dollars is a small repair. You can get into tens, obviously hundreds of thousands of dollars if you're talking about particular properties. So it's something that you want to have reserved for whatever appropriate in your community. So I'll say zero is inappropriate. What might be for your community? Talk to a couple experts, talk to your pest control operator and your reserve provider. Obviously, communities that are made of just concrete and steel don't have as many issues with pest control as us wood frame people. So that's another thing to think about. Do you even know what your community is made of? We have a lot of communities that we operate in our market, certainly along the East Coast, that are made of primarily of concrete and steel, but we'll have limited wood.
Speaker 2:So, for instance, it's been popular a long time glue land beams and other wood frame structures for roofing here in Southern California and across the Southwest and even much of the Southeast.
Speaker 2:Very popular commercial and industrial are concrete tilt-ups. You see them out there all the time, the industrial complexes that you pass. So these are concrete foundations that they pour and then they tilt them up and turn them into walls and that's the perimeter walls for the very inexpensive, very cost-effective. However, the roof for those are generally made of glulam beams or some kind of wood timber, and because most of them again are glulam beams, they're not real attractive to pests because the glue tastes awful to them, so they're not as subject to. So if you have a concrete tilt up building, well, you probably don't need to fumigate on regular cycles because they're never going to swarm in because you've got all concrete up until your roof and so you've eliminated the you know the subterranean termites and now you just have the swarmers that you would have to deal with. So you killed off half the population capabilities of coming to your property and then again they either got to get through roofing or other material inside of the interior to get to that wood.
Speaker 1:But once they get to that wood?
Speaker 2:well, it's not very tasty, they don't like it. To get to that wood well, it's not very tasty, they don't like it. So the chances that you're going to get a major infestation and have significant costs in that particular building are pretty low. But again, you wouldn't know that and if you've got some experience in that level. So if you own a community association, if you manage community association, work with your pest provider that will know those specific details about your community and then work with your reserve analyst to make sure the appropriate amount gets into your budgeting process. Whether it's every few years or every few decades, eventually you're going to have to deal with something in most communities, but again, that will vary greatly by your specifics.
Speaker 1:Okay, and what do you think about adding components that are over 30 years old to the reserve study?
Speaker 2:I think it's a good idea if you've got some level of predictability and you know there are areas where you know, quite frankly, you're going to have to make judgment calls. I recently attended the Association of Professional Reserve Analysts it goes by the APRA acronym and we had our annual conference that coincides with CAI's annual conference. So we were in Las Vegas just happened to be there, right but we got to talking about these kinds of components. Understanding that CAI changed its standards in 2023, and we're currently working on updating ours was, you know what about things that are very difficult to predict, as I mentioned. You know what about things that are very difficult to predict, as I mentioned? You know we often talk about piping. We can understand piping because it has a good history behind it. Other things we don't. So, as I mentioned, potable piping okay, reasonably predictable. Gas piping oh, really hard to do.
Speaker 2:There are some applications in which waterproofing is reasonably predictable and other application in which it's not. Um, so, generally speaking, uh, when it's on decking and exposed areas, you can kind of give it a, you know, on the low end of 15, mid-year 2025. But if you've got uh elements that are outside, uh, the you know the building footprint. They're going to be subject to, of course, the heat changes, so thermal expansion, they're going to be exposed to radiation, cold impacting, icing, all that. So eventually that substrate, the waterproofing, is going to fail. So it's reasonably predictable on those kinds of surfaces. But there are many surfaces, mostly the concrete and tiles that are designed with drainage systems in place that were, quote unquote, designed to be lifetime systems that were just turning out. Yeah, well, whose lifetime are we talking? Because after 50, 60 years, all of a sudden, no, that waterproofing isn't there. Some is failing as early as 25 or 30, but there's a lot of product that's in the 50 year range that has waterproofing in a variety of locations, based on, you know, the type of construction that is now just well, it's at the end of its life expectancy and sometimes there's predictability and sometimes there's not.
Speaker 2:So you know at what point can we start including waterproofing as a standard item and what you know applications? Can it be included and funded? You, you know, as I mentioned, I was speaking to some of these other practitioners and you know some of them use, you know, the standard dollar per square foot and other measurements. They have different cost base for not only the square footage of the waterproofing, but also the material that has to come out. In a lot of applications. You know, the waterproofing is in a planter now I've got to remove, you know, sometimes tens of thousands of dollars worth of plants so that I can access the waterproofing. Obviously, when I put, um, you know, dirt back after, they're going to want plants back, uh, so you have to include those kinds of costs. Well, that cost can vary greatly by community. So again, it's, you know, um, a very delicate.
Speaker 2:Okay, did we just throw a big number out there and put it out there? Well, no, that's not really prudent. So you know, don't try and just throw numbers out there to say, yeah, I know eventually you're going to spend some money, but I don't know how much. In an application where you don't know or it's unpredictable, yeah, put the waterproofing in as 30 plus and say you've got waterproofing in these applications in planter beds, exposed decking, a lot of the podium decks beneath sub-drain garages, those allow to have a decking on them. So there's access issues whether some of it is on common area and some of it is an exclusive use common area. So again, lots of variables involved. So if you wanna put it in a 30 plus, no problem, anytime, that's always a good idea.
Speaker 2:Throwing just a ballpark number at it and a ballpark I think it's going to be this timeframe. Wouldn't recommend to do that without you know, consulting others. If you've consulted with some professionals, some waterproofing contractors, some roofing contractors, engineers, whatever it takes in the application then, yeah, start using some of their information. So you know if an engineer has been out there, a hydrologist or somebody that can give you some good information that a contractor can convert to you know man, hours, labor and materials to give you an estimate to put in then yeah, by all means fund it at that point. But, like I say, don't guess.
Speaker 2:But that's just one of the things that's going to have to be worked out over the next, I'll say, decade in this industry. Is you know how much of that becomes quote, standard inclusion and how much of that becomes one-off, based on the association, because a lot of these circumstances that we talk about might just be that, it might be oh yeah, well, we had to do our planners. Well, that was once in. You know, 75 years of operation as an hoa, and that was 22 years ago, kind of number. So you know, you have to ask yourself is that something that automatically goes in a reserve study or, you know, part of the idea to be robustly funded is there are a lot of things that you can't predict with a great deal of accuracy however part of a reserve study's idea is let's reduce our risk and we're going to talk about insurance in a moment but that's, you know, part of a reserve study is just risk reduction.
Speaker 2:So if you fund well to the things that are predictable again back to our water heaters and our you know, our roofing material things that have a long history and a reasonable life expectancy that you can predict well, then that's terrific, because if we're funded at a high level for those kinds of items, then the items that we can't predict, that just come. You know, I could tell you. You know different stories, but when I was early in this industry we had a client got hit by a bark beetle. Yeah, they were in a more rural area and they owned a lot of trees in in this, in this rural environment.
Speaker 2:And a bark beetle came in and did a half a million dollars and this is in, you know, I'll say, 2005 dollars. So, yeah, they did a half a million dollars in damage to this association's trees. I can assure you there's no reserve analyst that's going to put that kind of a liability is, hey, you know what could happen, you could get hit by a bark beetle, and you know. And the other liability is hey, you know what could happen. You could get hit by a bark beetle and you know, and the other ass is okay, well, is it gonna come back? Well, of course, the bark beetle could come back the next year. That has been over 20 years now and the bark beetles haven't come back. Thank God, knock on wood for that fine community outside Redlands, california. So they haven't been hit by another bark beetle.
Speaker 2:So I would call that an anomaly, a one-time thing that you, by the way, they weren't insured for that, that wasn't an insurer, you know, uh, named the item of insurance, so they had to just literally eat that cost themselves as homeowners. But that's something that was predictable. It was uninsurable. It's one of those facts of life, you know. You got to move on. So I I think we need to apply, you know, as much importance as we should apply to making sure everything gets included, we should apply equal importance to make sure that nonsense doesn't get added in there, as just some, you know, filler like oh, just in case, because you know if you are budgeting accurately and you have a good inventory, funding well to just in case is going to leave you at a position If something happens that you didn't anticipate.
Speaker 2:You get it by a bark beetle. Well, you've got a well fund. You might have money set aside for roofs that have 20 years, okay, left on them, all right. Well, good news, we've got money set aside for these roofs and we're not going to need it for 20 years. So we're going to spend it today on this bark beetle thing. I'm going to take care of our bark beetle problem and then now we've got 20 years to catch up and put our money back into the roof.
Speaker 2:If you don't have that money to begin with, if you aren't following the advice of your reserve analyst and the other professionals around you, and you didn't have the money set aside for the roof, even though it was right, when you get hit by that bark beetle, well then you don't have that money. You don't have that set aside. So, yeah, you have to endure the special assessment that comes with those anomalies. So, as a risk reduction, a you know form of self-insurance, you can have a robust reserve fund and then when you get hit by these unpredictable, unknown, uninsurable you know catastrophes, you have assets to deal with that. So you are in a much better position to say oh yeah, we took the money out of reserves, we dealt with this terrible bark beetle problem and then now we can recover the reserves over time because it was set aside for longer term assets, thank God.
Speaker 2:Not a pleasant thing, you're not happy, you went through it, but you managed your way through. Without that robust reserve fund, without that reserve study to know how much to have in that reserve fund, you would get hit with that and have no other choice but to special assess the members at the time, which, again, it was several thousand dollars per member that they would have had to come up with to deal with it appropriately. So, again, a reserve study is a good risk reducer, just by giving you assets to deal with the things that nobody can predict with any level of accuracy.
Speaker 1:And you just spoke of the consequences of getting your reserve or being underfunded on the reserves or getting the reserves number drastically low, being underfinanced and the consequences of that special assessment. Can you speak about special assessments?
Speaker 2:Sure, they are unfortunately widely used because in many jurisdictions they're easy to do. Again, I don't have any CAI immediate data but I'm sure if you pooled the industry you would find that few states I'll say less than 10, have high level restrictions on special assessments. So I'll just give you some that I'm familiar with In California, our homeowners association. The board does not have the authority to assess its members greater than 5% of the total budget as a special assessment and they can't increase the regular assessments, the gross budget, again by more than 20%. Now to go above that they can have the membership approve it. So if the majority of members say yeah, up at 25%, and you know special assesses, you know 10%, then that's perfectly fine. But as far as the board doing it on their own, that authority is limited. Other states have similar limitations on that, have similar limitations on that. So many associations in California, you know, would have to violate that in order to get the money necessary. Just on the flip side, as a comparison, commercial associations in California have no such limitation. So if you own a commercial association and they have special assess you, they can do any amount at any time and just say send me the money. So a vast difference between owning a home and owning a business condominium here in California. So that same thing will apply in many states. If there are no limitations, then yes, the board is free to assess however much is necessary at whatever time frame necessary to meet their obligations Because, again, their first obligation is the association. So, hypothetically, if you've got a roof problem and it's going to cause secondary or consequential damages and or bring a life threat threatening issue, then no, you have no choice but to do it right now. So if that choice is well, the roofers don't work for free, so we have a fiduciary duty. The roofers don't work for free, so we have a fiduciary duty to maintain this structure and to keep this roof from causing further damage. So now we're going to special assess the entire membership. Remember, you know it could be nine buildings and only one of them needs the roof, but all nine are going to serve in that net special assessment. And now we're going to special assess whatever is necessary to deal with that problem. Sometimes it's only a few hundred dollars per unit, sometimes it's several thousand dollars.
Speaker 2:As a matter of fact, to go on that note, in 2023, fha changed its guidelines, so now FHA is a disqualifier among many. They have many products and, of course, many disqualifiers for each, but some of their general, just general, disqualifier among many. And they have many products and, of course, many disqualifiers for each, but some of their general, just general disqualifiers. One of them is now $10,000 per unit of what they would call accumulated depreciation or underfunding. So if your association and your portion of it is $10,000 or more underwater, they're not going to give you an FHA loan.
Speaker 2:And that may sound, you know, not like much, but those are tens of thousands of loans a year that are done by FHA, because these are not only resale loans. This is not only to acquire property. This is also to use your equity. So if you know you're a veteran and you want to take advantage of one of the many VA loans out there, same requirements are going to apply. If you want to use many of their home equity loans to send your kid to college, you're redoing your kitchen, same rules are going to apply.
Speaker 2:So there will be many people who get surprised at the condition of their HOA. But FHA, just like everybody else, like the insurance industry and others, they have to mitigate their risk. They have a responsibility to their you know interest holders. So they instituted some risk management procedures and one of those was to require at least $10,000 because, generally speaking, when you're talking about the, you know FHA level housing and so forth that it's used for $10,000 would impact your capabilities to make a payment right. You may or may not have that liquid, so that $10,000 can be devastating to a lot of community associated owners.
Speaker 1:So you know if you own a $5 million home on the coast.
Speaker 2:well then, no, that's not really the target with that particular requirement, but yeah if your association is such that you're lending to buyers that a $10,000 special assessment would be problematic to their ownership situation, then, yeah, fha is now no longer alone on those properties located within them. So we see this all over the market. As I mentioned, we talked about insurance, but homeowners themselves are taking these opportunities to reduce their risk because you know it's ever growing.
Speaker 1:What are homeowners doing to reduce their risk?
Speaker 2:Well, the first thing they're starting to do is read and understand the documents that they're getting and then get below those thresholds. As I mentioned FHA and again I encourage anybody to participate in CAI and the Foundation for Community Association Research but it was upwards of 70% of condominium loans are FHA of some form. Again, in the higher end markets that go well above the three quarter million dollar level for FHA financing, no, so yeah, in a lot of communities, no, fha is not a big thing. But in most of rural America and many parts of suburban America, fha is the primary lender for condominium associations, so it has a tremendous impact.
Speaker 2:So, for instance, one of their requirements has to do with non-owner occupied.
Speaker 2:So if you get too many rentals, if you get above their percentages, well then now you can't get another loan in that property.
Speaker 2:So if you wanted to sell your unit, well, I can't use FHA financing. So either you have to sell it to somebody who isn't using FHA financing, which means private lending, which generally means different terms, usually a point or two higher then they're not going to be as willing and or capable of paying you as much for your property because they get different loan terms and generally speaking and this is true all over the board most people buy as much home as they can afford. So until you generally get to the billionaire class, they're buying as much home as they can afford. So you know, if hypothetically I could afford a $4,000 a month payment, okay great. Oh, all of a sudden I got $500 worth of HOA assessments coming. Well, now I can no longer afford $4,000 a month, I can afford $3,500 a month, and so that goes at every level. So until you get to the you know literally the multi-million dollar homes, you know they, the amount assessments that you pay, um have an absolute impact on it.
Speaker 2:So there are many associations that their requirement to fund themselves has been under gauged for years, and so they're underfunded. So we understand that reserves make up a portion of a budget. In some circumstances it's a small percent 3% or 4%. In a high circumstance it might be 20%, 25%. It rarely goes over 30%, but in most circumstances we'll just use 10% to 15%. So whatever dollar you're collecting, well, most of that is going for your HOA insurance. If you have professional management, you're paying for legal and financial services. You've got utilities. So most of the dollar that you bring in is already earmarked for these services. So in any circumstance when you're bringing in money, ok, some of that's got to go to future endeavors. You know our roofs, our plumbing, our asphalt, whatever it may be, but again, broad numbers, 10 to 15 percent.
Speaker 2:If you, for years, are not doing that, you're just not setting the money aside. Ok, so we'll fast forward. Say I'm a 30 year old property. Now I've got a lot of deterioration. I've got just standard aging, right, I'm starting to look tired, tired. So you've got not only the infrastructure. You know, I've got 30 year old plumbing, it's only got 20 years left. Right, I got, you know, 35 year old roofing and, oh, my goodness, it's only got a half a dozen years left. So you find yourselves needing a lot of cash and you just simply haven't gotten that because you haven't funded for those 30 years.
Speaker 2:Well, now you have no choice, right? Either you Either you got a special assess and say, hey look, we need all this money for this roofing and plumbing, whatever we got, or you have to increase the regular assessments sufficient to bring the money in right. And if you do that, well now you're going to go outside the market Because, remember, you don't have control. How much the landscaper charge, right, the landscaper charge what the market will bear. And so you're going to pay whatever the market is for landscaping. You're going to pay whatever the market is for your water and utilities. You're going to pay whatever the market is for management and maintenance services, and you're going to pay those right, because if you don't pay those, then they turn off your water, they stop mowing your grass, so those are always going to get paid and they make up the bigger portion of your budget.
Speaker 2:So now, if you're an older community and you're, you know, significantly underfunded, well, now you would need to increase your assessments. Okay, all right. Well, we know that. 70 cents, 80 cents on the dollar, for sure, probably closer to 90 cents on the dollar is going to the operating. Well, that hasn't changed. So now that 10% of budget.
Speaker 2:So, if you know if to put a dollar, ok, well, now I got to be putting two or three dollars, you know, because I got to play catch up. I don't have any money. And where's that going to go? Well, it has to go on top of the operating. So now I'm out of budget, remember, because all the other area and all the other homes in the area that are in good run HOAs, remember, they have a sufficient reserve fund. So they're still collecting the dollar. You know, if you're collecting $10, okay, we're going to take our dollar and put it in reserves. They're still doing that, so they don't have to collect any more than the $10. They got $9 operating and a dollar of reserves. They're doing just fine.
Speaker 2:You, on the other hand, you got $9 worth of operating. That's the way the world works, you can't change that. And now you need $3 or $4, right. And so you know you have no choice but to get into $13, $14 because you have to pay. You know your reserve fund because it's been underfunded so long. So now your community at $13 or $14 is not as attractive as the one at $10. So that's going to be a problem because again, I'm using numbers I can do in my head. When you're talking about buying the average home in California just hit $900,000. I know there are many communities on the East Coast and the Midwest and certainly the Southwest that they have multi-million dollar communities, that every home in there is worth multiple millions of dollars. So it's really starting to impact their capability.
Speaker 2:So if you're just in an average community buying a half a million dollar home, you know if you have to now have 10, 20% of your budget be going to underfunded. You know, forget what we're putting away for tomorrow. This, this is just trying to catch up to where we are. Well then, yeah, you're not going to be competitive. So you're going to suffer that in the marketplace your home is not going to be as worth as much as other communities.
Speaker 2:And again, if it gets into a drastic condition again using FHA numbers they don't loan on less than 10%. So if you're not putting 10% of your funds away or you're less than 10% funded, you know there's a high likelihood you're not going to get anywhere near an FHA loan. So again you're going to have to go to the marketplace. You know, except whatever terms are coming your way, which are going to be a half a point, a point, you know it'll depend on the market, but certainly they're going to be higher and you know that's going to result in a higher payment, which means that you're not going to be able to offer as much for that house because, again, most people are buying as much home as they can afford. So they talk to their financial advisor and the real estate agent.
Speaker 2:They say yeah, I can afford my $800,000 home and my $3,700 payment. That's what I can do, based on my down payment. And if those numbers change, okay, well, the numbers change, but most people don't change their down payment in a significant way, right? I mean, if you have 50,000, if you have 100, if you just sold your home and you're sitting there with a half a million, it doesn't change. So the other circumstances that will change, of course, not your income, right? Did you get a better job yesterday? Did you get a huge bonus? No, okay, your income is still that variable. You know, your cash is still that variable. What's the other variable? Oh well, the loan, its terms. I know, by the way, how much I'm willing to pay for your home. So understand that that variable is going to get used in the transaction process because you're going to be a disadvantage over others in that same environment in that same environment.
Speaker 1:Okay, and how long do you think of underfunding it? You know, I mean it probably takes years of neglect towards funding to get to a point that it really turns bad.
Speaker 2:Yeah, I'll say you generally have a good decade. You know, we rarely see circumstances where a less than 10 year old building doesn't have sufficient funds. You know, using the numbers here I'll look just to just see here Twenty four states require a public offering of the finances in order to sell a condominium. So you know, again, nearly nearly half, just under half, of our states have recognized the need to get this from day one. Um, obviously the other 26 will do what they do. But generally speaking in all of the states, 10 years.
Speaker 2:You should expect that your reserve expenses are not gross, right? They're not going to. You know all of your major uh infrastructure items. You know asphalt replacement, your roofing replacement, any plumbing replacement, all that kind of stuff is generally more than most of your mechanical equipment, your big, you know HVAC operations all that more than 10 years. So you should not expect big expenses. So, depending on how you're funding yourself during that 10-year process, you probably shouldn't expect any special uh special assessments or uh added needs.
Speaker 2:That 10 to 20 year that starts to make a difference. That's when you'll start to I'll use the phrase nickel and diamond, right, by 10 years old. You know, certainly you got to deal with some painting cycles, right? You probably got, you know, carpeting, flooring, other aesthetic related issues. You might have small fixtures, other things starting to come into play by you know, 15 to 20 years.
Speaker 2:You start talking about your all of your water heating equipment, your small furnaces, air handlers, that kind of equipment. So you know, as you age, from that 10, 20, you know, by the time you're 30, it's too late, right? If you haven't been funding by the time you're 30, you're going to be in a drastic situation. Yes, I'll say that you have a 10 to 20 year window in which to correct a mistake. In the 26 states that don't have a public offering, we'll just say, oh, they got off on the wrong foot. So in those 26 states you got yourself a good 10 year runway, maybe up to 20, but you certainly don't have more than 20 years because you know if you're underfunded for 20 years, you're significantly underfunded.
Speaker 2:As I mentioned and I may have talked about it in other programs. Going back to my other rant of just a moment ago, let's use that $10. Let's say my assessments are $10 a month. Well, we know what happens every year is inflation right? In the last few years we've had some historic inflation you know 3%, 6%, 7%, 9%, right, and it varies by product, right. You have some things that inflate you know 300% and other things that inflated 4%. So it's been difficult to capture and put into forecasting, but nonetheless we've had significant inflation.
Speaker 2:So if you've got, you know, your ten dollars a month that you're putting aside, ok, well, you have inflation that you need to add to that. So maybe next year it goes from 10 to 11 or whatever. Your numbers are no-transcript, right? So during that period of time you have no choice. Again, you know your landscape or all these are market rate things that if you don't pay, get canceled. If you don't pay your insurance, they will cancel you. It's that simple. So you pay your insurance, you pay all these bills and since they make up 80 to 90% of every dollar you bring in, most of the money you bring in is for those ongoing expenses. So you're going to get yourself in that same kind of trap where you don't have enough money to deal with it. So if you don't raise your assessments, you know what happens you pay your regular assessments and you stop paying your reserve fund. So out of that $10, let's say that you put a dollar, okay, we'll get what. The next year you're going to put what you know like a 70 cents, in the year after that, like 50 cents, because you know that HOA has got to go up from 10. It should be collecting 10, 50, 11, $12, whatever it may be, but it stays at 10. And its operating budget again starts at $8 and then it goes to 8.50 and nine and 9.50. So again, by four or five years of this kind of pattern, you've probably erased any difference between your reserve contribution and your operating budget. Now you're forced to increase your assessments because now your income that like oh wow, our operating budget's more than $10. That wasn't the case a few years ago. Now we got to bring now it's $11 just to operate this place without putting the three now dollars that you should be putting into reserves. So you know they're going to get themselves into that same trap.
Speaker 2:So you know, pay attention to what your advisors are telling you you know management, cpa, your reserve advisor, follow their advice because you know you're going to pay one way or the other. It's your, it's your place, it's your house, it's your money. So, whether they collect it in a dollar a month or whatever sequence, or they hit you up for several thousand dollars every you know year, every few years, depending on the circumstances, you know you're the one who's going to pay. You own, you know, one, one hundredth. If you live in a hundred unit, hoa, you own a hundred of that and you're going to pay the appropriate amount. Again, many people now live in what they would call variables. So if you live at a big suite, you'll pay $1.25 of the assessment and somebody who lives in a smaller unit might pay 75 cents of that same quote dollar assessment. But nonetheless, one way or the other, no matter how it's calculated, it's your money, it's your association, you live there, you're part of it, it's all of your cash. So you will pay your appropriate amount. So you're really better off by you know well, funding yourself.
Speaker 2:You know we talked about insurance. Insurance companies are now using this as part of their criteria to the evaluation Because, again, understand, insurance has a pretty simple job. They, in essence they sell risk, right, they sell you an insurance policy and they take your risk. So, whether it's your car, your life, your house, your house, the chances of you losing any of those, as X, they have calculators that give them the accrual rates and they make their estimate and that's based on their I'm taking that risk on. And then, of course, they have costs. Right, people pass away. They have to pay that life insurance. People crash cars they got to repair the cars. And, of course, people's homes get damaged they got to repair the homes. So they are, in essence, they're selling the risks that they take on and they have to manage their costs. So what's happened to them, of course, is that their risks have increased and their costs have.
Speaker 2:You know, just on the cost, we'll talk real quick about car insurance.
Speaker 2:Everybody's car insurance has increased. Well, there's a few reasons for that. One, cars have increased, right, the cost to replace the car is higher now. Now, everything is electronic. You know it used to be. You'd have a fender, bender, we'd bang up okay, we'll just repair the fender. Well, now you've got to repair the fender and then you've got to call on a computer scientist to recalibrate. You know the 19 different sensors and cameras that this car has, you know. So things are just more complex. So now there's no such thing as a cheap auto repair. Every auto repair is a few thousand dollars, you know. You can check with auto club any of these. It keeps the statistics.
Speaker 2:But the cost of repair, the average cost of repair, continues to climb. So insurance, of course, is, you know, putting this out in premium. So that's why your premiums are increasing, because the cost of cars, the cost of repairing cars, is going up. So apply the same thing to housing. You know, it's not a secret, right?
Speaker 2:The two worst insurance markets right now are Florida and California. Why? Because those are the areas where climate change is having the biggest impact. Remember, you know, when we talk about population, we're talking obviously California. You got Texas, florida, illinois. You know we'll throw in New York and New Jersey and some of those. But you know, when you're talking about the biggies, obviously California is there. Texas and Florida are the ones that people talk about because their populations are so big and so when it affects them, it affects just a higher number of people.
Speaker 2:Well, they haven't been able to make any profit in Florida because they haven't been able to accurately predict what's going on. They know they've got issues, and it's not just to Florida, I mean, there are issues, you know, in the coastal Carolinas. There are issues all along the Gulf, the East Coast. There are parts of, you know, new Jersey, pennsylvania, virginia, west Virginia. The rivers are rising, you know they're starting to come up into homes, so it's not isolated to any one part of the country. There's just different, you know different areas that are suffering, um uh, from these consequences. Louisiana, a classic case.
Speaker 2:So the insurers are having a hard time predicting these costs because they don't equate to anything in the past. Same things happening in california. Um, in california they have a requirement that their costs are based on their experience, not their predictions. So, of course, these insurers, they hire a lot of actual aerials. They're sitting in offices, they're crunching numbers, trying to come up with it to say, all right, we know what we've spent in the past. Okay, that's just bean counter stuff. Right, that's easy math. We know what we spent. But what are we going to spend in the future? What's going to happen to homes? And they do that based on old models of where fires used to hit and how frequently they used to hit. Well, throw those models away.
Speaker 2:You know, I mean go all the way back to the, you know mid 2000s, but certainly you know by the time I think 2018 was the deadliest year. But you know, if you go back for the last 50 to 100 years where they've been keeping records on forest fires in California, you know the top five, most of them are within the last five years and in the top 10, a majority of them are within the last 10 years. So certainly you know it doesn't take a genius to tell you that the frequency and the severity of California fires is different. Now, it just is.
Speaker 2:So you know, to pinpoint any precision on that, that's not my area of expertise and unfortunately, the insurance company hasn't been able to use whatever they have come up with. So, whatever they've said, oh, I think this is what's going to happen. They're still isolated. To well, what have it cost you? So, yeah, they put the campfire and all these other tragedies into there. This is what we paid 2 billion here, 4 billion there, all that cost. So they can put that into their costing, but they can't use that as a predictor. That's why so many of them are leaving the state. They're just saying, hey, you know what? That's just unpredictable. We have pockets here in California where it's just becoming more and more challenging to get insurance on homeowners.
Speaker 2:So, whether you know, whether you're in an HOA or just a single family dwelling, or you own an apartment building, you're looking for renter's insurance, or you own the apartment building and you're looking for, you know, property owner's insurance. There's just, I'll say, a retrenchment in the insurance industry. So, you know, I talk to a lot of small business people and I tell them, so you know, if, if you were doing you know, 500 jobs a year, whatever it is you do, let's say you do 500 a year and they told you, oh well, we need you to cut 20%, so that's a hundred.
Speaker 2:Well, I'm sure that the first 50 are like oh that guy's an old crap, I'm tired of working with him. And oh, oh, that complainer, yeah. So some of those cuts are going to be fine. Let's all admit that as business people and as employees. There's just some clients you're like I'd be better off if they weren't around. But then after that it's just like oh, I liked that guy, he was pretty cool. Or oh, that lady was nice, she was always cool to work with.
Speaker 2:Why, well, you know, oh well, we're cutting 20%, so that's an arbitrary numberentrenchment. They're just like it's got too much risk. We can't accurately predict that, so we're just going to write less policies. And when you're talking about the major carriers out there, you know you're talking. In some cases some of these people have tens of thousands of policies. I think in the larger carriers they could have hundreds of thousands of policies in the state. So you are literally talking about hundreds of thousands of residents now that are either being impacted directly with these higher premiums, but literally tens of thousands of people who are just losing their insurance altogether and forced to go into this turbulent environment with oh yeah, xyz canceled me and I'd like insurance please. So you know, yes, you're going to get a premium increase. That's just natural. Right, but right, but finding the insurance now? So there's, quote unquote, a lot of underinsuring. So if you again add up your assets and your requirements and say, oh, you know what, we should have $50 million worth of coverage, and the carrier says, well, I'm only going to offer you a 30. Well, instead of walking away or looking for a different carrier, they'll say, well, I'll take the 30. And so now the independent, the property owner whether it's the HOA or commercial owner rep, whatever you want to call it, whoever's making the decisions they say, hey, yeah, insurance is just unreal. I could only get $30 million and it's got a terrible deductible, much higher, three times my previous deductible. But I'm going to take that because that's the only thing in the market. Well, okay, fine, you've got your increased operating right with that premium increase, but now you yourself, as a property owner, have taken on $20 million with risk.
Speaker 2:I was recently listening to a gentleman named Kevin Davis who's an insurer nationwide. He happens to be located here in California and he was saying there was over a billion dollars worth of uninsured property out there because people are either choosing to underinsure for costs or because they can't get the coverage and they don't want to go out to the market and pay the premiums that it would take to get proper coverage. So there's a lot of that going on. So again back to my earlier point before this rant is well, that's one of the tools that the insurance companies are using to get rid of clients. Because again, you know, go back to the tragedy of Champaign Towers, which woke up the entire country.
Speaker 2:A lot of these issues, a lot of the changes. You know it's not a surprise that CAI changed its reserve city standards, you know, two years after Champaign Towers, because that woke up the world, because that is the classic case of kicking the can down the road, as I'm sure most of your listeners are aware. There was an association and they knew they had a lot of issues. It was an older community on the coast and they, you know, kind of didn't deal with it. They let it go, and then the money increased, and so they let it go a little bit, and so by the time they got around to starting to work on the problem, the, the price of the property ballooned like tripled, and then, of course, it ended with 98 lives. So we all hear the stories of champagne towers, and so there's a lot of repercussions from that, both in the lending world and in the insurance world.
Speaker 2:So part of what the insurance industry is looking at now is are you a prudent HOA? And I got to tell you I've been doing this for a long time If an HOA today of almost any size I mean if you for a long time, you know, if an HOA today of almost any size, I mean if you're a small eight unit HOA, okay, maybe, maybe you got some good cousin, friend or uncle that can give you an idea of what's going on. But you know, if you have 400 units and you don't have a professional research study, I got to tell you you're high risk, right. And I mean you know that's just a good product to have. It'd be the same as telling me, yeah, we don't have professional management. Or my cousin Bob, he does the books Well, does he do them?
Speaker 1:for any other HOA?
Speaker 2:No, no, no, Just himself and his bakery. You know? No, that's not who you get to do your books. So you know, if you're an HOA, you're a corporation. You should act responsibly. So if you're telling me that you're a corporation today, an HOA of any significance, and you don't have a reserve study, you know, two years, five years, you can argue over the age of it, but if you're not getting regular reserve study updates on a regular basis, you know you're not protecting your interest holders, You're not preparing for the future. So you're not doing them any favors by saving the money. No, you're lacking the critical information that it takes to make these long term financial decisions. And so, as an insurer, well, who am I going to cut first? Well, these people.
Speaker 2:They've already proved to me you know, in many cases you're breaking the law. We already know that. You know, in certainly 12 states you're breaking the law. You know, and others, you know, you're breaking all prudency. So, yeah, if I was an insurer looking to cut 20% of the people out there, well, what an easy low hanging fruit for me. You know, because, yeah, these are the people that prove to be the problematics, right? You know, I do seminars for real estate agents and others and I'll tell this story.
Speaker 2:I'll say you know, if you want to know about an HOA drive-through, if you see a nice HOA, right, the things are painted, it's well-maintained, it looks like a well-maintained community. Well, now you're going to spend a lot of time looking over the finances of that community to make sure that it's properly funding both its operating needs pretty apparent, right, it wouldn't look good if it wasn't funding its operating needs. And right, they wouldn't have insurance, all those other things they cancel. Okay, I'm pretty good with that, I'm comfortable. Now let's get the reserves. I'd want to see their percent funded, their status, their funding plan, all of that Okay.
Speaker 2:Now if you're driving around looking at real estate and you pull into a community and it's got deferred maintenance, like you know it hasn't been painted in a long time. You see peeling paint on the wood and the metal. It's got rust coming through the asphalt, all old and cracked, everything. They're broke. Okay, Because there's never been an HOA that I've ever seen that has money in the bank and a terrible appearance. Right, If they had the money, they'd paint their bill right. If they had the money, they'd paint their building. If they had the money, they would repay their asphalt. If they had the money, they'd replace their light fixtures. Right, they would do that. So if it has got a lot of visually deferred maintenance, I can tell you they're broke because nobody allows their property to look like that. When they got a bank account that's full, so yeah, that community is broke.
Speaker 2:So, yeah, probably best be driving on, because your assessments are absolutely going to go up and you might be looking at a special assessment in the near midterm, depending on some things. So, yeah, if that's the only property around, then yeah, I guess take a closer look. But remember the risks that comes with that, because even with all that information, there's still risk, right? So if you've got a property that has much deferred maintenance, well, eventually they're going to rip that roof off and replace it and guess what they're going to find? They're going to find deterioration that wasn't visible and that's going to add the cost to replace that roof. So if you see a property that's had, you know, years of deterioration and deferred maintenance, well you can pretty much guarantee there's going to be corrective maintenance once they get to that regular maintenance that they overlook or deferred.
Speaker 1:And that's a huge point and you spoke about in our last podcast how an HOA is a business and when you join an HOA you're joining a business. So you don't want to join a business that's broke and you're going to have to pay for it when it's at its worst point and bring it up. And one of the best ways to be aware before you join that business, before you join that HOA, is to do that property inspection and really look around at what their common assets, their reserve components, look like.
Speaker 2:Yes, the prudent thing is to make sure that you know what your anticipated expenditures are, knowing that you can't predict everything. But if you're well-prepared you can deal with the unexpected. So, to prepare for that, because it's going to come and in the commercial world they call it a capital call, in the HOA world they call it a special assessment, but it's the same thing Give me lots of money now, and so you need to protect yourselves from that. You know, if you're independently wealthy, that's fine, but that can be problematic too. You know, um, going back a few years, during the pandemic, of course you know, everything shut down. So major league baseball had to do what's called a capital call to the owners, so the may, you know the owners of the major league baseball teams. They had to put money into the mlb in order to fund the operations because, of course, they weren't selling tickets and they weren't broadcasting games, etc. Etc. So you know, while you know I'm not gonna cry for the wealthy billionaire owners of the MLB, they nonetheless, during tough times, they had to send some money to maintain their operation. So it's the same thing for homeowners.
Speaker 2:You know, if you're out there with a piece of real estate, whether it's just a few hundred thousand or even a few million dollars, you could get hit with these special assessments. And that means you know, send us money now if you're um again, commercial um condominiums are becoming very popular out there. So if you're a small business entity and you're considering investing in that, you know terrific, they're great investments, uh. But you need to look at the paperwork to make sure that it's a well-run uh community and that you're, you know, investing. Because you need to look at the paperwork to make sure that it's a well-run community and that you're investing because, to your point, you own whatever percentage. So if it's 165th, then it's 165th, and you got to start doing the math on what your 165th means, both in an operating contribution and what your potential liability is for these long-term capital expenses which, again, depending on the property, can be, you know, tens of thousands, possibly hundreds of thousands of dollars.
Speaker 1:Okay, and you mentioned at the beginning of this podcast that when people purchase a home, they purchase the highest, the highest quality, the largest price point that they can in their home. Yes, and you know they might. You know, hopefully they're taking their hoa fees they're probably everything their mortgage into account, and you know. Then you speak about being prudent and actually looking into the hoa's quality, what you know, how the fixtures, how's the landscaping, how's the, what you know, how the fixtures, how's the landscaping, how's the paint, how you know, does everything look like it's been being maintained properly?
Speaker 1:And then, on top of that we spoke about you know how well funded is the reserves. You know what percent funded, funded are they actually doing their reserves study, as they should be? And also, you know these insurance on people going in underinsured with their property, deciding, okay, we can only get so much insurance. And so you mentioned a billion, a billion dollars by Kevin Dave, and Kevin Davis mentioned um, underinsured. How is this all? How you know, what do you think about this? And then you, uh, as far you know, what do you think about it?
Speaker 2:well, I think there's going to be a lot of surprise when the market comes back. Remember, you know, our interest rates are high, historically, recent history at least. So interest rates are high from recent history. So transactions are at, you know, all time lows for continuing. Obviously, there's been many dips in real estate so the number of transactions is, you know, has been below what it is right now. But right now we're at historically low transactions.
Speaker 2:There's not a robust market, so real estate is very limited right now because of that, the industry behind it, both mortgage and insurance, which drives a lot of that. I mean, how many people are buying cash houses, right? So most of the people are buying money with a mortgage. So they get the scrutiny that the financial industry is placing upon these. And of course, the finance company is going to require that you have certain insurances and so the insurance companies are applying their standards.
Speaker 2:So when we talk about the industry out there, the millions of homes that transfer every year, again, cai anticipated upwards of 78% of all new construction is within HOA.
Speaker 2:So it impacts a lot more than it used to right, the number of HOAs being sold is still higher today than it was in 1970.
Speaker 2:Even, of course, the number of transactions right now is lower than it was in the 1970s. When that changes, when rates come down and activity returns to normal whatever new normal is but when purchase activity goes up and you start seeing a lot more escrows fail because the HOA doesn't meet the criteria, that's when you're going to see a lot more consternation in the market and that's when you're going to have what I will brazenly call the unsaleable HOA. So if you are in an HOA that gets caught well beyond that line and that line is movable but again, if you are in single digits for your funding, if you have less than 10 cents for every dollar you should have, you've probably got a special assessment in your future future. And not only do you have a special assessment in your future, you've probably got some significant increases to your operating income and there will be very few finance or insurance companies that want to touch an HOA like that right. It is like we don't want to.
Speaker 2:You know we don't want to loan somebody to buy into that HOA and we don't want to insure somebody buying that HOA and we certainly don't want to loan directly or insure directly that HOA. So they've got the challenge of the HOA and then they're buying into that HOA. So once an HOA has finance and insurance, saying, well, we don't want people in there, well, if you own already, if you're one of the unfortunate that already own in that HOA, what are you going to do? Right, you're going to become an unwanted landlord or you're going to sell for pennies on the dollar. So you know, if you get that, you know that that job promotion, that transfer, you know you get married, graduate, college, high school, whatever, you know, there are a lot of things that determine why somebody moves. So all those life occurrences are still going to occur. So you're going to have to make the decision Well, gee, I'd really like to take that promotion, but I'd have to sell my unit. Oh, and I can't do that. So either you sell at a discount based on its circumstances in the market, or you become the unwanted renter. You say, oh well, I'll keep the unit and I'll rent it out to help cover that mortgage. But yeah, I can't sell it because again, you'd be looking for a cash buyer. Most of the people that are capable of buying cash would recognize the circumstances. And so now we're back to the underpriced offer so you can sell that asset.
Speaker 2:You know again, whatever the market will bear, it might be only at 10, it could be a 20, it could be a greater amount of loss that you get on the value of that unit because it's unsaleable by. You know what we call conventional. That would all vary by circumstance. But yeah, if you want to unload it, you're going to pay a price to unload it. If you can't unload it, then yeah, you're going to have to take circumstances into your own hands.
Speaker 2:And unless you want to have that property sit vacant and the cost just be a negative onto your own private books, no, you're going to rent that out as best you can. And again, some people live in communities that have rental restrictions. So if you're at the cap of that, well then, yeah, you can't do that. Some of them have exceptions for family members, et cetera. So you might be able to get some workarounds, but no, there could be more and more limitations to your asset. So, yeah, those properties that are significantly underfunded are going to feel it much harder in the next five years than they have in the past five years, and certainly more in the next 10 years than they have in the past 10 years.
Speaker 1:Wow, and have you seen that occurrence happen where an HOA becomes? What was that term you used? Unsaleable, unsaleable.
Speaker 2:Yeah, you know, nobody's willing to purchase in it under terms they can afford. Because, again, that you know, once you cross that paradigm, if, hypothetically, I'm in a community that homes sell for half a million dollars and you know the average payment's 2,500 and our assessments are 500. Okay, that all math works. Oh well, ours is $1,000. Well, now that just throws all that computation out, so it no longer works. So in almost every environment, you're going to have a better choice outside that HOA, right, you're gonna find a home that is similar value, similar benefits, and, oh, my payment's going to be $500 less per month or it's at the level I want. So I'm only willing to offer you $420,000. That's it, the way the math works for me. I can't pay $500 for your house because of these numbers, so I can only pay $420. So, again, one way or the other, the owner of that real estate is going to be impacted by the devaluation of their asset. Because, again, one way or the other, whether you have a massive special assessment to get out of it and you're well-funded and like, oh, good news, now we're well-funded, we can keep at market rate for our regular assessments, okay, well, you had to pay the big special assessment to get there. Or, oh no, we're going to sell with this tragic underfunding and we're going to go into a market that obviously in many states what is it? 32 now that have the disclosures that you know of our circumstance. So you're just going to be again disadvantaged by the fact that you know you're underfunded and you know they're going to have probably better options. You know there are unique circumstances, but in most cases they're going to have probably better options. There are unique circumstances, but in most cases they're just simply going to have a better option. So it's going to be very difficult to move those under conventional financing.
Speaker 2:So back to the earlier point yeah, you'll still be able to move it, but it's high risk financing. You're going to pay the premium, so you're going to pay a point or two higher, which means your rate goes up, which means your payment goes. Payment goes up and again, if you're buying as much home as you can afford, means that you can't pay as much for that house. So you know they're going to get you one way or the other. Um, there's almost no escaping the fact that you're underfunded. Um, if you're using um uh, you know loan dollars. If you're using, uh, financial industry dollars and again back to okay. There are people out there that are paying cash for real estate terrific, but most of those are fairly sophisticated and would take that your considerations into account when making an offer. I certainly wouldn't pay full price for a property that I knew was subject to one or more special assessment. I'd want a discount on my real estate for absorbing that risk.
Speaker 1:It seems like everything is coming together in a pretty tumultuous way.
Speaker 2:Yes, I don't get invited to parties because I'm such a naysayer, but we're coming on a very expensive time, this inflation that we've experienced. Good news it's under control now by most common standards and, by the way, I get this question a lot. We've had some terrible inflation. Obviously we had the one year with nine. So yes, if you look back since the pandemic, certainly inflation has been an issue. But the current 30-year average of the inflation rate is still at 2.5, I think it's 2.54, but it's like 2.5. So it's still 2.5%. So part of that is driven.
Speaker 2:Remember that in the 12 to 15 years leading up to the pandemic we had historically low inflation. We had several years that inflation was below our target 2% and it had been 20 years since we had had any kind of inflation. And you literally have to go back to the 80s to have what we would call problematic inflation. So we had gone a long period of time without inflation and now inflation came back. Good news it's now we got it under control. You know raising those rates is certainly not comfortable. As I mentioned. You know it really killed the housing market. It's at all time low. So there was some cost to raising those rates economically.
Speaker 2:But you know it had to stop and we could not afford nine percent inflation on any long term scale. That's that's too problematic. So the long term inflation right now, 30 year, is two point five. That's pretty consistent what it's been. You know, if you took you know, 30 years ago you took a 30 year average is probably close to that. 30 years from now you take a 30 year average is probably going to be pretty close to that. The challenge is those costs are already there. So you know what used to cost a thousand dollars a couple of years ago? Well, it's thirteen hundred dollars now. It is what it is and it's not going down from that 13. So we will feel the economic impact to these higher prices as we start to experience costs. So as we replace our water heaters and our furnaces and our roofing and our asphalt, we'll continue to see that.
Speaker 2:Another thing that's exacerbating the HOA issue financially is HOAs. Of course, a lot of their spending is regulated to services. So whether it's financial services like the ones that we offer, legal services, accounting, professional management, contracting services, you know maintenance services, janitorial services it's all driven by services. As you know, minimum wage has increased in many markets so that increases a wide spectrum of their spending. You know we get into these discussions. You know most of our customers would be delighted to know that they're spending less than a percentage point, right? If you ask, well, how much is my fee versus how much do you guys, you know, bring in revenue? Oh, it's 0.03%. You know, it's a really small number, whereas your landscaper can take up 20%. You can spend 20, 30% of your income on insurance, depending on the property. So we make up a small percentage, but these large percentages start to add up for a while. So, getting back to the minimum wage, one of the big expenses for HOAs is, of course, landscape and janitorial. So those have been, you know, typically hit very hard by these minimum wage. Speaking specifically of California, between I think it was 2015 to around 2020, we had a 47 percent increase to our minimum wage overall. That's not talking about this recent fast food thing, this is just our overall. We went from I was fourteen, fifteen dollars an hour up to seventeen, eighteen dollars an hour, so we increased our costs significantly. Oh well, if you know, thirty percent of your budget is a landscape, you know contract. Well, now it's going to go up, you know. So if it goes up ten percent, you don't have to increase your budget 10%, but you, you know you got to increase it a few percentage points. So these services now are getting expensive. So I mentioned that we have the low cost labor, the entry level labor costs, but we also have the higher level cost and three specific industries that we deal with.
Speaker 2:A lot in the HOAs the attrition rate is much greater than the entry rate, meaning more people are leaving the industry or retiring than are doing it. Unfortunately, for the last 20 years, everybody that graduates college is told they need to be a coder, right? So nobody bangs roofs, nobody. Nobody wants to work on plumbing and there are no elevator mechanics. So so if you own an elevator in your HOA, be prepared to pay higher costs because the attrition rate amongst certified elevator operators is much greater than the entry rate to people in the profession. If your HOA owns a roof, again be prepared, because the attrition rate is greater than the entry rate. And if your HOA owns any amount of plumbing, including pipes and water heaters and other devices, again those costs are far exceeding inflation because now companies are having to pay a greater amount to the remaining workforce that is out there. So good news for all you plumbers and roofers and elevator technicians out there, you're making more money. Now You're beating inflation because your service is in demand, because, again, just simple supply and demand economics. But if you're on the HOA side and you're paying roofers, plumbers and mechanical engineers or others, unfortunately that's going to be impacted.
Speaker 2:So while I think most of us can expect moderate inflation in the midterm and long-term, anything can happen. Inflation in the midterm and, you know, long term anything can happen. But in the midterm, yeah, low two, two and a half, even three, is not the end of the world. We could survive 2.8 for several years in a row and not go crazy. Right, we've done that in the past. So I think standard inflation for your day to day you know, groceries, household goods, et cetera is going to be relatively moderate.
Speaker 2:Unfortunately, if you live in an HOA, you're not going to be limited to those folks.
Speaker 2:We're going to outpace inflation again because so many of our costs are associated with services versus products. Most of the products unfortunately reflect a standard inflation cost, so it's difficult to get services into that. So we're just going to pay. You know, again, hypothetically, if inflation is two and a half, well, expect to pay three, three and a half. You know we're not going to pay five percent more than inflation, but yeah, we can expect a couple of points higher than inflation. So, whatever inflation is over the next three to five years, expect your association's costs to go up higher than that. If it's underfunded, as thought with well, then again all bets are off. It could go up significantly based on your starting point. So again, I'll plug our services. If you're thinking about buying real estate, don't buy without a reserve study, because that is a very risky proposition in today's market. It's always been a risky proposition, but in today's market it is especially risky to be investing in real estate without some kind of outline of its financial picture.
Speaker 1:And your company, scott Reserve Studies Incorporated. Where do they serve? We service all of the West.
Speaker 2:Coast Reservestudiesinc Incorporated. Where do they serve? We service all of the West Coast Reservestudiesincorporatedcom is our email 800 number on our website. You can call us, email us, but we service the West United States. We've been servicing California regularly for 34 years now We've been doing it. Our office is located in beautiful Cerritos, california, which is right between the LA and Orange County borders, so most of our clients come in the four or five Southern California counties but we've been servicing you know. For instance, our third biggest market, I believe, is Phoenix, arizona.
Speaker 1:Okay, great so Arizona, Phoenix, Arizona.
Speaker 2:Yeah, we service all of the Western United States. We don't service Nevada. That's a licensure state, so we've chosen not to service it with the licensure requirements. But again, you know you can go to any of the websites. Cai online is a great website. They have the reserve specialists there, apra, the Association of Professional Reserve Analysts. They have data and, as a matter of fact, on the APRA, the Association of Professional Reserve Analysts, they have data and, as a matter of fact, on the APRA website you can put in the particulars or attach a PDF of your property and send it to all APRA members to bid on. So if you're looking for multiple proposals for a property, literally within minutes you can get proposals from dozens of providers that service your area. So whatever part of the country you're in, I assure you there's a reserve analyst that services you. They may not be next door, but there's somebody that travels regionally to service your area and so with a few clicks of a mouse you can get somebody capable of providing you good, detailed information about your investment.
Speaker 1:That's good to know. So, scott, are there any last words or last thoughts you'd like to leave the audience about reserves insurance HOAs.
Speaker 2:Well, hoas specifically, but property investment is general. Be well-in informed before you make that decision. I, in an earlier career, was in real estate. I have been in property inspection and now research studies for a long time and all of these different providers whether it be a good, competent real estate professional, a good competent CPA lawyer, home inspector, reserve analyst, appraiser Listen to what they have to say. These are smart people. They've been doing a long time and don't go into it without good advice because your outcome is going to be much worse. So I know it's expensive on the front side to get this kind of data, this kind of information, but it's well worth it in the long run. When you're talking about the investment that you investment, even a modest home is most people's most significant investment in their lifetime. Take a little bit of time, a little bit of financial resources and make sure you're making an informed decision because, as they say, you've got to live with it.
Speaker 1:My guest today has been Scott Clements. Thanks for coming on the podcast, scott. Thank you, my pleasure, koresh.