There are two types of HOA assessments – annual and special. Annual assessments are adopted by the HOA Board of Directors based upon each year’s projected budget. The total amount is then divided among the home owners. Townhouse assessments tend to be divided by the number of units, with each owner paying the same. Condos typically allocate costs according to square footage, so owners of larger units pay more.
The annual assessment has two main components – operating expenses and reserve fund allocations. Operating expenses cover routine maintenance (landscaping, snow removal, garbage collection) and management expenses (insurance, recordkeeping, professional services.) The reserve fund portion will be discussed in Part 4 of this series.
Start by examining if the Governing Documents place restrictions on the assessment amounts. These documents may limit how much the annual assessment can change, such as a maximum increase of 5% over last year’s rate. While owners may want limitations like this, the lack of flexibility can cause long-term financial woes. Here are some examples:
- Prior reserve fund payments were inadequate and it is now necessary to “catch up” to keep the HOA solvent.
- The development has cash-flow problems because of foreclosures, delinquent payments or a bankrupt developer. The remaining owners must cover the shortfall, but the assessment formula does not allow the needed increase.
- There has been an industry-wide jump in prices on a required item. In recent years, the premiums for HOA master insurance policies have skyrocketed, even when deductible amounts were raised. Sudden price increases are also common in the energy field.
Arbitrarily restricting the annual assessment rate makes it more likely that shortfalls will need to be covered by a special assessment. Special assessments are charges for specific purposes and are in addition to the annual assessment. They may or may not be charged to every owner, depending on the circumstances. Under Minnesota law, this type of assessment can only be used to:
- cover expenditures of an emergency nature
- replenish underfunded replacement reserves
- cover unbudgeted capital expenditures or operating expenses
- replace items that the HOA Board previously excluded from the reserve payment formula.
Special assessments are itemized on Minnesota’s Resale Disclosure Certificate and are not inherently bad. They may in fact be evidence of a prudent Board and a well-maintained community. Even though the Certificate does not disclose the special assessment history, ask for a five year list of the annual and special assessments if you are buying a pre-owned unit. Is there a pattern of implementing special assessments in the past few years? This is a common sign that the HOA is financially troubled. If you still want to buy, assume that at least the same level of special assessments will continue and add an appropriate amount to your household budget.
Also note whether the Disclosure Certificate says that future special assessments have already been approved and ask how that money will be spent. The answers will help indicate if the HOA is prudently planning ahead or merely compensating for previous underfunding.