March 2010

Your HOA is short on cash, and an annual insurance payment is due. Or maybe you'd like to put in new playground equipment, but your board would rather not impose a special assessment.

Can you borrow against that large chunk of money in your reserve fund in instances like these? Would that even be wise? Here we discuss whether taking a loan from your reserves is proper or advisable.

Can You? That Depends.

As with so many questions about homeowner association governance, the answer to whether your board can authorize a loan from your reserves depends on your state's law and your governing documents.

In California, it's possible to borrow from your reserves. "Reserves are like 401(k) accounts—there are controls on when and how the money is to be used," says Robert DeNichilo, an attorney at Neuland & Whitney APC in Rancho Santa Margarita, Calif., who specializes in representing community associations. "The board has a fiduciary obligation to use prudent fiscal management in maintaining the integrity of the reserve account," explains DeNichilo.

In addition, California law specifically defines reserves and spells out how they can be used. It permits short-term borrowing if the board meets certain criteria. A board must give members notice that it's going to consider borrowing from reserves at a meeting and that the board will discuss options for repayment, including whether a special assessment will be required to repay the funds. "The board has to have a full discussion on it," says DeNichilo, "and part of that discussion has to be about how the board is going to pay this money back."

The funds must also be repaid within a year unless the board makes written findings supported by documentation that there's a need to stretch the loan repayment period out further. "The board has to follow the same notice requirements as when it first considered borrowing from the reserves and explain why it's not going to pay the loan back within a year," says DeNichilo. "The word 'documentation' is vague language. It could be that the board presents financial documents that show the association's cash flow doesn't allow for repayment and that there's a need to extend the loan for a brief period."

Texas also allows associations to borrow from reserves, says Jenny Key, Austin, Texas-based vice president of RealManage, a San Rafael, Calif., association management firm that oversees properties in Arizona, California, Colorado, Florida, Louisiana, Nevada, and Texas. "In Texas, I do see associations, particularly condo associations, borrowing from the reserves frequently."

Florida, however, is aggressive in protecting reserves, explains Bill Worrall, vice president of The Continental Group, which is based in Hollywood, Fla., and manages 1,300 condominium and homeowner associations totaling 310,000 residential units. "Reserves are segregated funds, and they're restricted funds to be used for the sole purpose of what they're allocated for, which is the repair and replacement of material components within the association. The statute essentially prohibits borrowing."

But there is a catch. Florida statute provides a slim window of opportunity for associations to borrow from reserves if certain notice requirements and supermajority votes of memberships are met.

"Strictly from a numbers standpoint, the board needs to look at whether it can pull the vote off in a reasonable amount of time," says Worrall. "Just the notice requirements could be 14, 30, or 60 days, so whether it can be done depends on your current cash flow. It's also going to cost in legal fees because you'll need your association's attorney involved, and what does that cost look like compared to a special assessment and the fact that you'll need to pass a new budget for the remainder of the fiscal year?"

Never a Lender or Borrower Be?

If you're considering borrowing from your reserves, be honest with yourself about what you're trying to do. Are you really borrowing, or are you kicking a can down the road that you'll eventually catch up to again later?

"If it's a true loan—if it's properly recorded as a loan and repayable in a certain fixed period—there's no problem with it," says David Regenbaum, founder, chairman, and CEO of Association Management Inc. in Houston, which manages 239 communities with about 62,000 units. "It's when the board purports to borrow and in fact is reclassifying the reserve's funds that it becomes an issue."

Here's an example. "A condo association has an insurance bill coming due on Jan. 1 and doesn't have the funds yet to pay the full premium," explains Regenbaum. "Rather than borrow money from the insurer by paying interest to the insurer—particularly in today's market where you'd be paying 4.5-5 percent interest to the insurer yet you'd be receiving minimal interest on your reserves—it pays to borrow from yourself rather than your insurance company. You can pay yourself back over the short term. I've seen some associations pay to the association the amount of interest they'd have paid to the insurance company, and I've seen others that haven't paid interest to the association. In my mind, that's a legitimate money-management question. But if your operating expenses aren't adequate, you don't want to increase assessments or pass a special assessment, and you're using reserves with the hope and prayer that you'll pay the funds back at a future date, that's unacceptable."

Also remember that borrowing from reserves is risky because you may not be able to pay if an unexpected reserve-fund expense comes up. "It's not necessarily a good idea," says DeNichilo. "Unless you have a plan to pay it back, there's always the unforeseen event that may arise that's a legitimate reserve expense and the money's not available because you've used the reserves for other purposes. That puts board members at risk of not meeting their fiduciary obligations."

You may also face tax implications if your association doesn't pay the money back. "There are IRS aspects of borrowing from reserves," says Regenbaum. "It has to be a true borrowing and not a reallocation of reserves or you could end up paying taxes when you didn't expect to." Check with your association's accountant on the tax implications of borrowing.

Despite the drawbacks, one of DeNichilo's association clients recently borrowed from itself. "In light of their current situation and economy as a whole, they had a shortfall," he explains. "Paying it back within a year—that's the board's goal. It hasn't been a year yet, and ultimately what the board will end up doing is still in the air. They may end up increasing their cash flow by reducing their expenses so when the time comes, they'll be able to pay back. Or they may have to raise dues or do a special assessment."

Key's clients have also borrowed from reserves. "Their assessments are too low, and most of the time the loan is for operating expenses," she explains. "A few used it to put in new park equipment, and one contemplated using reserves to put new lighting in a park. I was able to convince them not to borrow from reserves by explaining, 'If your pool pump goes down and there are a lot of owners angry that they can't use the pool, you'll wish you hadn't done this. Unless there's some sort of safety issue that requires you to put lights in the park, I'd wait.' They ended up following that advice."

Key's general recommendation is that unless an association has a true emergency, it shouldn't borrow from reserves. "It's so hard to put that money back, especially if you borrowed for operating expenses," she says. "When are you going to put that money back in, and how are you going to pay it back—by increasing assessments or doing a special assessment? I try to help boards understand that there's a consequence to their actions. They can't just borrow and go on their merry way."

Worrall also tries to dissuade his association clients from borrowing from reserves. "Even if associations can swing it, we always advise against it," he explains. "We advise them to take the emotion out of the cash-flow crisis and to look at it from a business standpoint—what makes more sense for the association's long-term viability? We like to look at reserves in a conservative manner and plan for the long-term success and viability of the association."

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