Counting the True Cost: Delaying Capital Improvements in the Age of Inflation

Interest rates in the US are the highest they have been in 23 years. Does this mean it's a bad time for Homeowners Associations or Condo Associations to take on capital improvement projects? Absolutely NOT!

Sometimes community members get so obsessed with interest rates (or avoiding interest) that they forget to take a step back and look at the whole picture. Of course interest is important and HOA Loan Services is here to help you find the best rate and term for your association, but there are many other factors that should impact the decision to borrow or not borrow money.

Before ruling out an HOA loan, ask yourself these questions:

1. Is our property leaking, falling down or cracking?

2. Is our property at risk of being condemned by the local authorities?

3. How much will project costs and labor increase year-over-year?

4. How does inflation impact our capital improvement expenses and future budget plans?

5. What does it mean to have a fiduciary responsibility to the community?

Consider This Scenario

A 30-year-old Florida Condo building needs major repairs. The roof is leaking, the siding needs to be replaced and the elevators work intermittently. All together, these major capital repairs are estimated to cost the association around $2,00,000.

Over the years, the board has kept the common charges low and has opted for a patchwork approach to property maintenance expenses. They call the elevator repair person out a few times a year ($1,500 per visit), a roofer comes out to do roof repairs after each heavy rain ($1,000 per visit) and as the cracks in the siding become larger the community begins to grumble.

What started out as routine maintenance are now serious capital expenditures that are negatively impacting property values and causing real concern for owners as the watch their properties become increasingly less desirable.

Capital Raising Options

The Association recently depleted its reserve funds to repair a significant facade-related deficiency. To replenish the reserve funds, the board imposed a special assessment of $5,000 per unit. Although they have a reserve study and they know they will need more money down the line, the $5,000 assessment was the most they could impose at the time.

As the maintenance costs continue to pile up, the community is facing the reality that something needs to be done. As the condo board reviews their options, they are left with three choices:

1. Raise HOA dues incrementally to try to replenish reserves and also raise sufficient funds to tackle their rising maintenance expenses.

2. Issue a large special assessment to cover all necessary expenses.

3. Leverage an HOA loan to get the money they need now and pay it back over a fixed repayment period.

Conflicting Viewpoints

The same board has been in place for a long time with the exception of two newcomers (Lisa and Jerry). The board votes in favor of a special assessment by a 4-2 margin. Additionally, instead of replacing the entire roof, they vote to just replace the parts that are experiencing the most wear. Now instead of a $2,000,000 capital improvement project, they will only need to assess for $1,000,000.

With 75 unit owners, this means in addition to the $5,000 outstanding assessment, the board would like to collect an additional $13,333 from each property owner.

Lisa raises her hand and asks, "why would we do a special assessment instead of a bank loan? We will have to pull money out of our own savings accounts to cover the cost and we still won't have a new roof!"

Jerry adds, "about 60% of the condo community are on fixed incomes and every dollar out of their savings account is a dollar they won't get back. Furthermore, not everyone has $13,000 available in an account. Just because one person can afford the special assessment doesn't mean their neighbor is in the same financial position."

Bernie, the longtime Vice President and longest tenured board member, cracks back at Lisa and Jerry. "I've been in real estate for over 30 years. In this environment, we need to avoid paying interest at all costs! The interest payment will make this project way too expensive. If we wait 2 or 3 years, then interest rates will go down and we can do it then."

Flawed Logic

Bernie's impassioned response is one we hear a lot and because he is a tenured and well-respected member of the board, he usually doesn't get a lot of pushback. However, the problem is that Bernie's logic is flawed and his extreme distaste for interest will end of costing the community association dearly.

As the cost of materials continues to rise with inflation, labor costs are also increasing. Ultimately, construction costs are increasing 5% - 10% year-over-year. By Bernie's logic, in a few years it should be cheaper to replace the roof, elevator and siding because he thinks the interest rates will have come down by then and they will still have a $2,000,000 project to tackle.

The numbers tell a different story:

In 2022, the total project (siding, roof and elevator) would have cost $2,000,000.

In 2023, that same project will cost about $2,200,000.

In 2024, the project will cost about $2,420,000.

In 2025, the project will cost about $2,662,000.

And so on...In four years, the cost of the exact same project has increased over $600k due to inflation and a compounding increase in materials and labor costs.

If they had taken out a $2,000,000 loan in 2022 with 7% interest, they might have spent about $2,800,00 total for the project including principal and interest (if they took the loan to it's full 10-year term).

By waiting and maintaining their patchwork approach, they will continue to spend some $10,000 a year on regular maintenance costs and their property values will remain stagnant.

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Long-term Effects

Fast forward to 2024, both elevators have failed entirely and the local government is threatening to condemn the building. The association is forced to take a loan in order to stay in their condos, but now they have to borrow $2,420,000 at a 10% interest rate because the rates continued to climb. Not to mention the $1,000,000 the board assessed it's owners which didn't actually pay for a roof replacement.

All in, with Bernie's strategy the association will spend almost $5,000,000. Bernie's failure to acknowledge his fellow board members concerns, act as a fiduciary for his community and consult with experts has cost himself and his community almost $2,200,000.

As I let that sink in, it demonstrates the failed logic by many associations to defer maintenance over and over thinking it will be less costly in the future. I wish I could tell you this was a one off situation, but it goes on every single day in the world of community associations.

Contact us for a free consultation. We will help you, your fellow board members and your management company think critically about capital projects and the true cost of special assessments and deferred maintenance.