It’s time to review the budget – but what does that really mean? A good budget covers the building’s annual income and expenses and attempts to maintain a strong reserve fund for future capital projects. In preparing a budget, it is important to differentiate between two aspects of a budget: “operating” and “non-operating.”
Operating items generally refer to regular income flows and expense costs. The funds to cover these items come from the monthly owner fees (common charges in a condominium and maintenance in a cooperative). Non-operating items generally refer to revenue and costs that occur once every few years or are enhancements to the building that last for an extended period of time and do not relate to the everyday operations. The funds to cover the non-operating costs usually come from an assessment paid by owners or from a reserve fund (an account set aside for unplanned/one-time capital expenses).
What are the factors that determine your monthly fees as an owner? The budget determines how much owners will be required to pay to operate the building. Items that contribute to the regular operations of the building are called “operating costs” (sometimes referred to as items “above the line”). An operating budget includes income and expenses.
A few sources that constitute income include: commercial tenant revenue; move-in/move-out charges; sublet income; and storage fees. The expense portion of the operating budget can include such expenses as taxes; the underlying mortgage for the building; payments on plumbing repairs; boiler repairs; staff salaries; insurance for the building; professional fees; and utility costs. If the total income doesn’t cover the anticipated costs, the prudent course is to require a monthly owner fee increase.
As costs continue to rise, many co-ops and condos are projecting budget deficits. “How can we eliminate the projected budget deficit?” is the most common question we receive after a budget is presented for a board’s review. The obvious answer is by increasing income, usually monthly owner fees. But that is not a solution anyone wants to hear.
The potential for creativity arises in finding alternative sources of income. Among them: installing storage bins; owning your own laundry equipment; installing a cell tower; charging move-in/move-out fees; charging fees for alterations; and flip taxes (charges incurred during the sale/transfer of an apartment). Even renting out unused basement space to a neighboring commercial interest, such as a restaurant, for storage has been successful.
While it is possible to be creative with estimated costs to eliminate a projected deficit there is not much room for creativity in a budget when reviewing expenses. The temptation to manipulate the budget numbers to eliminate the increase must be avoided. While you may think you are appealing to owners when you are keeping monthly fees down, if you are not realistic, as the year progresses it can be more costly. When you reach the midpoint of the year and unexpected repairs arise, the small deficit you projected (but did not cover with a maintenance increase) may balloon. At that point, you have less time to spread the cost and the monthly cost is much higher for owners.
After you have reviewed the budget, you realize that ownership fees must be increased to cover expenses. How do you sell the increase in monthly fees to owners and maintain their confidence in you as board member? These are no doubt tough decisions that, in spite of their unpopularity, need to be made to preserve the building’s economic health. The age old adage “Honesty is the best policy” still applies. The more notice you can provide to owners with a clear explanation the better.
Regularly reviewing expenses with an eye toward variances may help you reduce operating expenses. How many services are you willing to reduce? Can you eliminate the fresh flowers in the lobby each week and utilize the staff to install holiday decorations and trim your shrubs? There are usually areas in the budget that can be reduced but the largest budget items (taxes, insurance premiums, utility costs) are usually determined by the market and are out of your control. You should hire a certiorari attorney every year to fight the evaluation of your property, bid out your insurance coverage to get a better price, and consider locking in to or hedging specific utility costs. But, beyond that, there’s not a lot you can do.
If the budget is not balanced, the funds to cover expenses will need to come from the reserve fund. Continually drawing down the reserves for operating costs will deplete the reserve so money may not be available when a capital project is required. Additionally, when the reserve fund is depleted, a much larger maintenance increase that owners are not prepared to handle may become necessary.
Next, you need to consider the non-operating portion of the budget. This is much smaller than operating and includes items that occur only every few years or that are not regular costs or income items and are sometimes “capital items”/“below the line” items. These can include proceeds from a mortgage refinance, and costs from a façade repair, roof replacement, lobby renovation, or elevator modernization, among other things.
Generally, non-operating items determine whether an assessment is required. An assessment is usually imposed on owners when a one-time project needs to be funded. Usually, there is a fixed expense and the cost of it is divided equally among owners based on their percentage of ownership or shares. The amount is then charged back to owners within the year or over the term of the project.
Sometimes, the costs of the non-operating expenses are funded through a reserve account rather than an assessment. The amount of money in a reserve fund plays a part in determining whether or not an assessment is required. A large reserve can assist in paying for a required repair quickly and rebuilding the reserve can be accomplished over time with an assessment.
How much is the right amount of money to maintain in the reserves? Your managing agent or the building accountant can assist in determining the correct amount. Things to consider are the condition of the current building systems and the planned improvements. A reasonable level for this account should be equal to three to five months of the owners’ monthly fees at a minimum.
Balancing the budget is just the beginning of sound financial planning for the year. It is also important to monitor the spending to be certain that the building is operating according to the budget. As unplanned renovations are considered, for instance, the hallway painting that was not in the budget but now seems pressing, should only be scheduled when the board has reviewed the current financial progress of the building. As a board makes fiscal decisions throughout the year, its members must be conscious of the building’s financial position. They may need to pass on the painting project knowing that plumbing expenses are much higher than had been anticipated.
Income from sources such as flip taxes and moving fees can fluctuate in a slow economy so the non-operating items you planned may need to be reviewed to ensure funding is still available. Remember: keep your eye on the budget as the year progresses and be prepared for questions in the elevator, in the laundry room, on the phone. You are now a member of the board and subject to owners’ scrutiny. Be prepared.