What, in your experience, is the biggest mistake boards make when they draw up their budgets for annual operations and big capital projects?
There are two mistakes. One is combining the operational with the capital, and the other is drawing up the budget that they want to see versus the actual budget.
Do you mean there’s a little fantasy involved?
Correct. Boards typically decide beforehand how much they want to increase the budget, and they methodically get to that number instead of what their real operational expenses are. On the capital side, what happens is they decide how much the capital projects should cost, and then they assess that amount instead of properly budgeting the true cost, plus a contingency.
What’s driving this?
There are two reasons. The first is a fear of shareholders or unit-owners. Board members are afraid of the people who elect them, and they want to keep their position because they think it’s all-pow-erful. And the second reason is they don’t want to spend. They think that by setting an artificial budget or capital program, they will save money. And historically that has not been the case. The only thing that happens, operationally, is that those numbers remain constant. It’s just the main items, such as labor or real estate taxes on the co-op side, that increase.
Let’s say you’re facing a major facade repair. What is the right approach for the board when drawing up that budget?
Board members have to look at hard costs and soft costs. Hard costs they have bid out to multiple vendors. It’s overseen by an architect or an engineer. A lot of times they fail to include the soft costs, which is typically 10 to 15 percent of the budget. It can be a little bit larger or a little bit smaller depending on if it’s a large project or a small project. Soft costs are things like architectural fees, an asbestos test, engineering costs such as a structural test if they find steel that’s bad. Typically, boards don’t budget properly for this, and at the end of the day, they come up light. Additionally, they don’t factor in a contingency. And many more jobs seem to grow in scope versus projects coming in below budget.
So being on a board is not a popularity contest. What should boards be focusing on?
Management companies typically put a lot of effort into the budget. The boards look at the bottom line, and typically just ignore it and set a 2 or 3 percent maintenance increase when 8 percent is called for. And typically, operational items have remained constant over the past five years, whether it’s fuel or repair or maintenance. What’s really growing are real estate taxes, labor costs, and the fact that people don’t rebuild reserves. Those items are what boards should focus on.
Is part of the property manager’s job to inject realism into the thinking of boards?
We submit the budget, and we try to explain it. But at the end of the day, we don’t vote on it. And a lot of the boards do not act responsibly.