Borrow now or later?

A homeowner association approached us recently for advice on an interesting issue. Their association needed to undertake an extensive and expensive repair project. They all agreed that the project was necessary. However, there was disagreement on the timing and the financing approach.

Some homeowners lobbied the board to delay going into debt. They wanted to increase dues for the next 5 years. At the end of the 5-year period, they argued that the association would have enough funds in reserve to significantly reduce the amount of their loan request.  Another faction of homeowners felt that the association would be better off securing a HOA loan with a 10-year maturity as soon as possible. They wanted to use the loan proceeds to begin the work immediately.

While there were good points made by both groups, the more compelling argument clearly favored borrowing now to facilitate immediate repairs. If your association is facing a similar situation, you may want to use this outline as a framework for discussion.

Cost increases:

With a little digging, projected construction inflation numbers can often be identified. In the case of our recent analysis, several reputable sources were projecting regional construction inflation to be more than double core inflation for the foreseeable future. These projections were based on a number of factors including a tight labor market and the imminent commencement of multiple large-scale municipal projects. There was also robust activity in new home construction that was adding stress to the demand for materials. Driver shortages were also projected to keep transportation costs high adding upward pressure on material prices.

A combination of these factors implied the project cost would increase from $10 million to more than $13.3 million if the project start date were delayed by 5 years. This projection was assuming one of the more modest inflation targets of 6%. The assessment burden per household would be increased by more than 33% (due to cost compounding). If the more pessimistic targets of 8% were realized, costs would increase more than 45% to just under $14.7 million.

Although the reserve funds would be in an interest-bearing account, the interest earnings would be negligible in offsetting projected cost increases.

Interest rate environment:

Longer-term interest rates have been relatively low for quite some time. However, short-term rates have been creeping up recently. The federal reserve has clearly indicated its intent. They are planning to cease their aggressive bond-buying activities that began just after the 2008 economic melt-down. Many economists are projecting that lower levels of government bond-buying combined with a robust economy will put pressure on the fixed income markets.

This is another way of saying that interest rates are projected to increase. If the association opted to borrow as soon as possible, their interest rate would be fixed for a 10-year term. Predicting where borrowing costs will be 5 years into the future adds another element of uncertainty to the financial picture.

Home values:

Real estate values within the community have lagged the local market due to two factors. First, the general uncertainty around the impending capital improvement project has suppressed sales. And the overall appearance of disrepair has made the association uncompetitive and less desirable than other communities in the area.

The consensus from realtors was that even though the monthly assessments would be elevated to include loan repayments, the association’s [home values] would benefit tremendously from having the repairs done and the uncertainty removed. Realtors overwhelmingly felt that a post-repaired association would help buffer prices in a declining market and allow more favorable correlation if prices continue to appreciate.

Conversely, If the association continued on its current path, the consensus was that housing prices would lead declines in a downward market and continue to lag during a strong market. In other words, the association would experience lagging performance regardless of the direction of future housing prices.

Further disrepair:

Left unattended, disrepair issues that exist today are likely to worsen over time. Although not as quantifiable, there was also concern that any delay in repairs could trigger a domino effect. Unrepaired roofs could lead to leaking, collapsing and mold issues. Further deterioration in balcony and pool areas exposed the association to expenses related to potential and preventable injuries.

Legal costs:

There are disclosure and defect-related duties that the board needed to adhere to.  Aside from avoiding potential injury-related litigation, the board was obligated to repair and maintain their community. The homeowner association analysis had not considered these duties and obligations in their analyses.

In summary, there was an indisputable financial argument to borrow the funds that were necessary to expedite the repairs. The advocates for postponing the borrowing realized that their argument was mostly based on an emotional approach to remain debt free as long as possible.

Arch Capital Solutions acts as an advocate for your HOA. We have relationships with lenders throughout the country who specialize in HOA loans.

In many states, the board may actually have a fiduciary duty to make financial decisions that are in the best interest of their members. Arch Capital Solutions can satisfy those fiduciary duties acting as the HOA’s financial advisor. We help HOAs obtain financing and choose the best proposal from multiple lenders. Contact us at 1-239-304-6180 or [email protected]. Or visit us at https://archcapital.wpengine.com

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