Published in Greater Salt Lake Edition of Attorney at Law Magazine, Vol.2 No.1.
By Kevin Dwyer
The 2008 housing crisis was a wake-up call to many sectors of the real estate industry. In Utah, no sector has seen the kind of sweeping changes that homeowners associations (HOAs) have experienced through the imposition of new statutory requirements.
As the foreclosure crisis unfolded, banks were left holding properties — sometimes multiple units within the same development — and found themselves obligated to abide by HOA dues and assessment requirements. Often governed by volunteer boards, HOAs were ill equipped to project future needs or manage maintenance costs. This resulted in unpredictable assessments and unhappy bankers.
By 2010, the Utah legislature was tightening the reins on HOAs. Statutory changes have focused on: (1) governing documents; (2) HOA registration; and (3) reserve analysis. These changes have resulted in a complex landscape of due process, regulatory, and financial requirements, and a substantial increase in the need for regular professional insight.
HOAs serve in both municipal and corporate roles. Practitioners must therefore deal with both civic-type and commercial issues and familiarize themselves with two chapters in Title 57 of the Utah Code, i.e., the Condominium Ownership Act (Chapter 8) and the Community Association Act (Chapter 8a).
The requirements for governing documents are contained principally in Chapter 8, Sections 10, 15, 16 and 39, and in Chapter 8a, Sections 104, 212, and 216. A Declaration of Covenants, Conditions and Restrictions (the “declaration” or “CC&Rs”) is the principal operating agreement for an HOA. The legislature has established requirements for CC&Rs with an emphasis on distinguishing private from common property, and setting limits on the restrictions that HOAs can require on alienation or transfer.
HOAs also adopt bylaws, which dictate management and control of an HOA through a committee or board of directors. Both Chapters provide new requirements for control. For example, a supermajority for amending governing documents cannot exceed 67%. HOAs must exercise their operations and control in a regulated and consistent fashion, incorporating a democratized process.
The Chapters also now require HOAs to register with the Department of Commerce. See Sections 57-8-13.1 and 57-8a-105. Failure to do so has significant consequences: an HOA’s power to enforce liens is suspended if it is unregistered.
The most extensive new requirements for HOAs are detailed in Sections 57-8-7.5 and 57-8a-211, which require HOAs to regularly engage in a reserve analysis /study and build a reserve fund to provide for the repair and replacement of common interest assets. A sophisticated and highly useful tool, a properly completed reserve analysis will minimize special assessments (often a source of litigation) and maximize the efficiency with which HOAs maintains their value and assets. HOAs must update the study every three years and conduct a new one every six years. HOAs must also provide a reserve analysis summary annually to members and, beginning 2014, allow members to approve or reject a specific budget line item on a reserve contribution. The first step in a reserve analysis involves a comprehensive look at the HOA’s common area obligations, as detailed in the Declaration, Bylaws, contracts with third parties, and rules of the HOA. By examining these documents, a practitioner can determine the scope and limits of the HOA’s responsibility for common areas and infrastructure. Additionally, the governing documents detail the mechanisms and rules through which the HOA may collect revenue and, in some instances, how those funds are to be held or invested.
After a thorough overview of the HOA’s obligations and resources, a reserve analysis necessitates a physical analysis of the HOA’s property, detailing information about the condition and repair/replacement cost of the components that the HOA maintains. By statute, the analysis must include: a list of the components that will require reserve funds; those components’ probable remaining useful life; and an estimate of the cost of repair, replacement, or restoration. The most accurate reserve analysis utilizes local contractor estimates and bids as well as professional inspections and evaluations. Typically, a fully-funded reserve balance will equal the current cost of each component’s replacement or repair, multiplied by the number of years the component has been in service, and then divided by its useful life.
The next step evaluates the HOA’s actual reserve fund balance and its income. Utilizing statistical software and modeling, the reserve study calculates an HOA’s percentage funding level by comparing the actual reserve balance to a fully-funded balance. An estimate is then made of the total annual contribution necessary to defray future costs. A comprehensive reserve study will analyze these contributions in light of expected reserve fund returns and project the dues required to fulfill future operating and reserve obligations.
The final step in the analysis is to match the HOA’s obligations to the tools and mechanisms for revenue generation, as outlined in the governing documents. Often, a declaration limits the ability of the board to increase HOA assessments and dues or requires owner consent. Careful document analysis and feedback from members is required to craft solutions that are practical, timely, and compliant with statutes and governing documents.
Practitioners in all fields touching on HOA law are advised to be well informed of the new legislative requirements. Compliance, which is increasingly scrutinized by mortgage lenders and prospective buyers, will protect HOAs and their board members from liability and preserve the financial health of the HOA and the salability of its properties.
This article is not intended to constitute legal or tax advice and cannot be used for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending any transaction or matter addressed herein.
- On February 13, 2014