It has happened before, but we didn’t think it would happen to us. Our world experienced a harsh challenge when the COVID-19 pandemic completely shut down major sectors of the economy, affecting the entire country’s ability to pay their basic bills. The unprecedented spike in unemployment caused by the coronavirus created a volatile economic climate, and placed cash flow at considerable risk.
For your association, the impact has been significant uncertainty related to collection of assessments, payment of vendor services, ability to pay or retain employees; and potentially even the continuity of the organization.
Is there any way to alleviate this critical situation? What are your options?
In this new reality, associations should consider all means of funding the operating budget at an emergency level sufficient to continue vital operations.
It’s possible your association might qualify for a Paycheck Protection Program (PPP) loan under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, or the Small Business Administration’s Economic Injury Disaster Loan program (EIDL), but there have been significant delays and issues regarding those sources.
As an expert Reserve Study preparer, we’ve counseled associations to avoid underfunding reserves; and to never, except in extreme emergency, borrow reserve funds to use for operations.
However, the current crisis economy is entirely different than you expected when developing your 2020 budget.
With that said, you might also consider supporting operations in this time of crisis with “internal financing,” by gaining access to your reserve funds. How do you do that?
Internal financing from your Reserve Fund
You have three possible ways to access your reserve funds:
- Decrease future reserve funding for up to three years.
- Eliminate future reserve funding for up to three years.
- Borrow from the existing reserve balance.
An association could combine these three activities over the short term (three years), but we recommend avoiding that. You should never consider doing so unless all other avenues of funding have failed because it heightens the possibility of potential disaster.
Weigh the options
Your association's operating budget takes precedence over the reserve fund budget, particularly during a crisis. However, failing to fund reserves to a baseline level results in increased future costs, and potentially, a complete failure of the association over the long term.
The reserve fund is not a slush fund
But for most associations it represents a large amount of cash set aside for future major repairs and replacements, some of which may be decades in the future.
This gives your association an opportunity to evaluate the reserve fund to see if any of it may be used on an emergency basis to fund day-to-day operations.
After all, justifying set-aside funding for a roof replacement due in 20 years is difficult when you can’t pay utility bills today.
Proceed carefully to avoid disaster
The first step is to determine the legal authority for taking such an action. The second step is to determine if reserve funds are available to access for emergency operating purposes.
When attempting to determine legal authority for accessing reserve funds you should:
- Consider restrictions in state law.
- Consider restrictions in your governing documents.
- Consult with legal counsel—always.
Don’t even consider going down this road unless you have put all of these pieces together. That way can lead to disaster.
Compare your current balance and projected income to projected expenses.
Expenditures are the controlling factor, so look at them first. Can any reserve projects scheduled in the next three years be postponed without further property damage?
If yes, postpone those expenditures and consider alternate funding plans that allow your association to shift reserve funds to increase the operating funds.
To document your due diligence in making this unprecedented decision, the Board must obtain a revised reserve study.
Cash flow matters the most
Remember, your reserve expenses don’t go away. You’re just shifting the timing of when they occur. The reserve funds diverted now should be repaid at a future date as economic conditions improve. Your association must
- Make sure cash flow is adequate to cover the remaining reserve projects planned during the next three years, and
- Plan for a “make-up” reserve assessment for later years.
In evaluating your reserve funding during a critical period, cash flow is the only thing that matters.
What not to consider: percent funded
Forget the concept of percent funded in this analysis. Percent funded is a crude tool to evaluate the adequacy of the reserve balance. It cannot take the place of the cash-flow analysis and has no place in a critical situation.
Is it ok to raid the Reserve Fund?
We almost always recommend against “raiding” reserve funds for operating purposes, but in times of emergency, exceptions can be made. Ask your professionals if internal financing using your reserve funds is a good option for your association.
As a reserve study preparer since 1982, Facilities Advisors is dedicated to helping guide your association toward the goal of having sufficient funds to pay for your future major repairs and replacements – the reserve fund. We hope that working with us will bring you and your Board members a greater feeling of safety and security about the future of your investment.
Contact us for more information about Reserve Studies and Capital Management.