A homeowner association (HOA) is a legal entity that is created by a real estate developer when a residential real estate development is constructed. In the majority of cases the HOA is organized under the corporation laws as a not-for-profit corporation. There are exceptions in which an HOA may be an unincorporated entity, but they are becoming more and more rare.
The purpose of the HOA is to enforce the covenants, conditions and restrictions (CC&Rs) which are rules that govern the use of the land that is under the jurisdiction of the HOA. These rules are codified in a legal document known as the Declaration. The HOA is also responsible for managing and maintaining the so-called common areas or common elements of the Association, which are those assets and improvements that are jointly owned by all of the property owners within the HOA. In some cases these common elements may include the exterior of your home, up to and including the doors, windows, siding, paint and even the light fixtures on the exterior of the building.
The HOA is governed by a Board of Directors who are elected by the HOA membership. In almost all instances Board members must be owners or co-owners of a lot of unit within the HOA. On rare occasions the governing documents may allow a tenant (renter) to serve on the Board of Directors as a representative of the owner from which the tenant is renting the property.
In those instances where a property within the HOA is owned by a lender or corporate entity that acquired the property through a foreclosure proceeding, the governing documents typically include a provision that allows an employee, partner of corporate officer of the ownership entity to serve as a Board member even though the individual is not technically an owner/member of the HOA.
The role of the management company is to handle the day-to-day administrative tasks that are required for the organization to function smoothly, under the direction and supervision of the Board of Directors. The Board of Directors is the executive council that is responsible for policy-making and overseeing the employees and contractors who provide services to the Association, which includes the management company and independent managing agents who may be employed directly by the HOA. The management component of an HOA is similar in this respect to the middle management level of the Association’s corporate hierarchy.
The term replacement reserves is the more formal name for what most people refer to as simply the “reserves.” In the context of finance and accounting, the term reserves can have more than one meaning, so the term replacement reserves is used specifically to identify those funds that are being saved or reserved to pay for the renovation or replacement of the common area improvements that the HOA is responsible for maintaining.
In the context of replacement reserves it is important to distinguish between routine maintenance expenditures and expenses that are incurred when capital assets are replaced or sufficiently renovated to extend the service life of the asset in question. The reserve account is not an ordinary savings account used to accumulate money that may be spent on anything the Board of Directors feels is warranted. Rather, the replacement reserves are there to pay for specific expenses that are required to renovate or replace commonly owned assets and improvements which are the responsibility of the HOA to maintain.
The PUD, or planned development, is the most common and recognizable form of HOA in the United States and is typically associated with traditional subdivisions that contain single-family detached homes located on individually owned residential lots. The subdividing of a larger parcel of land into smaller, individually platted lots that are owned by the homeowners is the defining feature that distinguishes a PUD from a condominium.
When a development is designed and platted as condominium the land is not subdivided, but is instead left intact as a single parcel of ground. In a condominium the owners are said to own an undivided and indivisible interest in the land.
In a PUD that contains detached homes on individual lots, the HOA is typically responsible for maintaining common area improvements that are located on commonly owned tracts of land within the development but it is responsible for maintaining the homes in the community.
In theory and in practice, any residential real estate development can be developed as a condominium, even a development that contains single-family, detached homes. Although it is somewhat uncommon to find detached housing developments that are platted as condominiums, they do exist. In some instances the HOA in these situations will be responsible for maintaining the exteriors of each home even up to the point of deciding if or when to replace the windows and doors of each home.
The Declaration, Bylaws and Rules & Regulations along with the Articles of Incorporation are collectively known as the governing documents of the HOA. It is a common mistake made throughout the industry to refer to this collection of documents as the “CC&Rs,” although the CC&Rs technically consist only of the Declaration. Each of these documents plays an important role in the organizational structure of the HOA. To learn more about the differences between these documents please continue reading…
The Declaration is a legal contract between the HOA and the property owners who, by virtue of purchasing real property within the HOA, are contractually bound to membership in the Association. The Declaration is a legally binding agreement which establishes the obligations of the HOA to the membership and likewise the obligations of the members to the Association.
The Declaration codifies the covenants, conditions and restrictions (CC&Rs) that are imposed on the land by virtue of the incorporation of the Declaration into the real property deed and recording of both documents with the County Recorder in the County where the property is located.
The Declaration defines the General and Limited Common Elements of the Association and dictates who is responsible for maintaining each of the Common Elements. The restrictions imposed by the CC&Rs may include dictating the minimum size and/or the architectural style of the homes that may be constructed within the community; the choice of exterior finishes used in the construction of the homes; minimum requirements for landscaping of the individual lots; and other restrictions that the developers of the project may deem to be appropriate.
The Bylaws are the rules that establish how the HOA will be operated. In this respect they are no different from the Bylaws of any corporation. In general, the Bylaws of most HOAs are somewhat standardized; in particular, when dealing with Associations that have been formed within the last twenty years or so.
The Bylaws establish how the Board of Directors is organized and what the specific responsibilities of the Board are with respect to governance of the organization. The Bylaws may also contain language that impose certain obligations on the HOA membership. For example, the Bylaws will often contain a clause that requires each HOA member to maintain a minimum level of insurance coverage or specific types of coverage that are not otherwise provided by the HOA.
The Bylaws may also set forth rules that dictate or restrict certain types of behavior on the part of the HOA members. In the wake of anti-smoking legislation around the country, many condominiums have elected to amend their Bylaws so that smoking is not permitted anywhere within the condominium – in some instances even going so far as to ban smoking inside the boundaries of the condominium units.
The Rules & Regulations are the protocols that dictate how the residents who live in the community must behave. These rules apply to both owner-occupants as well as tenants who rent a home that is located in the HOA. In certain respects the Rules & Regs, as they are commonly known, are a catch-all for codifying aspects of the HOA’s code of conduct that are not addressed in the Bylaws or the Declaration.
Typically there is a hierarchy of difficulty that makes it much more difficult to alter the Declaration or the Bylaws. In some instances the Rules & Regulations may be altered by a majority vote of a Board of Directors in the absence of any objections by the HOA membership, whereas changing or amending the Declaration or the Bylaws will typically require that the matter be put to a vote of the full membership, often with the approval of a so-called super majority being required to alter the CC&Rs or the Bylaws.
As a member of an HOA you have a choice of being a passive owner or a proactive and involved owner. If you elect to be a passive owner you are allowing other people to make decisions that can and will impact your life, possibly in an adverse manner and very likely in a way that impacts your personal financial situation. As a passive owner you have little if any control over the HOA’s decision-making process. You are left to deal with the decisions made by fellow HOA members who have chosen to serve on the Board, or worse yet, by hired management who may be indifferent to your needs.
The alternative is to become a proactive member of your HOA by serving on the Board of Directors, or if the organization is large enough to have established standing committees, you may elect to serve on a committee instead of, or in addition to, serving on the Board. As a proactive and involved member of your HOA you become one of the decision-makers; a leader as opposed to a follower. Most importantly it allows you to have some control over your financial destiny and the future value of the investment you have made in your home, rather than allowing other people to make important financial decisions that impact your financial situation.
The Declaration establishes what the contractual obligations of the HOA members are with respect to contributing to the financial support of the Association by allocating a percentage of the ownership in the HOA to each property within the Association. This allocation process may be as simple as dividing 100% of the ownership by the number of privately owned units or lots. For example, the Declaration for an HOA consisting of 100 residential lots might dictate that each lot owner is responsible for 1% of financial obligations of the Association.
Under the condominium form of ownership the allocation of ownership interest is more often based on the percentage of each condominium’s square footage relative to the total square footage of all of the condominiums combined. Hence, a condominium that contains 1% of the total square footage of all of the condominiums in the development would be allocated 1% of the ownership interest in the condominium, whereas a condominium that contains 2% of the total floor space would be allocated 2% of the ownership interest.
In those situations where the ownership interest is allocated according to the square footage of the units it is not uncommon for the voting interest of each owner to also be allocated using the same methodology. In other words, a condominium owner whose condo contains 2% of the total floor space would have twice as much voting power as an owner whose condominium contains 1% of the total floor space.
The alternative to this type of voting interest is the so-called “one unit, one vote” strategy which dictates that each unit or lot owner is entitled to a single vote regardless of the size of the unit relative to the other units in the case of a condominium or whether the unit or lot in question is co-owned by two or more individuals.
Pre-purchase due diligence refers to the process of evaluating the financial and historical records of a homeowner association before a buyer commits to purchasing a home in the HOA. The purpose of the due diligence examination is to develop a better understanding of the inner-workings of the organization including how the Association manages its money; the administrative competency of the individuals and companies who over see the day-to-day affairs of the Association; and perhaps most importantly, how effective the Board of Directors is at governing the community.
The pre-purchase due diligence process works in much the same manner as a home inspection in that a buyer will typically order a due diligence report after their offer has been accepted but before the period of review that has been agreed to by the seller, has expired. The CIDA Report, which is the outcome of the due diligence examination, provides the buyer with a wealth of data that is designed to enlighten, educate and inform the buyer, and in so doing empower the buyer not only with respect to negotiating the best possible terms of sale, but also as the buyer moves forward and becomes a member of the HOA.
When you purchase a home in a homeowner association you are automatically conscripted to membership in a not-for-profit corporation. As a member of this corporation you are responsible for an allocated share of the debts and financial obligations of the Association. These obligations may include existing debts that the Association is already committed to pay or future spending obligations that are determined by conducting a reserve study.
These obligations can be significant, and in those instances where an HOA has underfunded its reserves or deferred various big-ticket maintenance expenses due to a lack of funds to pay for the work, it means that you, as a later generation owner, will bear a disproportionate share of the financial burden for funding the reserves or otherwise paying for these expenses.
Without proper due diligence a buyer is making one of the most important financial decisions of their life without being fully informed. If you do not know how to read a reserve study or a financial statement or are not familiar with the mechanics of how HOAs operate, then you may or may not be able to make sense out of the documents that you receive, in which case it is prudent to hire an expert to conduct the due diligence on your behalf.
Knowledge is power, and in a real estate deal the party with the most knowledge usually wins when it comes to negotiating the best deal.
In most states a buyer is entitled to any HOA documentation that the seller has access to by virtue of the seller being a member of the HOA. Documents that have been determined to be confidential by the HOA’s legal counsel are typically exempt from the the disclosure requirements that may otherwise require that the HOA provide the documents to a buyer.
A handful of states, including Florida (the state with the largest percentage of its population living in HOAs) do not require that the seller or the HOA provide any documents to a buyer under any circumstances. In these situations the issue must be brought to the negotiating table by including a requirement in the buyer’s offer that the seller will provide specific documents as a condition of the sale.
If an HOA or an individual seller is unable or unwilling to provide relevant documents to a buyer who has requested them, it should be viewed as a serious red flag. Buyers who are faced with this situation need to take a long look at the HOA and ask themselves if they really want to invest in an organization that is unable or unwilling to share pertinent financial and historical records with the buyer.
The documents that are required to conduct a due diligence examination of a homeowner association are typically in the possession of the Association’s management company or a third-party archiving service such as CondoCerts of HomeWiseDocs.com. In some cases the Board of Directors may have physical possession of the documents.
In all of these situations it is the seller who has a legal right to the documents and as such the seller is the party who should be tasked with the responsibility for obtaining the documents. Some states require that the seller provide certain documents to a buyer either before the buyer tenders an offer to purchase the property or after the seller has accepted the offer, with the act of acceptance triggering the obligation of the seller to provide specific documents that are required under the state’s real estate disclosure laws.
In other states a buyer is entitled to HOA documents, but only if they request the documents as a condition of the sale. If the seller accepts the buyer’s offer without challenging the request for documents, the seller is hereafter obligated to provide whatever documents the seller has requested.
In all of these scenarios the seller is the party with a legal right to the HOA documents, and as such the seller should be expected to obtain the documents that the buyer has requested. If there are any fees that must be paid to acquire the documents, the question of who will pay the fees is likely to come up. To avoid any confusion about who is responsible for the fees it is always advisable to include a provision in the offer which states that the seller will pay and and all fees that may be incurred to acquire the documents that have been requested.
CondoCerts and HomeWiseDocs.com are third-party archiving services that warehouse HOA documents and make those documents available to HOA members, buyers, lenders and other interested parties for a fee.
These firms are also in the business of selling lender questionnaires, or “lender letters,” as they are sometimes called, which are documents that are required by mortgage lenders as part of the mortgage underwriting process. The information that is contained in the archived documents may be relevant to the preparation of the lender questionnaire and therefore offers the firm two ways to profit from offering to warehouse the HOA documents: by selling the documents back to the owners or other parties who request to have access to the information, and when they use the documents as a source of information for preparing lender letters which are then sold to borrowers who are seeking to mortgage a home in the HOA.
The fees that both firms charge are not insignificant and can be almost as much as the cost of a CIDA Report depending on which documents are purchased. In addition to the questions raised by the practice of charging HOA members to gain access to documents that belong to the HOA, it is often the case that the documents that purchased from these services are not current or complete. CIDA’s experience with buyers who have been forced to purchase documents from both of these services is that they rarely provide a complete, current suite of documents after a buyer has paid $200-$300 to obtain the documents.
CIDA recommends that all buyers insist on having the seller pay any fees that may be associated with obtaining documents from any archiving service or management company that may choose to charge buyers or sellers for documents in their possession.
Once the task of obtaining the documents has been completed a buyer has two choices: either wade through the documents and try to make some sort of sense out of what you have assembled, or hire an independent examiner to complete the due diligence process by reviewing the documents and preparing a written report summarizing the data contained in the documents.
While there are many people who are obviously qualified to perform their own due diligence, many buyers will elect to hire a third-party examiner in the interest of saving time if for no other reason. As experts who have examined hundreds of HOA’s and developed an efficient and thorough system for evaluating the data and summarizing it into a written report, CIDA has quickly become the nation’s leading provider of due diligence services for homebuyers.
If you elect to conduct your own due diligence you may find some useful information on this website as well as some of those that are listed under Useful Links.