Understanding Your HOA
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 (CCRs) which are rules that govern the use of the land under the jurisdiction of the HOA. These rules are codified in a legal document that is recorded in the official property records of the county where the HOA is located. The CCRs a legally enforceable rules that are incumbent to the deed of each privately owned lot in a planned developed, and each unit in a condominium. The HOA is responsible for managing and maintaining the common areas or common elements within the in additional to enforcing the CCRs.
The common elements of a condominium may include the exterior of your home, possibly including the doors, windows, siding, paint and even the light fixtures on the exterior of the building. In the more elaborate and condominium developments the common elements may include building systems such as elevators, fire suppression systems and an almost endless array of expensive amenities.
In a planned development (PUD), the common elements may include a variety of site improvements in addition to building exteriors. These common areas may include the front yard of your home, including the irrigation system; fencing, roads, recreational amenities, water treatment and storm drainage installations and more.
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 or 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.
If 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, or a 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 a HOA is similar in this respect to the middle management level of the Association’s corporate hierarchy.
The replacement reserves are 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 (reserved) to pay for the renovation or replacement of the common area improvements that the HOA is responsible for maintaining.
In the context of HOA 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 that may be used to pay for any expense the Board of Directors feels is warranted. Rather, the replacement reserves are established to pay for specific expenditures required to renovate or replace commonly owned assets and improvements which are the responsibility of the HOA to maintain.
The PUD, or planned unit 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 real estate development is platted as a 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, while the individual ownership of the condominium unit is determined by a boundary description that encompasses the air-space within the unit.
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 of Covenants, Conditions and Restrictions (CCRs) is the controlling legal document of the HOA. The CCRs, Bylaws, Rules & Regulations and Articles of Incorporation, is commonly referred to as the governing documents of the HOA. The term Declaration is often used to refer to the CCRs.
The Declaration of Covenants, Conditions and Restrictions (CCRs) is a 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. Also referred to as the Declaration, the CCRs result in 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 CCRs codifies the covenants, conditions and restrictions 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 public records of the County where the property is located.
The CCRs are the document that 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 CCRs may include restrictions on the individual lots such as minimum size and/or the architectural style of the homes that may be constructed on a lot; the choice of exterior finishes used in the construction of the homes, etc. The CCRs may be used to establish occupancy limitations such as residential vs. commercial occupancy or various "mixed-use" occupancy classifications.
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.
Typically, there is a hierarchy of difficulty that makes it much more difficult to alter the CCRs 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 CCRs or the Bylaws.
s a member of a 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 CCRs establish the contractual obligations of the HOA members are with respect to contributing to the financial support of the organization. Under the CCRs each owner is allocated a percentage of ownership in the HOA sometimes referred to as the allocation interest. 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 CCRs for a 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
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 due diligence 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 oversee the day-to-day affairs of the Association; and perhaps, most importantly, how effective the Board of Directors is at governing the community.
The HOA due diligence process works in much the same manner as a home inspection. Buyer should order a due diligence report after an offer has been accepted but before the period of review agreed to by the seller, has expired. The outcome of the examination is the CIDA REPORT™, which provides a wealth of information designed to educate and inform the buyer. The result is an empowered 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 HOA a buyer is 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 organization. These obligations may include long-term debts if the Association has borrowed money from a bank, or future reserve spending obligations which are determined by conducting a reserve study.
These obligations can be significant. 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 subsequent generations owners (buyers), will bear a disproportionate share of the financial burden for funding the reserves or repaying outstanding loans.
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.
IState law vary with respect to the disclosure requirements imposed on sellers and HOAs at the time of sale. In states, CA, HI and WA for example, the HOA is required to provide specific documents to a buyer either before an offer has been tendered or at the after the offer has been accepted.
In other states, buyers may be entitled to specific HOA documentation if requested, but the documents required to be provided under state law are limited and may not include critical documents needed to gain a comprehensive understanding of the HOA operation. In most instances the seller, as a member of the HOA, is entitled to documents that buyers may or may not be provided during the disclosure process. Oregon, establishes the right of the HOA members (sellers) to HOA documents with the exception of specific documents which may be classified under state law.
Oregon statutes are limited with respect to HOA disclosure at the time of sale but they do not prevent the seller from providing documents the buyer has requested with the exception of confidential information. In this respect Oregon law is Caveat Emptor statute, buyer beware! You are entitled to HOA documents the seller agrees to provide, but only if requested.
In 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.
Documents that are required to conduct a due diligence examination of a homeowner association are typically in the possession of the HOA management company or a third-party archiving service. In some cases, the Board of Directors may have physical possession of the documents.
In most states, a seller, as a member of the HOA, has a legal right to the HOA documents. If state law does not require the HOA to automatically provide a comprehensive dossier of documents, buyers should include a request for the documents in their offer. If a seller accepts the offer, it is then up to the seller to fulfill the terms of the offer by providing the documents.
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 facilitate the transaction by providing the requested documents. Any fees that must be paid to acquire the documents are a point of negotiation between seller and buyer. CIDA recommends that all buyers include a specific request in their offer that the seller pay all document procurement costs as a condition of the sale.
Third-party archiving services are companies that warehouse HOA documents in digital form, typically at no charge to the HOA. The company then make those documents available to HOA members, buyers, lenders and other interested parties for a fee.
Some firms, CondoCerts® and HomeWiseDocs® for example, are also in the business of selling lender questionnaires, or “lender letters,” which may be required by mortgage lenders as part of the mortgage underwriting process. Archived documents may contain relevant to the preparation of the lender questionnaire. The firm profits by selling the lender letter to buyers and also by charging fees when buyers, sellers or other interest parties download documents from the company's database.
The fees are not insignificant and can be almost as much as the cost of the 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 purchased from these services are not current or complete. Buyers who are forced to purchase documents from various archiving services often end up with incomplete and/or outdated documents for fees that can exceed $300.
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.
If You have any Additional Questions Let Us Know