DEERFIELD NEWS CONNECTION
September 21, 2023
Homeowner Associations (HOA) are set up by developers when creating new residential communities. This is done to financially maintain the shared property of the community (“common areas”), and to provide an organization through which property owners can jointly participate in the activities of the HOA. After purchasing property, all property owners automatically become HOA members and share the cost to maintain the community equally. In the initial stages of neighborhood development, the developer controls the HOA, and the board is comprised of directors appointed by the developer. After the majority of the property has transferred from developer to owners, then the control of the HOA is transitioned to owner control, with the board comprised of directors voted in by HOA members.
Typically, once the majority of lots have been sold, a meeting is called to elect owners to the board of directors to fully transition from developer to owner control. This is more smoothly and successfully accomplished when the developer includes the transition process in HOA governing documents, and owners are invited to serve on the board or board committees as the percentage of property ownership grows. This gradual process of owner involvement growing over time helps educate owners on HOA governance, management, and operations so that they are prepared to take responsibility for the HOA when the time comes. It is important to understand that the election of a board of directors comprised of owners is only one step in the transition process. The best time to start the transition process is about 4-6 months before official developer turnover. The following sections provide a brief overview of other important tasks to consider and implement during transition.
Document and Asset Turnover
In preparation for transition, it is recommended that a group of owners work closely with the developer to request that all documents, financials, funds, and assets, as briefly outlined below, are transferred from developer to owners.
▪ Common Areas: Once common areas are created, the developer inspects and documents that everything is built per plan and in proper working condition. Generally, throughout the developer control period, common areas are inspected at least annually. To properly prepare the HOA budget, a reserve study is used to establish financial reserves needed for common area maintenance; and it is typically updated every three years. Before transferring common areas to owners, current conditions should be fully documented through a transition study.
▪ Financials: Setting up a community for a successful transition begins with setting a foundation for financial stability. The developer owes a duty to the HOA to establish a sound financial basis by maintaining detailed and accurate records to account for the financial affairs of the association, and to disclose all material facts affecting its financial condition. This includes maintaining a balanced budget, and adequately funding operating and reserve accounts. A funding plan is considered “adequate” when special assessments or borrowing is not required for replacement. While the developer may be subsidizing the budget during the development period, it is strongly recommended that developer contributions be paid to the HOA rather than the developer paying invoices in lieu of association contributions. This practice is preferred because it records and tracks the actual expenses of the HOA. Deficiencies funded by the developer prior to transition are an indication that the fees were not properly set to support operations and maintenance. When the developer monitors the budget throughout the development period, then the fee levels required to provide sufficient HOA income for operations and maintenance will be there at the time of transition.
▪ Documents: Approaching transition, it is prudent to ensure that the HOA is well organized. Owners should work with the developer to become familiar with the records and the operation of the HOA to be transitioned. The owner’s board of directors will be responsible for the community after transition. Therefore, it is critical that owners request and receive all pertinent HOA documents for the time period during which the HOA was under developer control. Developers should proactively work with owners to transition all HOA records to owners, including but not limited to the items listed below. A more complete list is attached to this newsletter.
▪ All Deeds to HOA-owned property
▪ By-Laws and CCR’s (Covenants, Conditions and Restrictions)
▪ All HOA financial records (including annual audits)
▪ Audits of reserve and emergency funds
▪ All books and records of meeting, and completed business transactions
▪ All operation schedules for the upkeep and care of equipment and common areas
▪ Inventory of all HOA capital equipment citing age, warranties, depreciation schedules, location, etc.
▪ All maintenance and vendor contracts (including insurance policies in effect)
▪ All development plans, plats, and engineering studies
▪ All HOA paid personnel and contract personnel (including adopted salary schedules)
▪ Compliance documents with all Local, State and Federal Laws
A team of professionals will likely be needed to assist owners in the transition process, including engineers, accountants, attorneys, and insurance consultants. It is important to make sure that selected professional partners have worked with community associations in the past and have a strong track record of success with similarly sized communities.
▪ Engineer/Reserve Specialist: During the transfer process, transition and reserve studies should be prepared. A transition study is an inspection of the association’s common areas, providing a punch-list of discovered deficiencies so that these may be brought to the attention of the developer. Additionally, the transition study provides utility line locations, warranties, and permits necessary to run the HOA. It is important to complete this study before transition is complete. A reserve study details the costs to repair and replace common areas. The replacement cost of each item is divided by its useful life to determine how much money should be allocated to the reserve fund annually.
▪ Certified Public Accountant: HOA’s have unique financial circumstances, and therefore, it is important that owners retain an accountant to represent the HOA. The accountant should conduct an audit during transition – even if it is less than a full audit. The reduced scope could focus on budget, bank reconciliation, contracts, and reserves. It is important to conduct an audit to determine whether developer-related expenses have been charged to and paid for by the HOA.
▪ Attorney: An attorney should be engaged to conduct a review of HOA governing documents and contracts, make sure insurance coverage obtained during the period of developer control complies with governing documents, industry standards, and applicable laws; and educate the new owner board members as to their duties and responsibilities related to the transfer of HOA real and tangible property, records, and financial assets. Additionally, during transition, an attorney will advise as to the resolution of potential conflicts of interest related to board members, advisors, vendors, and employee matters.
▪ Insurance: HOA boards are responsible to ensure that all insurance coverages meet the minimum standards required by law and the HOAs governing documents. Generally, during transition, owner boards hire an insurance consultant to review HOA policies in place, so that the appropriate coverage will remain in place during the time of transition (e.g., Directors & Officers, General Property & Liability, Workers Compensation, Fidelity Bonding, etc.).
Hiring professionals to perform tasks and prepare recommendations protects the HOA and its newly formed owner board from liability. When properly structured from the outset and with owner involvement phased-in over time, the HOA transition from developer to owner control will have a greater chance of achieving success.