SUBJECT: Building a VCA Budget for Fiscal Year 2017

Transcription

1 MEMORANDUM TO: FROM: VCA Board of Directors John Deegan, Jr., Ph.D. President SUBJECT: Building a VCA Budget for Fiscal Year 2017 DATE: I am sharing with you some of my thoughts about the process and substance of building a VCA budget for fiscal year (FY) While there are numerous ways to approach this subject, the approach I have chosen is to ask a simple question (which is analogous to zero-based budgeting): How much money would it cost for the VCA to meet its usual and ordinary annual obligations? While this question may seem straightforward, there is an implicit underlying question that influences whatever decision making process might be used, and it is this: What yardstick can be used to determine the degree to which the VCA s usual and ordinary annual obligations are to be met? Because this latter question is fraught with numerous imponderables, including unresolvable interpersonal comparisons of satisfaction, I will not spend any time trying to answer it. Instead, I will simply make assumptions and move forward. My first assumption is this: I will use a reasonable man standard and state the objective that I choose to meet. Obviously, others can apply different standards and the outcomes will change accordingly. VCA budgeted expenditures are currently grouped into nine (9) categories. 1. Activities 2. Administrative Expenses 3. Capital Expenditures 4. Contracted Services

2 Page 2 of Facility Expenses/Utilities 6. Facility Maintenance/Repairs 7. Insurance, Taxes and Fees 8. Professional Services 9. Reserves I address each of these expenditure categories in turn. 1. Activities This category contains only one entry Newsletter. I assume that the Villas Update is a desired communication vehicle for the VCA, the amount of money budgeted is based on experience, and that the newsletter should be continued. The best estimate of FY 2017 expense for Activities is $ Administrative Expense This category contains ten (10) entries and includes such items as bad debt, bank service charges, CAI membership, office supplies, postage, etc. Two new items were added to this category for FY 2017: accounts payable processing and record storage. These two new items add about $1,000 to the total category expense. I assume that all of the other entries are customary and reasonable, the amounts of money budgeted are based on experience, and that all expenses must be continued. The best estimate of FY 2017 expense for Administrative Expense is $4, Capital Expenditures This category contains ten (10) entries and all entries are derived from our reserves study. The funding for this category comes from our reserve account and does not have any effect on operations. Because it is based on reserves, it is imperative that the reserves fund be sufficiently robust to meet VCA needs.

3 Page 3 of 16 I assume that all of the expenditures in this category are customary and reasonable, the amounts budgeted are based on best available information, and that all expenses must be continued. The best estimate of FY2017 expense for Capital Expenditures is $155, Contracted Services This category contains eight (8) entries and contains items such as backflow inspections, grounds maintenance contract, irrigation maintenance contract, snow removal (Entry 6 in this category s Draft 2017 Budget), and termite control contract. I assume that except for snow removal, all of the other entries are customary and usual, and that all expenses must be continued. To determine a reasonable estimate of snow removal budget item expense, I have compiled our annual expenditures, both budgeted and audited, for every year available to me, which encompasses 2008 to The data for snow removal costs, budgeted and actual, from 2008 to 2016 are reported below in Table 1. My best estimate for FY 2017 of the snow removal budget item amount is taken from Table 1, and I have selected the average actual expense, excluding 2008 and The figure reported is $30,778 and I have elected to round this upward to $35,000. I assume that all other expenditures in this category are customary and reasonable, the amounts budgeted are based on best available information, and that all expenses must be continued. The best estimate of FY2017 expense for Contracted Services is $129, Facility Expenses/Utilities This category contains two (2) entries; water for irrigation and exterminating (other than termites). To determine a reasonable time period and frequency of irrigation, I assume that the irrigation system will be run for three months (July, August, and September) and the irrigation cycle will be activated twice each week. Based on historical data, the cost per month for irrigation water is approximately $6,400 and I have elected to round this amount to $19,000 for the year. The cost for exterminating is based on historical data.

4 Page 4 of 16 I assume that all other expenditures in this category are customary and reasonable, the amounts budgeted are based on best available information, and that all expenses must be continued. The best estimate of FY2017 expense for Facility Expenses/Utilities is $19, Facility Maintenance/Repairs This category contains ten (10) entries such as drainage improvements, erosion control, general maintenance, plumbing maintenance, and roof maintenance. Several items in this category require special attention. First, irrigation maintenance/repairs is included in this category. From experience, we have learned that if we are going to run the irrigation system, we must maintain it. We have learned hard lessons that an un-maintained irrigation system can cause expensive problems such as threatening the integrity of our cast concrete retaining walls. My best estimate of the cost of irrigation maintenance/repairs in FY 2017 is $10,000. This expense must be borne annually for however long the irrigation system is used. Second, I have added a new entry for painting. We have clear, recurring annual needs for painting and I have elected to create a four-year cycle for four specific painting jobs: (1) repainting doors/trim, (2) repainting shutters, (3) repainting cast concrete retaining walls, and (4) repainting the metal railings on the retaining walls. Based on historical information, these four tasks have estimated costs of: doors/trim ($20,000), shutters ($25,000), retaining walls ($25,000), and railings ($39,000). I have calculated the average cost of these four items ($27,250) and have rounded-up the amount to $30,000 for budgeting purposes. It occurs to me that whenever a painting expense is less than the $30,000 amount budgeted, the surplus can be saved as member equity and then applied later for a painting expense that exceeds the $30,000 budgeted. Third, I recommend that power washing our buildings should be budgeted on a recurring basis and that we can employ a three-year wash cycle where we power wash one-third of our 55 buildings each year. Based on historical information, the annual cost to power wash about buildings per year amounts to approximately $6,000.

5 Page 5 of 16 I assume that all other expenditures in this category are customary and reasonable, the amounts budgeted are based on best available information, and that all expenses must be continued. The best estimate of FY2017 expense for Facility Maintenance/Repairs is $93, Insurance, Taxes and Fees This category contains four (4) entries such as insurance coverage and taxes. I assume that all of the expenditures in this category are customary and reasonable, the amounts budgeted are based on best available information, and that all expenses must be continued. The best estimate of FY2017 expense for Insurance, Taxes and Fees is $61, Professional Services This category contains five (5) entries such as management contract, legal expenses, and audit. I assume that all of the expenditures in this category are customary and reasonable, the amounts budgeted are based on best available information, and that all expenses must be continued. The best estimate of FY2017 expense for Professional Services is $34, Reserves The final expense category, Reserves, contains two (2) entries; replacement reserves and reserve interest. To determine a reasonable reserves budget item expense for both annual contribution and annual interest, I have compiled data from our two most recent reserve studies performed by Mason and Mason. The data for reserve contributions and reserves interest are reported below in Table 2 and the table is divided into two sections for ease of presentation. The top half of Table 2 reports data extracted from the October 3, 2011 Mason and Mason study and includes their yearly recommended reserves

6 Page 6 of 16 contribution, their estimate of reserves interest earned, and their total reserves amount from 2011 to I have added to this portion of the table, for 2011 through 2015, the actual audit figures of our total contribution to reserves as well as our budgeted total reserves contribution for For the 10-year period 2016 through 2025, Mason and Mason recommends an average total reserves of approximately $347,000, consisting of an annual reserves contribution of approximately $306,000 plus an annual average reserves interest of approximately $41,000. Our budgeted reserves contribution for 2016 is $252,581 which is nearly $95,000 less than the recommended Mason and Mason average. The bottom half of Table 2 reports updated data from the April 25, 2016 Mason and Mason study and includes their yearly recommended reserves contribution, their yearly estimate of reserves interest, and their recommended yearly total reserves amount for the 10-year period 2016 to For the 10-year period 2016 through 2025, Mason and Mason now recommend an average yearly total reserves budget of approximately $283,000, consisting of an average yearly reserves contribution of approximately $264,000 plus an average yearly reserves interest of approximately $19,000. Our budgeted reserves contribution for 2016 is $252,581 which is approximately $30,000 less than the recommended Mason and Mason average. Based on the latest Mason and Mason reserves analysis, and assuming that our budgeting objective is to approximate the Mason and Mason reserves recommendations, the total amount budgeted in FY2017 for reserves would be approximately $280,000. Consequently, I assume that the budgeted reserves contribution would be $245,000. I also assume that the budgeted reserves interest would be approximately $35,000. Therefore, the total budgeted reserve contribution for FY 2017 is $280,000. The best estimate of FY2017 expense for Reserves is $280,000.

7 Page 7 of 16 Determining Monthly Assessment for FY 2017 Now that we have completed the task of determining expenditures for FY 2017, we can calculate the amount of money needed from monthly assessments in order to balance operating revenue with operating expenses. In Table 3, I have summarized the expense information assembled thus far. Column A lists the nine (9) expense categories of our budget and Column B lists the expense amounts detailed in the preceding pages. Note that I have intentionally left blank Category 3, Capital Expenditures, in Table 3 because the income for such expenses is drawn from reserves and not from operating funds. Likewise, I have omitted reserves interest from Table 3 because it is earned from our reserves fund and not derived from operating funds. The TOTAL figure reported near the bottom of Column B informs us that we need approximately $590,000 in operating revenue in FY 2017 in order to meet the FY 2017 operating expenditures identified previously. The entry for Monthly Assessment at the bottom of Column B was obtained by dividing the TOTAL expenses in that column ($590,000) by the product of 199 condominium units times 12 months (which equals 2,388). The monthly assessment needed to meet the FY 2017 operating expenditures listed in Table 3, Column B, equals approximately $247. I have also included in Table 3 several additional columns of expenses incorporating alternate levels of reserves funding. Please note that the only change found in Columns C through F, is to reduce the level of reserves funding successively by $10,000 each, from $245,000 down to $205,000. I have included these additional calculations in Table 3 to provide the reader with alternate reserves funding scenarios and to inform the readers of their corresponding alternate monthly assessment requirements. Some Concluding Thoughts This exercise leads me to several thoughts. First, I have not attempted to answer the question of how large a monthly assessment amount our current

8 Page 8 of 16 owners and future prospective owners can bear. Clearly, at some unknown point, we risk pricing the Villas beyond the capacity of the market. Are we there yet? Obviously, we are not now at a critical point because the current assessment rate of $220 per month has not yet resulted in an unacceptable vacancy rate. Such an event would quickly provide evidence that we have priced ourselves beyond what the market will bear. Is $230 per month a tipping point? How about $240 per month? Is $247 per month the tipping point? Do we really want to find out what the tipping point is because finding out might mean that we are, unfortunately, too late? Second, I think that if the monthly assessment were to be raised to $247 per month (or rounded to $250 per month), the monthly assessment figure could be held constant for (probably) five (5) years or more. The driving factor would be the reserves contribution and, based on Mason and Mason (see Table 2), we would probably be in great financial shape through 2021 (ceteris paribus). Third, a potentially unanswerable (at least analytically) question is: how much money should we budget annually to contribute to reserves? Remember that a $10 monthly assessment translates into approximately $24,000 (actually $23,880) in annual income to the VCA. Would the VCA be on thin ice if the total reserves contribution were reduced below the $280,000 level recommended by Mason and Mason? Fourth, an additional complicating factor is estimating the amount of reserves interest that will be earned in the coming years. If interest rates rise, we might be able to reach (or get closer to) the Mason and Mason reserves contribution goal of $280,000 by reducing the annual reserves contribution and off-setting the reduction with increased earned reserves interest. I do not know what the likelihood of this happening will be. Fifth, if we were willing to entertain an unknown and perhaps unknowable risk, to what level could (or should) the reserves contribution be reduced? If the annual reserves contribution were reduced from $245,000 to say, $205,000, how much would this change the required monthly assessment? The answer to this question can be found by simply consulting Column F in Table 3. There, we find that the required Monthly Assessment is

9 Page 9 of 16 approximately $230 per month. In fact, we can easily compute the required Monthly Assessment for any level of reserves funding we might choose by dividing 2,388 into the corresponding TOTAL which yields the desired result. Sixth, what will happen to the total amount of interest earned over the long run by the reserves (e.g., the next 20 years) if our annual reserves contribution is reduced? If earned reserves interest increases from its current paltry level, then this could offset the reduced contribution to reserves. To what degree might this happen? Unknown. I guess it all comes down to this: how much risk are we willing to bear that our budget meets the needs of our Association as a function of the risk we incur by raising our monthly assessment? Finally, I have attached a detailed copy of the corresponding (to the analysis in this paper) draft FY 2017 budget for your information. See Table 4.

10 Page 10 of 16 TABLE 1 Cost of Snow Removal Actual Year Budget Expense Difference 2008 $25,000?????? 2009 $25,000 $18,790 $6, $25,000 $27,800 -$2, $25,000 $8,860 $16, $25,000 $0 $25, $25,000 $16,915 $8, $25,000 $66,691 -$41, $27,500 $35,343 -$7, $30,000 $41,045 -$11,045 TOTAL $207,500 $215,444 -$7,944 (2008 Not Included) AVERAGE $25,938 $26,931 -$993 (2008 Not Included) AVERAGE $26,071 $30,778 -$4,706 (Excluding 2008 and 2012) The data are obtained from our annual budget and audit reports.

11 Page 11 of 16 TABLE 2 Mason and Mason 2011 (October 3, 2011) Alternative Funding Analysis, Hybrid Approach, Cash Flow Method, Table 3.1 Recommended Reserve Reserve Actual Total Year Reserve Contribution Interest Total Reserve Contribution 2011 $157,047 $19,557 $176,604 $182, $179,047 $21,066 $200,113 $188, $201,047 $24,721 $225,768 $256, $223,047 $29,162 $252,209 $229, $245,047 $34,259 $279,306 $273, $267,047 $39,332 $306,379 $252,581 (budgeted) 2017 $275,058 $44,660 $319, $283,310 $50,650 $333, $291,809 $35,986 $327, $300,564 $24,356 $324, $309,581 $30,070 $339, $318,868 $35,795 $354, $328,434 $42,240 $370, $338,287 $49,398 $387, $348,436 $56,963 $405,399 AVERAGE $306,139 $40,945 $347,

12 Page 12 of 16 TABLE 2 (Continued) Mason and Mason 2016 (April 25, 2016) Funding Analysis, Cash Flow Method, Hybrid Approach, Table 3 Recommended Reserve Reserve Actual Total Year Reserve Contribution Interest Total Reserve Contribution 2016 $252,581 $18,292 $270,873 $252,581 (budgeted) 2017 $255,135 $20,255 $275, $257,714 $22,793 $280, $260,320 $22,051 $282, $262,952 $18,540 $281, $265,610 $14,752 $280, $268,296 $13,871 $282, $271,008 $16,381 $287, $273,748 $19,093 $292, $276,516 $21,886 $298,402 AVERAGE $264,388 $18,791 $283,179

13 Page 13 of 16 Table 3 Summary of Budgeted FY 2017 Operating Expenditures Column A Column B Column C Column D Column F Column F Expense Category Amount Change 1 Change 2 Change 3 Change 4 1. Activities $350 $350 $350 $350 $ Administrative Expenses $4,966 $4,966 $4,966 $4,966 $4, Capital Expenditures N/A N/A N/A N/A N/A 4. Contracted Services $129,773 $129,773 $129,773 $129,773 $129, Facility Expenses/Utilities $19,400 $19,400 $19,400 $19,400 $19, Facility Maintenance/Repairs $93,000 $93,000 $93,000 $93,000 $93, Insurance, Taxes and Fees $61,923 $61,923 $61,923 $61,923 $61, Professional Services $34,773 $34,773 $34,773 $34,773 $34, Reserves $245,000 $235,000 $225,000 $215,000 $205,000 TOTAL $589,185 $579,185 $569,185 $559,185 $549,185 Monthly Assessment $ $ $ $ $229.98

14 2017 Budget DRAFT Building a Budget for FY 2017 Page 14 of 16 The Villas at Falls Run Condominium Unit Owners Association # Units % Monthly Assessment $ $ $27.00 Annual Assessment $2, $2, $ Jan-June 2016 Actual Jan-June 2016 Budget 2016 Annual Budget 2017 Annual Budget 2017/2016 Budget Diff INCOME Assessment Income General Assessments 262, , , , , Late Fees Legal Fees NSF Fees Total Assessment Income 263, , , , , Other Income Land Plan , , Miscellaneous Income Operating Interest Income Reserve Interest Income 20, , , , , Reserve Transfer Income 25, , , , Total Other Income 46, , , , , Total Income 309, , , , , EXPENSE Activities Newsletter Total Activities Administrative Expenses 1 Accounts Payable Processing (An Annual Expense) 2 Bad Debt Bank Service Charges CAI Membership/ Training Checks & Coupons Misc Admin Expenses Office Supplies Postage , Printing & Copying 1, , ,

15 Page 15 of Record Storage (An Annual Expense) Total Administrative Expenses 2, , , , Capital Expenditures 1 Capital Expenditures 22, Common Area Tree Replacement , , , Concrete Retaining Walls , , , Domestic Water Supply Lines , , Downspout & Underground Drain , , , Landscape Sprinkler System , , , Masonry Repair Allowance , , Metal Railings , , Reserve Study 3, , , , Villa Unit Landscaping Allowance , , , Total Capital Expenditures 25, , , , , Contracted Services 1 Backflow Inspections (Annual) 2, , , , Grounds Improve/ Replace , , , , Grounds Maintenance Contract 31, , , , , Irrigation Maintenance Contract , , , , Land Plan , , Snow Removal & Sanding 41, , , , , (Estimate of Annual Cost) 7 Termite Control 25, , , , , Tree & Shrub Care , , , , Total Contracted Services 75, , , , , Facility Expenses/Utilities 1 Water-Irrigation , , , , (Jul-Aug-Sep, 2X Per Week) 2 Exterminating Total Facility Expenses/Utilities , , , , Facility Maintenance/Repairs 1 Building Maintenance Drainage Improvements , , , , Erosion Control , , , General Maintenance , , , Gutter Maintenance 2, , , , Irrigation Maintenance/Repairs , , (Must Maintain to Use) 7 Painting (4 Year Cycle) , , (Re-Paint Railings - $39,000) (Re-Paint Walls - $25,000) (Re-Paint Shutters - $25,000) (Re-Paint Doors/Trim - $20,000)

16 Page 16 of 16 8 Plumbing Maintenance 3, , , , Power Washing (Annual) , , , , (3-Year Cycle, 1/3 Units/Year) 10 Roof Maintenance 5, , , , Total Facility Maint/Repairs 37, , , , , Insurance,Taxes & Fees 1 Insurance Coverage 22, , , , , Insurance-Losses/Deductible , , Income Taxes 4, , , , , CICB Certification Total Insurance,Taxes & Fees 27, , , , , Professional Services 1 Management Contract 14, , , , Additional Management Services Legal-Collections Legal-Board Issues , , Audit/Tax Services , , Total Professional Services 15, , , , Reserves 1 Replacement Reserves 105, , , , , $250,000/Yr (Mason & Mason) 2 Reserve Interest Expense 20, , , , , (Estimate of Interest) Total Reserves 125, , , , , Total Expense 310, , , , , Excess Revenue / Expense , , ,011.00