The Consumer Price Index and Assessments

Introduction
Associations are generally formed to perform many tasks on behalf of the owners within the common interest community.  In order to perform these tasks, there must be sufficient monies.  Thus, a funding mechanism is provided through the levying of assessments.  The declaration for a community generally contains a provision addressing how the yearly assessment is calculated and what should be included in the assessment budget.  The declaration may also contain a formula to be used in increasing the assessment from year to year.

A surprisingly large number of declarations were written with a provision which ties the allowable increase in annual assessments to the Consumer Price Index.  Associations with declarations which contain these restrictions may increase assessments only within the confines of the formula contained in the declaration provision based on the Consumer Price Index.  Associations with declarations which contain these restrictions may increase assessments only within the confines of the formula contained in the declaration provision based on the Consumer Price Index as stated in the provision.  Some of these may be straight forward, yet others look as if it would take an economist and a mathematician working together to figure out the proper calculation.

What is the Consumer Price Index?
The Consumer Price Index (CPI) is a measure of the average change over time in the prices of a specific market basket of consumer goods and services.  Each month, Bureau of Labor Statistics (BLS) field representatives visit or call thousands of retail stores, service establishments, rental units, and doctors’ officers, all over the United States to obtain price information on thousands of items in the CPI market basket.  The information is compiled, compared and calculated to generate the CPI for that month.  Then, the CPI provides a means for consumers to compare what the market basket of goods and services costs this month with what the same basket cost a month or year ago.

The items included in the market basket are developed by the BLS from detailed information gathered from families and individuals about what they actually buy.  The items are classified into over 200 categories arranged into seven major groups.  Some of the services which are included are water and sewage charges, auto registration fees, and vehicle tolls.  Taxes that are directly associated with the prices of specific goods and services, such as sales and excise taxes, are also included.  Taxes which are not directly associated with the purchase of consumer goods and services, such as income and Social Security taxes, are not included.  The CPI does not include investment items such as stocks, bonds, real estate, and life insurance because these items relate to savings and not to day-to-day living expenses.

The CPI is based on the spending patterns for each of two population groups:   All Urban Consumers (CPI-U) and Urban Wage Earners and Clerical Workers (CPI-W).  The CPI-U is based on the expenditures reported by almost all urban residents, including professional employees, the self-employed, the poor, the unemployed, and retired persons as well as urban wage earners and clerical workers.  Farm families, those in the Armed Forces and people in prisons or mental hospitals are not included.
The CPI-W is more specialized and is based on households that meet additional requirements:  More than one-half of the household’s income must come from clerical or hourly wage occupations and at least one of the household’s earners must have been employed for at least 37 weeks during the previous 12 months.  As a subset of the CPI-U, the CPI-W represents about 32 percent of the total U.S. population while the CPI-U represents about 80 percent of the total U.S. population.

The CPI is not a cost-of-living index, as it is frequently and mistakenly called, nor does it necessarily match the inflation rate.  It is nothing more than an indicator of how much the average family spends for an average group of items as compared to basically the same group and the same items at a specific time; the time could be a month, a year, several years for comparison.

In addition to the two types of population, there are different CPI’s generated for different regions and metropolitan areas of the country.  Price indices are available for the U.S., the four Census regions, and for 29 local areas.  Each index is identified by a title of what it represents in what area.  The most commonly used CPI is the CPI-U for U.S. City Average All Items Index which began in 1913.  This is a national index encompassing nearly all urban residents and the market basket includes the most number of items.  There are other types of indices as well for major groups of consumer expenditures, such as food and beverages, housing, apparel and upkeep, transportation, medical care, entertainment, and for items within each group and for special categories, such as services.

Local area CPI’s, while more specific to the area, may be more volatile than the national or regional indices, even though their long-term trends are similar.  These local area indices are byproducts of the national CPI program and use a much smaller sample size.  Therefore, the local area indices are subject to more sampling and other measurement error.  The BLS strongly urges users to consider adopting the national or regional average for use in escalation provisions.

Why Was the CPI Used in Declaration Provisions?
The development of Common Interest Communities flourished in the 1970’s and 1980’s but many lenders were skeptical as to how the concept would sustain itself.  The idea of a Board of Directors and/or Owners setting the amount of assessments without specified constraints seemed too broad a power.  Tying increases in assessments to the CPI put a control in place that the average lenders and buyers could understand and rely upon.

How to Use a CPI
Movements of the index from one date to another can be expressed as changes in index points, but need to be converted to the percent of increase so the allowable percent of increase in assessments may be ascertained.  The following example illustrates the computation of percent change:

This is the percentage of increase by which assessments may be raised for the appropriate period as stated in the declaration provision.

Problems With CPI
When drafting assessment escalation provisions in declarations, it is important to accurately identify the CPI to be used.  The value of using a CPI is to obtain the measure of increase in consumer spending for a specific time as shown by a specific index.  Unfortunately, there are declarations which do not correctly identify the CPI, making it difficult to interpret what the intention of the drafter was or to calculate the increase in assessments correctly.  For example, one such provision referred to the “U.S. City Average for the Denver-Boulder area”.  There is a CPI entitled U.S. City Average All Items and there is a CPI entitled Denver-Boulder area CPI.  These are two different indices.  There is no way to know which index is the correct one to use.  For the same period of time the percentage of change for the U.S. City Average index may be substantially different from the Denver-Boulder index.  For example, using the same base year for both indices, the percentage of change for the U.S. City Average CPI-U from 1994 to 1995 was 2.8%, while the Denver-Boulder CPI-U for the same year changed 4.3%.  This difference is significant to the Owner whose annual assessments are being increased by this percentage.

Additionally, the example illustrates the difference for just one year.  The affect is compounded if the calculation is being made over a period of several years.

In addition to the different population coverage and area coverage represented, the base period on which an index is calculated must be identified.  The base period is the period for which the BLS sets the average index level equal to 100.  Changes are measure in relation to that figure.  The two most commonly used base periods are 1967 = 100 and 1982 – 84 = 100.  As you can see, the base period is not always a single year.  An index of 110, for example, means there has been a 10 percent increase in the price since the base period.  Many declarations do not contain a referral to the applicable base year.  For example” “Assessment may be increased in an amount equal to one and one-half time the increase in the Cost of Living Index for the City of Denver issued by the U.S. Department of Labor Statistics.”  Not only does this index not exist, but no base year is given.  A better provision would reference the base year.  For example: “The CPI-U U.S. City Average, All Items, Base Year 1967 = 100.”

The declaration may also simply refer to the CPI and not provide which index is to be used.  For example:  “Assessments may be increased in conformance with the rise, if any, in the Consumer Price Index for the preceding month of July.”  Based upon this provision, an association would not know whether the CPI-U or CPI-W should be used, whether a regional index should be used, or which base year to use.

A constraint with the use of a CPI formula is that the Cpu only allows associations to keep up with their maintenance obligations.  The increase allowed by a CPI formula is often not enough to cover the increased costs of the association’s budget.  And, the CPI formula often does not allow the association the flexibility necessary to improve or better the community to create necessary reserves.  The use of a CPI formula is designed to allow the association to increase its assessments to keep up with inflation.  It is not designed to give the association the ability to increase assessments to make improvements within the community or to undertake one-time special improvements or to create new amenities.

In addition to the above disadvantages, most CPI formulas are very difficult to understand and are often times impossible to use in calculating increases in assessments.  For example:

… the maximum annual assessment for each Condominium unit may be increased, without any vote of the Owners, by an amount equal to (I) one and one-half (1 ½) times the increase in the Cost of Living Index for the City of Denver issued by the U.S. Department of Labor Statistics multiplied by that portion of the assessment which is not attributable to taxes, insurance and utilities, plus (ii) such Condominium Units’ pro rata share of the actual or estimated increases in the cost of utilities, taxes and insurance (the “Permitted Increase”) …   .

Using a CPI Formula
If your governing documents contain a CPI formula for calculating increases in assessments, you should consult with your community association manager or attorney regarding the possibility and advisability of amending your declaration.  Amendment could delete the CPI formula.  In place of the CPI formula, your association may wish to consider using a provision similar to that contained within the Uniform Common Interest Ownership Act whereby the annual budget is set by the board of directors and is deemed to be ratified by the owners unless a requisite percentage of the owners veto the budget.  This protects the owners from excessive increases in the assessment amount which is the general purpose of having a CPI formula for assessment increases.

If, however, an amendment is not possible, the board of directors should consult with the association’s attorney, manager and/or accountant to evaluate the current formula and adopt resolutions, if necessary, to address any ambiguities.  Things to be considered in evaluating the formula required by your declaration are:

1. Does the declaration accurately identify an index;
2. Does the index stated in the declaration exist;
3. Is the base year provided for in the declaration;
4. Does the BLS still use the base year provided for in the declaration;
5. Does the index adequately provide for the increased needs of your community;

You should also develop a standardized formula similar to the formula discussed above to be used in applying the CPI formula by discussing the formula with an attorney and/or accountant to insure proper calculation.

The Future of the CPI
As discussed above, there are numerous indices compiled by the BLS.  Many of these indices have been in place since the 1900’s.  The BLS has recently made a determination to phase out the 1967 base year for all its indices.

In addition, there has been a recent push in the political arena to make adjustments to the various indices.  Alan Greenspan commented earlier this year, that the CPI overstated inflation considerably.  As a result of his statement, many politicians jumped on the bandwagon and suggested that the BLS and the Consumer Price Index should be abolished or adjusted downward.  Newt Gingrich said that if the BLS did not “fix” the CPI within the month, that he would abolish the BLS.  Obviously, there has been no “fix”, but neither has the Bureau been abolished.

Conclusion
The complexity of the Consumer Price Index, its validity and its future are all reasons to shy away from its use in calculating increases in assessments.  However, if your association is required to follow an existing formula utilizing the CPI, addressing the inherent problem areas via a corporate resolution should ease many of the frustrations associated with its use.