As the association industry matures, more and more communities are faced with the responsibility and need to perform major repairs of common facilities. Often, because of poor planning, inflation, or unanticipated problems, associations have not accumulated sufficient reserves to finance needed repairs.
In the past, when faced with major repairs and insufficient funds, associations had no alternative but to pass a special assessment to raise needed cash, defer repairs, or complete the work piecemeal over time. Each of these solutions can create new problems for the board and association members.
Fortunately, banks are becoming increasingly aware of the need for associations to take out loans. Some financial institutions have even established specialized divisions to handle association needs. Loans can be a practical alternative to the choices listed above.
Where to Find a Lender
When shopping for a loan, an association is better served if it can find a lending institution which offers specialized financial services to associations. A lender who does extensive business with associations has a better understanding of the powers of association boards, the complex responsibilities of association directors’, and familiarity with association governing documents.
If you cannot find a lender familiar with the basics of community associations, the board’s representative should be prepared to discuss with the lender the organizational structure of the association, assessment powers of the board, association governing documents, and the fiduciary duties of association directors. Legal counsel and management can also assist in this regard.
When approached for a loan by an association, a typical lender thinks in terms of tangible collateral for the loan, i.e., a lien on the common areas, liens on the individual units, or personal guarantees for the loan by directors and officers of the corporation. In most situations, these alternatives are impractical or limited by the association’s documents.
Unless the association has title to a unit, owns commercial leases, owns buildable land, or has other such assets to pledge as collateral, the most practical way to secure a loan is to pledge future assessment revenue as collateral. Pledging future assessments may require owner approval and should be discussed with the associations’ legal counsel prior to meeting with the lender.
Lenders who understand the collection and enforcement powers of association boards usually secure loans with future assessment revenue. If the association has sufficient cash flow to service the debt from regular assessments, the lender will probably require a line item in future budgets for loan payments.
In many loan situations the exact amount of money needed to complete repairs may not be known when the project begins. This is particularly true with roofing projects and similar jobs where the full extent of work to be done sometimes cannot be determined until after the project is underway.
The easiest way to manage these variables is to have the loan structured initially as a line of credit for the maximum amount which may be needed. A loan structured in this way gives the association flexibility and minimizes loan costs. Funds can be drawn on the line of credit as needed. During the draw-down period, interest payments are due, but only on the amount drawn, not the full amount of the loan. When the project is completed, the final principal balance is converted to a term loan and regular payments, including principal and interest, commence.
For less complicated or short term projects, the loan can be structured as a regular term loan. These loans are funded in full when approved and are paid off over a fixed term with an amortization schedule such as those used for a real estate or installment loans.
The Application Process
Loan procedures vary from lender to lender, as do the particulars of what information is requested from the association. Typically, however, the lender may require the following:
- copies of the association’s governing documents
- copy of the current year budget and current financial statements
- copy of the association’s last audited or reviewed financial statement
- copy of the current reserve study
- copy of the association’s written collection policy
- minutes of the recent board meetings
- a Borrowing Resolution properly certified by the association’s secretary
Associations should involve their attorney at the early stages of loan negotiations. Before proceeding with a loan application, some lenders may require a written opinion from the association’s attorney certifying the association’s authority to borrow and pledge assets as collateral.
Before closing a loan transaction, most lenders require a second written opinion from legal counsel stating that counsel has reviewed final loan documents and all details of the transaction on behalf of the association. The attorney is requested to certify that the loan documents are legal, binding and enforceable, and that all resolutions passed and actions taken by the board and/or the unit owners, relative to the loan transaction, were taken in accordance with the association documents.
Even if a written opinion from the association’s attorney is not required by the lender, a prudent board is wise to seek the advice of counsel for its own protection. Another reason for involving the association’s attorney early in the process is that the association’s governing documents may include requirements which affect how the loan is structured and how resolutions are drafted.
The association’s attorney is the person best able to advise both the association and the lender on how to structure the transaction to fit the requirements of the governing documents. If the association has special requirements or restrictions affecting the loan transaction, time and trouble can be saved if they are defined early in the application process.
Before agreeing to loan conditions, the association should consult with its attorney and managing agent to ensure that ongoing operations of the association are not unduly disrupted.
Obviously, a decision to seek a loan to finance major repairs can have a significant impact on the association board and the community as a whole. Although associations are hesitant to borrow money, like any other business, associations have legitimate needs and responsibilities and serve its community well if, in addition to the more traditional alternatives, it also considers the feasibility of financing repairs with a loan.