Appraisers and Condominium Reserve Studies
Barry C. Wilson August 5th, 2008
By Michael N. Read, Certified General Appraiser (WA & OR)
& Barry Wilson, Certified Residential Appraiser (WA)
Changes and new provisions to the Washington State Condominium Law, which took effect June 12, 2008, may impact valuations and appraiser liability. These need to be understood by appraisers (and by owners, purchasers, and real estate agents) when becoming involved with a condominium, whether it is newly declared or has been in existence for many years.
For a quick overview of this topic, refer to an excellent article by Elizabeth Rhodes of the Seattle Times.
For a complete and detailed look at the law itself, please see the Condominium Act and scroll down to Section 64.34.380 through 64.34.390. The history of the new legislation is available at http://www.leg.wa.gov/legislature. You can view the Original Bill or the Bill as Passed in Legislature.
The goal of the new law, sponsored by Senators Rodney Tom, Jim Honeyford, and Bob McCaslin, is to enhance consumer protection in the purchase and ownership of a condominium.
In addition, new rules adopted by Fannie Mae and Freddie Mac, the two secondary mortgage market enterprises that purchase most residential loans, now require that lenders verify that the community association has a line item in its budget requiring annual reserve contributions equal to 10 percent of revenues. An article in the Community Associations Institute New England Chapter newsletter on July 25, 2008 discusses the responsibilities of and potential liabilities for condominium home owners associations.
RCW 64.34.380 ‘encourages’ every Washington Home Owners Association (HOA) to establish a Reserve Account to fund major maintenance, repair and replacement of common elements, including limited (long term up to 30 years) common elements. The Reserve Account is to be established in the name of the Association and the board of directors of the HOA is responsible for administering the Reserve Account. The Reserve Account is to be separate from the HOA’s normal operating and maintenance budget.
‘Unless doing so would impose an unreasonable hardship’, the HOA must prepare and update a Reserve Study in accordance with the HOA’s governing documents and RCW 64.34.224 (1), which requires each unit to have a proportional undivided interest in the common elements.
The Reserve Study must be based on a ‘visual site inspection’ conducted by a ‘reserve study professional’. The Reserve Study must be updated annually and at least every 3 years be based on a ‘visual site inspection’ conducted by a ‘reserve study professional’.
This requirement does not apply to condominiums consisting solely of units that are restricted in the declaration to non-residential use.
In its definition of a Reserve Study, RCW 64.34.382 uses terminology that appraisers will immediately recognize from the Cost Approach. A Reserve Study must include:
- A reserve component list including quantities and estimates for useful life, remaining useful life, and current repair and replacement cost for each reserve component.
- The date of the Reserve Study and a statement that the study meets the requirement of this section.
- The level of Reserve Study performed.
- Level I: Full Reserve Study, funding analysis and plan.
- Level II: Update with visual site inspection.
- Level III: Update with no visual site inspection.
- The association’s reserve account balance.
- The percentage of the fully funded balance that the reserve account contains.
- The special assessments already implemented or planned.
- Interest and inflation assumptions.
- Current Reserve Account contribution rate.
- Recommended Reserve Account contribution rate.
- Projected Reserve Account balance for thirty years and a funding plan to pay for projected costs from those reserves without reliance on future unplanned special assessments; and
- Whether the Reserve Study was prepared by a ‘reserve study professional’.
The Reserve Study must also include a disclosure that warns about the failure to include a particular component or provide contributions to the Reserve Account for that component may result in the unit owner having to pay on demand a special assessment for that component.
RCW 64.34.384 allows the HOA to withdraw funds from the Reserve Account for unforeseen and unbudgeted items providing they notify the unit owners and repay the amount within 24 months, unless the 24 months would impose an ‘unreasonable burden’ on the unit owners.
RCW 64.34.386 gives unit owners legal recourse to demand of the HOA a Reserve Study if none has been completed within the past three years. The unit owner’s duty to pay for common expenses cannot be excused because of the HOA’s failure to comply.
RCW 64.34.388 relates to the preparation and updating of a Reserve Study at the discretion of the Board of Directors.
RCW 64.34.390 may be of particular interest and concern to appraisers (and real estate agents) as it states that monetary damages or any other liability MAY NOT BE AWARDED against or imposed upon the association, the officers or board of directors of the association, or those persons who may have provided advice or assistance to the association or its officers or directors, for failure to: Establish a Reserve Account; have a current Reserve Study prepared or updated in accordance with the RCW 64.34.380 through 64.34.388, or make the reserve disclosures in accordance with RCW 64.34.382 and other referenced RCWs.
The legislation as written idemnifies all parties involved in the production, management and maintenance of a condominium but leaves the unit owners, purchasers, and their advocates (the very parties who the legislative author’s goal was to protect) with little legal recourse.
A Reserve Study Professional is defined as ‘an independent person suitably qualified by knowledge, skill, experience, training or education to prepare a Reserve Study in accordance with Sections 1 and 2 of this act.’
This definition is not very definitive and could easily result in poorly prepared and ineffective Reserve Studies where the preparer is protected from any liability!
Because of the dearth of professionals currently providing Reserve Studies, community managers, CPAs, contractors and other related professionals are rushing in to fill the void. Appraisers and home inspectors may look upon this as an opportunity to provide a new fee service. Be careful!
Mike Read, the primary author of this article, states:
“I have personally assisted in the preparation of these studies in Oregon under the tutelage of a licensed architect and even though I am a degreed engineer (Mechanical, UK) and a Certified General Appraiser licensed in Washington and Oregon, I do not feel qualified to complete a Reserve Study without additional training and experience. At present I am not aware of any education available in this field, but a background in Building Sciences would be relevant. There is an organization, the Community Association Institute (CAI), which has some certifications, but I do not know the details of their educational path.”
Nena Groskind, the author of the article in the CAI New England Chapter newsletter referenced above, recommends that the Reserve Study be performed by an engineering firm “with expertise in this area.”
There are two main parts to a Reserve Study. The first requires the completion of a ‘Property Condition Assessment’ which is a detailed site inspection of the property and all its common areas and systems. This report identifies the immediate repairs and replacements required plus short and long term replacements required of all common area components. The second part is the number crunching, which places the work items in an orderly time and dollar budget (RCW 64.34.380 recommends a 30-year projection for major maintenance and replacement), to be presented to the HOA and its owners. In her article, Ms. Groskind also noted that IRS regulations require separation between operating funds for maintenance and reserve accounts for replacement and strongly cautioned against commingling funds.
If an appraiser (or real estate agent) is involved in the transfer of a condominium (in Washington State) where there is an action brought by a unit owner or purchaser for nondisclosure of a pending assessment or large unfunded or undisclosed liability contained in a Reserve Study, they could be the only entity in the chain of responsibility that could be held liable. Likewise an appraisal that does not include in its value conclusion the amount and effect of such an assessment or unfunded liability could become the focus for recourse of action by an owner or purchaser.
In preparing a condominium appraisal report on the Fannie Mae form 1073, the appraiser must answer four questions in the “Project Analysis” section on page 2; two of those questions may now have more significance. The appraiser is expected to comment on the project budget for the current year and the adequacy of fees, reserves, etc. and to opine how the unit charge compares to competitive projects of similar quality and design.
Just stating that the budget was not analyzed because the documents were not provided and checking the “Average” box may not be an adequate defense.
Henceforth, when appraising a condominium, in addition to the other documents typically required (minutes of annual membership or monthly board meetings, resale certificate, etc.), it is incumbent upon the appraiser to obtain a copy of the current Reserve Study. If none is available, the appraiser should clearly state in the report that:
- A copy of the Reserve Study described under the provisions of RCW 64.34.380 was not provided to the appraiser (and describe the efforts made to obtain same);
- Inadequate reserves for replacement of critical components of the building could result in special assessments that would financially impact the borrower;
- The opinion of value is based on the Extraordinary Assumption that the HOA has adequate reserves and/or plans to address such expenses; and
- If this assumption proves to be in error, the value of the property could be affected.
The authors of this article are both experienced appraisers and are aware of appraisers being sued for failure to disclose critical financial information or information on property conditions that impact value. With the changes to both Washington law and the lending requirements of Fannie Mae, more responsibilities are being placed on the appraiser.
About the Authors:
Michael N. Read has been appraising residential and commercial property in Washington, Oregon and Mexico since 1986.
Barry C. Wilson has been appraising residential property in Washington since 1986.
Additional expertise concerning the items discussed above was provided by:
Carson M. Horton, RS of HOA Services Group, LLC in Beaverton, Oregon.
[email protected]
www.hoaservicesgroup.com