What is a Capital Improvement
When communities are built, they are done so to provide the lifestyle and amenities that residents desire at the time of development; however, as time passes, residents' desires change, and so do their desired amenities for the communities that they live in or want to live in. In order for communities to keep up with these changing desires, some communities will need to perform capital improvements.
For the purpose of this discussion, we will define a capital improvement as a substantial improvement to an existing asset or the construction or installation of a new asset involving a substantial expenditure. The Internal Revenue Department defines capital improvements using specified standards that differ from the method used here, and some states or industries will have varying definitions, but for the Community Association industry, this definition is generally accepted.
Examples of Capital Improvements
Over the past decade or so, pickleball has become very popular. This has led to some communities building pickleball courts for their residents. The addition of pickleball courts would be a capital improvement.Other examples of additional sporting amenities would be tennis courts, bocce ball, and basketball courts, to name a few.
A community may have a modest play area that they want to improve with a larger play structure. Depending on the size of the new structure and the cost, it may be considered a capital improvement. A community may have been built without a pool, but a majority of the residents may feel that the addition of a community pool would be a nice amenity for the residents. The addition of a pool would be considered a capital improvement. Other examples would be the addition of a surveillance system or even building a clubhouse or similar building for a community. There are many options for capital improvement for communities depending on the size of the community and what the residents feel would be beneficial.
How do HOAs pay for Capital Improvements?
After inquiries from homeowners and considerable discussion by Board and Committee members, the Board of Directors may come to the decision that a capital improvement is in the best interest of the community. Inevitably, the next question to ask is: How to pay for a capital improvement?
The first step in determining how to pay for a capital improvement is a thorough review of the community governing documents to see what restrictions may be in place regarding funding capital improvements. Some residents may propose using reserve funds to pay for capital improvements; however, reserve funds are established for the long-term maintenance and replacement of existing assets in the community. While reserve studies plan for the replacement of assets that have reached the end of their useful life, they normally do not plan for substantial improvement of those assets. The study will usually plan for the replacement of the asset with a similar version of the asset at a comparable value. Therefore, if the asset is to be substantially improved, it may be considered a capital improvement. The community governing documents may also include restrictions preventing using reserve funds for capital improvements.
Other funding options may include establishing a capital improvement fund, the Association taking out a loan, or establishing a special assessment to fund the project.
Suppose a community's governing documents allow for the collection of special closing fees. In that case, the Board of Directors may be able to establish a closing fee that could be used to fund a capital improvement account to be used for such projects. While this funding option may have the least impact on the community's immediate finances, it also takes longer for the community to accumulate the desired funds as this relies on home closings; therefore, this may not provide a funding timeline that meets the desires of the community.
A more immediate funding option would be for the community to take out a capital improvement loan to fund the project. If this option is allowed by the governing documents, the community would need to put together a comprehensive plan for the project that could be presented with the loan application to the lending institution for review. This may involve hiring a project manager, architect, or other professionals to assist in preparing these documents.
If the aforementioned options are not viable, the Board of Directors may choose to consider a special assessment to fund the project. A special assessment may provide more immediate funding for the project than collecting closing fees, and it avoids the challenges in getting funding from a lending institution; however, special assessments have their own challenges. Foremost, many homeowners do not like special assessments and may not be in a financial position to pay for them. In addition to the individual homeowner impact of a special assessment, the Association's governing documents may have strict requirements for approval of special assessments.
While the funding of capital improvements may be a challenge, the end result when the project is completed may add considerable value to the community and its residents through the quality of life, accessibility, exercise options, or increased overall monetary value of the community and its homes. Therefore, with open discussion, resident involvement, and thorough research, a capital improvement may be very beneficial for your community and your residents.