Performing due diligence before buying in an HOA community
An English proverb says: “measure twice, cut once.” This is an old carpenter’s way of saying you should perform adequate due diligence before taking action. This advice aptly applies to individuals looking to buy a home in an HOA community. Homeowner associations have been established through cooperation between the local municipalities and the real estate developers. Prior to the advent of HOAs, towns or cities would assess and collect property taxes from each homeowner and in exchange they would take care of the streets, parks, trash collection etc. Homeowners would also be bound by the provisions of the city’s code that regulate landscaping and the condition of the property.
In the 1960s real estate developers began to develop HOA communities. Since then HOA communities have exploded across the nation. Currently, more than 68 million Americans live in HOA communities – which is 53% of all households in the nation! In these types of communities, the Developer creates a non-profit corporation to manage the community and to take over many of the duties that were traditionally performed by cities. Before selling any homes, the Developer records Covenants, Conditions & Restrictions (CC&Rs). By purchasing a home in the community a person automatically becomes a member of the non-profit corporation and is automatically bound by the CC&Rs. The day-to-day operations of the HOA are run by the HOA Board of Directors. The HOA Board is made up of volunteers from the community.
HOAs have been given great power by state legislatures. Essentially, the HOA steps into the shoes of the city in many respects. For example, the HOA Board has the authority to collect monthly or quarterly assessments (i.e. taxes) and to regulate, penalize and fine homeowners for violating the CC&Rs and the other rules and regulations of the community. Because of its inherent power, the HOA will have a big impact, good or bad, on a homeowner’s life. But when buying a home, many people are so busy inspecting and performing their due diligence on the home itself, they spend little to no time conducting any due diligence on the HOA that will govern their life and the use of their property as long as they live in the community.
A wise buyer would spend some time making sure the community is a good fit for them before purchasing the home. There are three categories of recommended due diligence: 1) Community documents; 2) Financials; and 3) Litigation.
Prior to close of escrow a buyer receives a large stack of documents from the HOA which includes copies of the CC&Rs, Rules and Regulations, and Bylaws. These are often very lengthy and are filled with “legalese” so you may need an attorney to help you understand what you are getting into. For example, these documents indicate whether or not you can have a boat or an RV at your home, a basketball hoop or a swing set. They can even restrict what types of plants, trees or rocks you can have in your yard. They may require you to paint your house every so often or they may prevent you or your guests from parking on the street. You should become very familiar with the all the rules, requirements and restrictions in the community to make sure they are compatible with your lifestyle. If you violate any of these provisions, or if you fail to pay the dues and assessments, the Association my fine you and put a lien on your home. You should talk to members of the community to find out how the HOA Board interprets and enforces the rules and regulations of the community.
You should also review the financial information you receive from the HOA prior to close of escrow to understand the financial condition of the Association. The Association collects dues and assessments from its members and must budget and use those funds to take care of the common areas of the community. If you buy the home, you will be a member of the non-profit corporation that manages the community and you will benefit or be punished by how financially solvent the HOA is. For example, if you are looking to buy a home in a community with lots of amenities such as a clubhouse, swimming pools, tennis courts and parks, you want to make sure that the HOA has enough money in reserve to be able to repair and replace all of these things when they eventually wear out or break down. If not, the HOA would have to make a special assessment to cover these large expenses and each homeowner would have to pay their pro rata share, which could be quite large. Some communities pay a professional to prepare a formal Reserve Study. You should ask if the community has one. A Reserve Study evaluates the amenities and common areas and then recommends how much money the community should have in reserve to make sure it is able to repair and replace them over time. By reviewing the Reserve Study you can determine if the community has adequate funds in reserve. And if the community does not have a formal reserve study that says something about the community as well. Make sure you are comfortable with the financial condition of the Association before you purchase the home.
Finally, you should check the local court records to see how litigious the community is. However, not all lawsuits are bad. Sometimes an association must file a lawsuit to collected dues and assessments from a homeowner that is not paying his or her fair share of the community expenses. But if a community is overly litigious it can negatively impact the community and its members. For example, the more times the HOA is sued, the more it will pay for insurance. And the higher cost of insurance is then passed on to its members. Also, excessive litigation may indicate poor communication and dispute resolution skills within the community. Prolonged litigation can also cause significant division and discord within the community. All lawsuits are public records so you can access them for free. You can also ask questions of community members to better understand the dynamics in the community.
Buying a home in an HOA community is a big decision. People are often drawn to HOA communities because of the wonderful amenities they offer such as pools, tennis courts and parks. But they often fail to perform adequate due diligence to make sure that the personality and culture of the community fits their lifestyle. Prospective buyers can avoid a lot of stress, frustration and cost by simply taking the time to perform a little due diligence on the community before deciding to purchase the home.