The Board recently sent all residents a link to a proposal outlining three alternatives for financing the next road project.  It essentially zeroed in on the “borrowing option” as being the best of the three. The write-up can be found here:  Board’s Loan Proposal

Important Point! The Board is looking for your feedback. It believes that borrowing is the best alternative, but it does not want to borrow money if there is strong community sentiment against the idea.

The proposal says that the Board wants to “assess resident support” before proceeding any further. But it does not specifically ask residents to indicate their support one way or the other; for example, by giving an email address and clearly asking for a response.

Therefore, if you have an opinion, you must take the necessary steps to make your views known. And I believe the absence of any significant level of response will be interpreted as community support for the “borrowing option”.

Reminder: As noted in previous summaries, the Board is empowered to borrow money on behalf of the POA without a vote of the property owners. And I don’t believe the Board is planning to take a poll on the issue. This is your only opportunity to convey your sentiments on the idea of borrowing money to finance this project.

I recommend that you read the proposal, but I will try to summarize the key points here as simply as possible. In addition, I will offer some editorial comments at the end of this write-up. Even if you are in favor of the borrowing option, you may find that information to be of interest.

Summary

First, all costs used in the Board’s summary are rough estimates. Once the Board decides how to proceed, these numbers will need to be finalized.

Two road rebuilding projects are at the top of the priority list:

1. Governors Drive from Manly to the intersection at Upper Morehead. ($2.0 million)
2. Lower Manly ($750,000)

Three payment options were presented:

1. Accumulating money in the Reserve Fund to pay for all work in cash (2020 start).
2. Levying assessments to allow us to pay for all work in cash (2015 start).
3. Borrowing funds and repaying the loan out of our annual assessments (2015 start).

To simplify the comparison, the proposal used only Project #1 to compare the three funding options. But the most important comparison was between option 1 (accumulating funds) and option 3 (borrowing funds); which is all I will be focusing on here. The cost comparison did not include any contingency amounts; which is not an issue in that the primary purpose is simply to compare the two funding mechanisms to see which might be preferable.

According to the proposal, there are two possible costs for Project #1 depending on when it is undertaken:

2015 Start – Borrowing Funds: Assumes a total cost of $2,140,000. This would be funded with a loan of $1.25 million with the balance coming from our Reserve Fund. Repayment of the loan would not require any special assessments.  Rather all loan payments would come from our regular annual assessments.

2020 Start – Accumulating Funds: Assumes a total cost of $2,990,000. Why so much higher? Because the project would not start until 2020, and it assumes construction costs will go up 7% every year.

It doesn’t take much to see which option is a better financial deal. Just compare the interest cost on the loan to the higher cost of the “2020 Start”. In this proposal, the interest cost is $175,000 compared to an increased construction cost of $850,000.

Therefore, if one accepts that costs will increase by 7% every year, the loan is obviously the better option; because the interest costs are far lower than the projected cost increases. But there is one more factor to add into the equation. If we wait until 2020, the Board estimates that we will spend approximately $50,000 per year repairing that section of road just to keep it drivable. That totals $200,000 to $250,000 for repairs; and that money would not be spent if we borrowed the funds and started in 2015.

Those potential additional savings make the difference between the two options even greater (over $1.0 million) and thus create a very compelling argument for borrowing now and starting in 2015.

The basis of this huge cost differential is the assumption that constructions costs will rise 7% every year. But, even if they rise only 3% to 4% per year, you still end up with the same result; namely that borrowing would be cheaper than waiting until 2020.

However, there is one significant aspect worth noting. The interest cost of $175,000 assumes a five year term with payments of $250,000 per year. That $250,000 is roughly half of the $490,000 yearly allocation to the Reserve Fund that comes from our annual assessments. Therefore, in the borrowing scenario, the balance of $240,000 would accumulate each year in the Reserve Fund. That causes the Reserve Fund to gradually increase to over $1.0 million by the time the loan is paid out.

But every dollar that stays in the Reserve Fund is, for a period of time, essentially borrowed money; because it could otherwise be used to pay down the loan and reduce our interest expense. That would argue for using most or all of the annual contribution of $490,000 to pay down the loan as quickly as possible. For example, if we used $400,000 of the $490,000 allocation to pay down the loan, the term of the loan would be shorter, and the interest cost would be closer to $115,000; which would be a savings of over $50,000.

So, why keep anything in the Reserve Fund if we can use that money to pay down the loan and lower our interest cost? There are two answers to that question. First, it is a good idea to have some amount in the Fund for emergency reserves. Second, the funds might be used for other projects that could be started before the loan is paid off.

I asked the Board why the assumed payment was only $250,000 per year and what projects the Board might consider funding with the money that would accumulate in the Reserve Account. And I specifically asked if the Board would consider funding any of the community amenities listed on page 16 of the Long Range Plan (see Editorial Comments below for an explanation as to why I asked about this). Here is the response:

“1. Using half ($250,000) is purely arbitrary. It was a convenient choice to calculate the cost savings in the example over five years.

2. If funds were to be accumulated in the reserve fund those funds can be used for any project. The Board will consider all projects and communicate to the residents when a plan has been developed. I would suggest that the Board always maintain a reasonable balance in the Reserve Fund in case of emergencies.”

 

Editorial Comment: When the idea of a loan was floated several years ago, I was against the idea; primarily because I did not like the idea of saddling the POA with debt. But, with this information, I have changed my view and believe it is a viable alternative for this project. What I find attractive is the fact that we have the ability to pay down the debt rather quickly; and it appears to make financial sense to avoid the expected cost increases and yearly maintenance expenses.

However, there is a “But”. And that has to do with the funds that would accumulate in the Reserve Fund during the five year loan repayment scenario. Unless there are good reasons to accumulate those funds, it might make more sense to use that money to repay the loan more quickly and thus reduce the interest expense.

But there may be good reasons for those funds to be accumulated.  For example, it makes sense to maintain adequate reserves for emergencies. And it might make sense to accumulate the funds if they are earmarked for specific projects; but only for infrastructure related projects and not for community amenities.

Why am I bringing up “community amenities”? Because of the major projects listed on page16 in the Long Range Plan; which plan the Board approved earlier this year.

Those projects came from the Community Appearance Committee and were not subject to any community review or input. They simply represent the views of one or more of the committee members. Here is a summary of that fairly broad list:

• Install additional gardens throughout the community.
• Create a scenic viewing area at a high point within Vance Villas.
• Construct a walking bridge within the wooded area between Country Club Drive and Governors Drive.
• Build a park next to the POA building; to include teak benches, a circular garden, a swing and mulched paths.
• Redesign and replace the plantings at the Mt. Carmel and Lystra entrances. (However, I assume that the Mt. Carmel entrance project mentioned here is the work that was just completed recently.)

The LRP addresses the funding of these projects with the following language:

“These potential projects have been identified below; however, no capital expenditures have been identified in the Long Range Plan due to the uncertainty surrounding the future road projects cost and schedule. The POA hopes to begin funding these projects once a more complete road plan is established.”

That is somewhat open-ended language. Because of that, I clearly asked in my inquiry (mentioned above) whether the Board would consider funding these specific amenities with the money that would accumulate in the Reserve Fund. As you saw, the Board’s response said that the money could be used “for any project”. Since it did not address my specific question by excluding those amenities, it appears that the Board is leaving open the possibility of funding one or more of them while the loan is outstanding.

In short, I would be concerned if accumulated funds in the Reserve Fund were diverted to such amenities. As long as we are borrowing money, I believe surpluses in the Reserve Fund should be used to pay down the loan, maintain adequate emergency reserves or undertake other important infrastructure projects; but not used to fund community amenities such as those listed above.

If you agree, I’d recommend writing the Board to express your view. The addresses can be found here: Board Contact Information