Wednesday, October 3, 2012

Who, Why, What, When and Where do I Perform Due Diligence When Buying or Selling Real Estate in a Common Interest Community?

With a Very Special thanks to attorney Brian McLean, who expanded on our published question list and with helpful contributions from other Forum attendees, several useful tips appeared in our October session. Since attendees represented condominiums only, that's became our discussion focus.

Who's Responsible?

Whether you're about to purchase a unit for yourself, your college student dependent, or your mum/dad, there are several  entries that you can add to your checklist of what to look for in order to perform the due diligence necessary to make an educated buy.

If you're selling a unit, you, too, can develop a checklist of facts so as to maximize the transparency and 'inspect-ability' of your association's documentation.

If you're a board member, you can hereby be reminded that the condition of your association's documents must bear scrutiny, whether by owners, prospective buyers or the legal community.

High-level Overview: What's Important to Explore as a Buyer or Seller?

Regardless of the nature of the community, Brian recommends looking particularly at two items: the building structures and the association's finances and governing documents.
  1. "Hire an analysis of the building structure." There may be other analyses or documents prepared by others that address the structure, but if you commission and pay for your own analysis, you are more assured that your interests are being protected.
  2. "Review the financials and governing documents." 
  • Request the most recent financials and the past couple of years' worth of audits, as a way to assess the financial health of the association. Use your business judgement to spot abnormalities or irregularities that signal caution and more investigation.
  • Does the association possess 'healthy reserves'? Compare reserve funding to a current reserve study. Do your homework and reach out to professionals if necessary.
  • It's hard to tell good from bad governing documents without experience. You can compare covenants to what you find in the Resale Certificate, for example, to find matches. If there is a difference, the covenants govern the issue.

What is a Resale Certificate, who prepares it, how do I trust it?

In Washington State, the condominium law dictates that a Resale Certificate be prepared by the owner prior to any resale of a unit. In practice, however, the association's management company is best prepared to provide the bulk of the data required, and generally, the owner commissions and pays for the certificate.

Use your critical thinking to review what is presented there, so that you're confident that you are comfortable with all the data. Review everything, so that if there is an attachment referenced in one of the entries, you understand fully what is implied in the attachment. Again, reach out to professionals if necessary.

Tip: Brian recommends that if you are a seller with an interested buyer at hand, that you commission a Resale Certificate and review it. In your review, verify that there is no point of view or language that will 'kick the slats out from under' your sale.

What is a Reserve Study, what questions should I ask about it?

A Reserve Study is a financial planning tool that associations can use to put away money to pay for repairing significant real estate assets owned by owners in common with other owners. Questions you can ask include:
  • How current is the Reserve Study?
  • Who prepared it?
  • What is the contribution level recommended?
  • What is the funding level that the association has in the bank?

What should I look for in association financials that I inspect -- three years' worth?

Brian's first caveat is that a potential buyer is only given access to association records through the seller/owner. In fact, the buyer only as a right to deal with the seller: not the board or the association manager. 

One way to obtain financials -- and meeting minutes -- is to prepare a written request detailing what you want to inspect, and passing it along to the owner/seller, who then exercises their right to examine and copy the business records of the association. You can expect to pay for any copies that you make.

You can ask for past audits if they are available, or financials for several years: three years will give you a good idea of the trend of the association's financials.

What should I look for in board meeting minutes that I inspect -- three years worth?

Association board meeting minutes are not included automatically in a Resale Certificate, but a potential buyer can request them, as above in writing, for review.

You can look for transparency and form in the meeting minutes. The caveat, however, is that a properly formed set of meeting minutes may not reflect a dis-functional board -- which you want to look out for, and newsletter-length minutes detailing every comment made may not reflect a properly functioning board that makes sound business decisions and exercises its duty of care of the association's business affairs -- which you also want to look out for.

What you can look for is explanation of agenda items, motions, seconds, and votes that detail the actions of a cohesive board that conducts business in a transparent manner and for the benefit of the association.

 What questions should I ask of the board?

Again, a prospective owner cannot approach any director or board directly, but must work through the owner/seller. If you gain access and the director lives in the community, you can ask about how the director likes living there, and open an informative dialog.

How can I attend a board meeting in advance of buying?

You  may be able to attend a board meeting at the invitation of the owner/seller, depending on the board meeting and the agenda items listed. There may be meetings where the board wants to limit the dissemination of data, such as a meeting where a construction defect attorney makes a presentation about pursuing a developer for defects, which you may not be invited to attend.

The spirit of a board meeting often reflects the spirit of the community, so attending one can be deeply informative.

Who else should I speak with, such as the association manager?

Attendees suggested returning to a community without a realtor, and asking people who live there -- someone publicly visible -- how they like living there and what a buyer needs to know about the community. Again, buyers only have access to the association manager through the seller/ owner.

What Else Do I Need to Know?

An attendee recommended asking for a Condominium Purchase and Sale Agreement, to best understand what's involved in the transaction. Especially for first-time or inexperienced buyers, buying into a condominium association can be revealing as to what's included in the purchase.

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