Incompetence, Fraud, and Association Reserves

I

After finishing The Big Short book I had to re-watch the movie. This time not only was I watching for signs of purposeful fraud vs. emergent fraud, but trying to tease out the difference between incompetence, fraud, and something else that is something between ignorance and stupidity and folly.

A real world example of this showed up in my life a week ago. I’m the Treasurer of my homeowner association (townhouses and condos, not a gated community of McMansions). We received our bi-annual reserve study, produced by the country’s biggest supplier, Association Reserves.

[If you don’t live in a condo, a reserve study is an inventory of the expected repairs, replacement, and maintenance to keep up a property. For example, repainting buildings, sealing asphalt, replacing the roof. The standard is to estimate the total costs over 30 years and compute the amount of money that the association needs to save up to perform the maintenance.]

When we received the first-ever study six years ago, I couldn’t understand why it recommended we save up $1.2 million to spend $400,000 on maintenance over the next 30 years. I asked my property management group and the response what a lot of hand waiving without any real substance.

1 point incompetence, 1 point ignorance, 0 points fraud.

That was the first reserve study I had seen, the association was new, as such we had almost no savings in reserves yet, and given all the unknowns of maintenance, I let the non-answer go.

When the updated reserve study arrived two years ago, I was not a board member and didn’t look at it until the end of last year, when the board used it to recommend a budget with a 20% increase in monthly fees based on the recommendation in the reserve study. I spent hours reading the 75 page report in detail, extracting the tables into a spreadsheet to analyze, and ultimately asking to be nominated for Treasurer to get to the bottom of this and a few other issues.

When I asked my my property management group to justify the 20% increase, I got the same hand waving again, and then left for Winter Break and let it go once again.

2 points incompetence, 2 points ignorance, 0 points fraud.

But then came the 2020 update right after I finished reading The Big Short, and I couldn’t let it go. I had to understand whether I was looking at incompetence, fraud, or something else, as the numbers simply didn’t make sense. The estimated expenses for the next 30 years are $350,000 and yet the recommendation is that we save $1.5 million.

This time I skipped by property managers and asked the same question of the Project Manager at Association Reserves. He replied with a link to primer on reserve study standards. That didn’t answer my question.

3 points incompetence, 2 points ignorance, 0 points fraud.

I reframed my question given this new information, sent that to the Project Manager, and received a response from the President of the Washington State division of Association Reserves, (which apparently is large enough to need a dozen regional Presidents).

His response seemed the equivalent of a form letter, ignoring the specifics of my question and stating in a lot of words that the report is just guidance:

First, I can assure you the computations are correct, and not misinterpreted, within the context of common industry practice.

In attempting to interpret your position on the matter, it is important for you to understand that the reserve study is a budget guidance / planning document, from which the board makes decisions they feel are responsible as a funding plan, in light of their duties as a board member. Those decisions are up to you based upon your risk assessment / tolerance of the members.

Jim Talaga, RS
President, Association Reserves

“Guidance” is the financial market’s equivalent of “following orders” after the WWII. It can’t be fraud if it’s just guidance, can it? Can it be incompetence if it’s only guidance? Skipping ahead another half dozen email in this conversation, and at best I think there is another category, one that is best described as “covering your ass”.

3 points incompetence, 2 points ignorance, 1 point ass covering, 0 points fraud.

As a board member, I’m legally required to have someone draft a reserve study. That is my own ass covering move. However, given I’m personally paying for that study as are all my neighbors, is it too much to ask that the study be believable?

I don’t think so, and thus I pressed on with my email. I asked again why $1.5 million was needed for $350,000 of expenses. I pulled citations out the the study and asked how they fit the standards the Project Manager has provided. The very standards this President claimed to have written into Washington State law.

There is no error in our reporting. As stated previously, there is also no requirement in WA law for your association to fund reserves to a certain level. The requirement is to have a reserve study conducted by an independent reserve study professional, disclose that study to current owners and prospective buyers.

Jim Talaga, RS
President, Association Reserves

3 points incompetence, 2 points ignorance, 2 point ass covering, 0 points fraud.

Most people would give up at this point. I’m not most people. To me, this is a clear example of a problem that needs a root cause analysis. Is this company incompetent, a fraud, or something else? Five email and a few hours into what I thought was a simple question, I outright asked if the company was a fraud or incompetent.

That led to a new realization, the company is “Too big to care“. They claim to be the biggest supplier of reserve studies. My association is tiny.

I have answered your questions to the best of my ability. I chose to ignore your threating tone and abusive language within your last email, as a courtesy. My goodwill ends here. If a more reasonable board member wishes to continue the discussion, I am open to their contact. I am not open to any further discussion with you, personally.

Jim Talaga, RS
President, Association Reserves

3 points incompetence, 2 points ignorance, 2 point ass covering, 5 points bad customer service, 0 points fraud.

At this point it sure felt like Association Reserves was running some sort of scam, but I couldn’t figure out what it could be. Best theory I had at the time is that they just provide the same recommendation to every association, saving themselves the time and effort of doing any work, charging $100 per unit every other year for the required-by-law report.

My two other board members wrote back to the President both succinctly saying they want an answer too, but we didn’t hear back from the President. Instead, I pressed on, look at the team page of their website, and found the CEOs email address. After filling out a Better Business Bureau’s complaint and providing a 1-star review on Yelp.com, I added the CEO to the email thread and asked my question again.

Finally, a glimmer of hope that someone in the company not only cares about customers but who actually understands a reserve study.

Luni – sorry to hear of your frustrations. I understand you are Treasurer of your association, [name and account number]. I applaud your concern to get a clear answer regarding your association’s finances.

The simple answer is that the recommendation that your association’s Reserves approach $1.2M in 30 yrs does not have to do with WA law or even National Reserve Study Standards. You are correct in that there are not a lot of expenses you can see in your Reserve Study’s 30-yr summary seeming to justify annual Reserve contributions beginning with $29,940 in 2021. The answer is found in the Executive Summary listing of components. You will see that in current day dollars, there are five components summing to $498,450 scheduled to occur in your 31st year. This large expense does not appear in the 30-yr summary which you examined closely. Yet your Reserve Fund needs to build towards handling this large expenditure 31 yrs from now. Note that with 3% inflation, that expense is projected to actually be about $1.21M 30-yrs from now. So that’s why we are recommending your Reserve Fund build to about $1.25M in 30 yrs. It is simply a matter of responsibly building your Reserve Fund to a size it can handle the timely execution of scheduled projects.

Robert Nordlund, PE, RS
Founder/CEO

+1 competence. +1 customer service. +1 for company founders.

The CEO’s answer was two more paragraphs of equal competence, ending with a request to revise the BBB and Yelp submissions. This is a great example of how to deal with an unhappy customer. Start with a compliment. Acknowledge the problem from their point of view. Show you understanding of the product/service you are providing.

If this answer were provided six email earlier by the Project Manager, I might have simply replied thank you and gone on with life. Same if my property manager was sufficiently informed to know this answer. But note that while this answer explains the cause, it doesn’t necessarily explain the root cause. Once I’m on a quest for a root cause, I’m not going to stop.

What were these big expenses in Year 31? Replacement of three items: roof, fiberboard siding, and metal siding. All oddly projected to have exactly the same 45 year lifetimes. Odder still that nothing else was projected to have a lifetime beyond 45 years. Why 45 years?

The roof lasting 45 years? Maybe. If anything, that seems too long. I though high-end asphalt roofing needs replacing ever 30-35 years.

Ten minutes on Google and fiberboard siding is another story. It was invented less than 45 years ago. Best anyone on the builder’s forums can tell, it’ll last 100 years. The biggest manufacturer guarantees it for 40 years. Similarly with stainless steel siding. It’s almost 10 years old and still looks brand new. It wasn’t a common siding 45 years ago to see what it look like when old, but at worst it’ll start rusting in which case we can paint it rather than replacing it.

Back to the CEO, I pressed on for three more email asking for studies of fiberboard and metal siding lifetimes. I received back one anecdote. I pushed back on the financial model for its lack of probability on those 45 year lifetimes, as they may be short by 45 years.

The man is patient. He provides reasonable sounding answers. But he’s ultimately still saying that the reserve study is nothing but guidance, that it is as accurate as it can be.

I may not convince you of my opinion, but that is not my job. I do not believe there are any “errors” in the [Association Name] Study. The calculations are simple and sound, and we’ve explained our position on how those 17 components were chosen as appropriate for Reserve funding. You appear to share a fundamentally different view of the future. And that is ok. Your association hired Association Reserves as a budget planning counselor. Based on our credentials, experience, and National Reserve Study Standards, we’ve given you the best of our counsel. Now it is your job to take what we’ve provided, and choose how to lead [Association Name] successfully to the future.

Robert Nordlund, PE, RS
Founder/CEO

3 points incompetence, 2 points ignorance, 3 point ass covering, 5 points bad customer service, 0 points fraud. +1 competence. +1 customer service. +1 for company founders.

In the end, the scoring is complicated as this post’s question is complicated. Where is the line between incompetence, ignorance, and fraud? Where in the landscape do you find organization simply covering their ass, following the letter of the law, but not doing what is right? I’m known for being different, not just because I ask the hard questions, not just because I don’t stop asking questions before understanding the underlying assumptions, but also because I try and do what is right, rather than what is easy.

There is no end yet of this reserve study story. Today I wrote my (hopefully) final email to the CEO. I asked for one extra page to be added to the study. A page that explains that the lifetime of the siding is estimated at 45 years. That it may last longer. That without that replacement in Year 31, the total amount of savings required drops from $1.5 million down to $500,000.

If this were my company producing these reports, that is not what I’d consider “best of our counsel”, but it’s the most I’m likely ever to get from Association Reserves, and they clearly have a different threshold of competence.

And as for The Big Short, I don’t think the mortgage industry is any more competent than the reserve study industry, nor significantly more fraudulent.

By "Luni"

Books

HardcoverThe Next StepThe Next StepThe Next StepThe Next Step The Next StepThe Next StepThe Next Step

Podcast

Fledge

Recent blog posts

Categories

Archives