Monday, April 11, 2022

The Selling of a Country Club Part 3


Introduction – This post details the problems with trying to integrate the newly purchased club into the HOA budget process.  The HOA sent out a budget packet that showed the Master Association Budget, the Division Budgets, and the Drive Budget.  It is difficult to discern the Association’s fiscal position due mainly to poor accounting practices.    

Master Association Budget – The first thing to notice is the 2022 Budget is the same as the 2021 Budget   Equality between budgets was necessary to keep the dues the same level.[1]

More problematical is the failure to consider any impact due to inflation.  The budget for 2021 shows the Master Association breaking even.  With rising costs in 2022 any deficit will have to be funded by a transfer from the Operating Reserves or a reduction in one or more of the expense categories.

It is possible the Master Association had a large operating income last year that it can be used to counter any inflationary cost increases.  There is no indication that is the case.  What happened this year will be detailed in the financial report for 2021 and is not published until 2022.   That report does not report on budget variances and does not use the exact same expense categories as the budget.  As an example, in the year 2020 (the last year available) the expenditure on landscaping was reported to be $719,712.[2]  The budget for landscaping in 2020 was $604,164.[3]  The overrun of approximately $100,000 is not contained in any report made available to the members.  In essence, the budget is not a control document but merely a general idea of where a member’s dues will go.

The budget package includes the Reserve Study completed for 2021.[4] That study states the Master Association reserve account is expected to be only 40 percent fully funded as of December 31, 2022.  The Drive Budget reserves are only 57 percent fully funded as of that date.  The Master Association Board has made an effort to increase the reserve expense to decrease the shortfall.  What is missing in the budget package, however, is any mention of reserves for the recently purchased Club (Cantina, Club House, Tennis Courts, Golf Course, etc.).  Even the divisional budgets (discussed below) for the golf and racquet facilities do not have a “reserve” cost element.    

Division Budgets – There are two divisions—Sports and Fitness and Golf Club.  The budgets for both are shown in Table 1.

Golf Club Budget – It is strange the Golf Club is not a cost element in the Master Association budget.  Instead, it is shown as a separate entity and not the most important asset owned by the Association. Nothing in the budget indicates there is an approximately $8 million liability for refundable member deposits.  A prospective golf member would not know he is accepting this liability when he joins. 

The budget is also mute on estimates of the expected membership fees and refunds to departing members in 2022.  If, for example, all 68 Premier members decide to become full members they would pay approximately $1.97 million to the Golf Club.  Will any net membership fees be set aside for capital expenditures?  The answer does not lie in the budget packet provided by the HOA.               

Table 1

Division Budgets ($)

Description

Combined

Sports & Fitness

Golf Club

Membership Income

9,858,896

3,611,771

6,247,125

 

 

 

 

G/L Sale of Assets

 

 

 

Golf Shop Net

130,199

 

130,199

Golf Services

(244,044)

 

(244,004)

Golf Course Maintenance

(4,898,114)

 

(4,898,114)

Sports and Fitness Net

(688,833)

(688,833)

 

Dining Room

(154,083)

(154,083)

 

Kitchen

(923,404)

(923,404)

 

Cantina Net

(152,135)

(152,135)

 

The Turn Net

23,177

23,177

 

Banquets

11,244

11,244

 

Clubhouse Operation

(337,222)

(337,222)

 

General and Administrative

(1,069,365)

(695,087)

(374,278)

 

 

 

 

Department Expenses

(8,302,541)

(2,916,344)

(5,386,198)

 

 

 

 

Unadjusted Net

1,556,355

695,428

860,927

 

 A budget should be sufficiently detailed that it can be used for planning and control.  That is not the case for the Golf Club.   That budget only shows the Golf Club has a big pile of money as income and a slightly smaller pile of money for expenses.  The budget gives no indication of what is driving income and expenses as would be expected of a multi-million-dollar company.  The five-line budget prepared for the Golf Club would not even pass muster as a Junior Achievement project.

A closer look at membership income figure will illustrate the inadequacy of the budget.  Membership income is projected to be $6,247,125.  This equals the dues for 348 members, but it is not clear that is the basis for the budget estimate.   If it is, the estimate neglects trail fees, guest fees, credit card fees, and Premier members who will not pay full dues for the entire year.[5] 

Sports and Fitness Budget – This budget suffers from the same lack of specificity as the Golf Club budget.  The food and beverage operation is projected to lose $1.2 million.  Most of this loss is due to a budget category termed “kitchen.”  What are the components of “kitchen” that are driving the cost?  The budget does not tell you. 

The membership income is apparently based on 912 members (890 HOA members plus 22 Invitational members) though even that is not clear.  Also hidden is any revenue from the dining room. The Cantina and the Turn are given net estimates while the dining room is not.

It is also curious the Sport and Fitness divisional expense of $2,916,344 does not reconcile with the Racquet Club expense of $3,524,400 shown in the Master Association budget.  There is a $600,000 difference.   

Drive Budget – This budget is arcane and has outlasted its usefulness.  This budget was intended to allocate joint costs among the Club, the Ventanas, and the HOA according to the 2009 Drive Agreement.   With the Club gone,[6] it would be more understandable to have a unified budget that displays all income and expenses.  There no longer is a need to separate costs such as landscaping and security into two separate budgets.  A unified budget would be more transparent in informing members where their dues are being spent and would also allow for year-to-year comparisons.   

Table 2 demonstrates the problems with the 2022 Drive Budget.[7]  It is clear something is amiss as shown by the large differences in cost categories between the 2021 and 2022.  It is possible landscape personnel were classified as administrative in 2021.  If so, it raises the question of why any accountant would approve of such an allocation.  The two budgets indicate the HOA has budgeted $2,657,949 for landscaping in 2022.   This differs radically from the reported expenditures for landscaping in the 2020 Financial statement ($719,712).  This lack of consistency in budget assumptions makes it impossible to determine the efficacy of expenditure decisions.

Table 2

Drive Budget Comparison ($) 

              Drive Budget

2021

2022

Difference

 

 

 

 

Operating Income

4,018,390.12

4,018,390.12

0.00

 

 

 

 

Costs

 

 

 

Administrative

970,082.51

52,367.45

-917,695.06

Professional Services

271,120.12

281,120.12

10,000

Utilities

749,060.00

749,060.00

0.00

Landscaping

178,400.00

1,096,565.06

918,165.06

Repair & Maintenance

116,515.00

113,140.00

-3,375.00

Access Control

1,387,935.49

1,391,310.49

3,375.00

Taxes

3,911.00

3,911.00

0.00

Reserve Contribution

330,916.00

330,916.00

0.00

Total

4,007,940.12

4,018,390.12

10,470

 

In the brochure promoting buying the Club (Better Together), it was never mentioned the Club owner  paid the HOA approximately $300,000 a year as its share of the Drive Expenses (e.g., Security, landscaping).  How was the HOA to make up for this drop in income after the purchase?  It simply charged the Golf Club that same amount in the Drive Budget.  Whether the Golf Club actually incurred this charge cannot be determined because the Golf Club budget does not show that level of detail. 

 



[1]Staff had some problem in copying the 2021 Budget.  For example, the 2021 Budget expense for utilities is $280,000.  The 2022 Budget package shows the 2021 budget for utilities to be $290,000.  This is not a major error but does indicate a lack of care in preparing the 2022 budget.

[2] Beck and Company, Master Association Audited Financial Statement for 2020, May 17, 2021

[3] The Operating budget has a landscape expense of $425,764. The Drive Budget has a landscape expense of $178,400. 

[4] SCT Reserve Consultants, Temecula CA, November 11, 2021

[5] The Club has 68 Premier members in 2021 as reported in the sales contract.  T.D. Desert Development kept the initial membership payment for these members leaving a liability of 468 months of foregone dues to the new Golf Club

[6] T.D. Desert Development still operates the real estate office so it should make a reduced payment under the Drive Agreement.

[7]It was not possible to get the 2021 total expense to match what was reported in both the 2021 and 2022 budgets (i.e., $4,018.390.12). 

The Selling of a Country Club Part 4

 

This post is not directly about golf handicaps.  When a homeowner's association takes over a golf course, however, the election of the Board will have a huge impact on how the golf course will be run.  Below is a case example of how an election should and should not be run.  Golfers should be vigilant about elections to ensure their rights are protected.  It is important that election inspectors are independent and not appointed by the incumbent Board as in the case cited below.

Though a secret election of HOA directors is required by law, the election at this Club was far from secret.   The vote tally was run by three inspectors, A, B, C.   At first, A would call out the name on the outer envelope, open the inner envelope, and pass ballot on to B.  B would check off the name on a master list and pass ballot onto C.   C would announce which candidates received votes and record the votes.  To be fair, I asked the votes to be announced so I could keep an independent tally.  It was obvious there was no secrecy.  For example, the seller of the Club always cast two votes for the HOA's lead negotiator.

After about 20 percent of the vote was counted, C realized the lack of secrecy and would no longer announce the results.  There were three problems with this remedy.  First, the process still allowed election officials to know how each member voted.   That is not legitimate even if the inspectors had no interest in how a member voted.  Second, it was still possible to discern how a member voted.  If C put a mark at the top of the tally page, it would have been for the incumbent.  Similarly, a vote near the bottom would be for a write-in candidate.  Again, the secrecy of the ballot was not protected.  Third, with no announcement of the vote, an independent tally was not possible.  The entire accuracy of the voting relied on C who was putting down marks like “ IIIIIIIIIIIII” across a page.  C could have tilted the election one way or another.  

Here is the way the election should have been run.  The law gives the inspectors authority to verify the member’s information and signature on the outer envelope prior to the meeting where the ballot will be counted.  At this point the first sealed envelope containing the ballot should be separated from the signed envelope.  The inspectors would then count the ballots and secrecy would be preserved.




Wednesday, August 11, 2021

The Selling of a Country Club Part 2

 

A previous post detailed how an HOA painted an optimistic picture of the future financial position of a country club in a sales brochure entitled Better Together (BT).  Homeowners were asked to vote (i.e., give their proxy to the Board) before the sales agreement was finalized.  That was an error in judgment made by many members because the sales agreement and proposed changes in the CC&Rs contain provisions detrimental to the bests interest of golf members.  If these provisions had been aired and debated before the vote, would it have affected the outcome?   Probably not.   The acquisition decision was framed as “good versus evil.”  For most homeowners, this made the choice simple. The major differences between BT and reality are detailed below so their impact on the club can be measured over time.      

1.       BT does not specify that the golf club members will be responsible for the golf course even though they have no control over its management.   The golf club will be required to be self-supporting as shown in the proposed new CC&R:

Section 18.1 (B) The expenses incurred by the Master Association in the operation and maintenance of the Golf Facilities SHALL NOT be included in the Common Expenses and Regular Assessment levied pursuant to Article 5, Section5.3 of the Declaration.  All such expenses shall be paid from income received from the operation of the Golf Facilities, including without limitation the Golf Membership fees and dues.

The proposed CC&Rs put the golf club in the same precarious position other clubs have faced. Morningside Country Club and Indian Ridge Country Club, both owned by the golf members, had to negotiate with their respective Homeowner’s Association (HOA) for financial support to put them on a sound financial position. At this Club, the HOA has stipulated no support is forthcoming. BT did not spell out the golf members obligation which could turn out to be onerous.

2.      BT presents a superficial estimate of the financial future of the club.  It does not present a separate analysis of the viability of the golf club.   For example, BT does not contain any audited records of the costs and revenues or pro forma income and cash flow statements of the golf club.    Many golf members believe the golf club is on strong financial footing based on the numbers presented in BT.  That analysis, however, is highly suspect as shown in “The Sale of a Country Club Part 1,” June 7, 2021, www.ongolfhandicaps.com.

An approximate divisional accounting is provided in BT (p. 10). BT shows the golf operation is near breakeven. It is probable the golf course operates at a loss, but the Club makes a profit because of the Racquet Club Assessment ($330/month/homeowner). In a Board produced brochure, Racquet Club dues are projected at the same $330 per month or $3.52 million per year. BT estimates the operating cost of the Racquet Club is only $721,000. What will the Board do with the excess funds? It is only clear from the proposed CC&Rs that the Golf Club will not receive any funds from this account.

3.       BT stated ”To manage the diverse interests of the Racquet Club and the Golf Club, divisional accounting will be used to capture the actual costs and revenues of each facility.”   This statement implied golfers would pay for golf and racquet players would pay for racquet sports.  This statement was either misleading or an example of “bait and switch marketing.”   A homeowner cannot opt out of the Racquet Club.  According to Section 5.3 (E), expenses incurred in the operation and maintenance, and/or improvement of the Racquet Club and Related Facilities are a part of the Common Expenses for the Master Association and will be billed to each Owner as part of the Regular Assessment. 

4.      Over the past year the Developer has been selling what are called Premier Memberships. A Premier Member pays his/her dues for one year upfront.  To entice more members, the Developer has increased the length of the Premier Membership by several months. In real estate transactions it is customary to pro-rate pre-paid revenues (e.g., rent) between buyer and seller.  The sales agreement, however, lets the seller (Developer) keep all of the Premier Membership fees.  This amounts to $1,214,880 in revenue (12/31/2020 to 8/17/2021) which will not be shared with the HOA.  As of the closing date, 68 Premier members will not be paying golf club dues at least until 2022.  The Golf Club is obligated to provide 468 months of membership to these Premier Members while receiving no dues.  At the current dues level of $1,495 per month this amounts to $700,000 in foregone revenue.

At the end of one year, a Premier member can convert to a full golf membership. BT indicates the conversion price would be $39,500 though this is not explicit. In practice, Premier members have been given a $10,000 discount and only pay $29,500.

The short-term fate of the Golf Club is dependent on how many Premier members convert and at what price. A high conversion rate would be a shot in the arm to the Golf Club and provide it with needed reserves. This financial windfall is not likely to be repeated in future years since the low sales inventory in housing reduces the pool of potential golf members.  BT does not mention the Premier Member program even though the decisions made by the 68 participating members are vital to the financial viability of the club. Why was such an import fact left out of BT?

5.       BT and an associated Frequently Asked Questions imply the Board cannot impose an assessment with the homeowner’s approval.  This is false.    Neither homeowner nor golf membership approval would be necessary.  Section 18.1 (B) states “nothing in this Section shall prohibit the imposition of a Special Assessment pursuant to Article 5, Section 5.4 of the Declaration to the extent that any such Special Assessment is necessary to defray in whole or in part, the cost of any capital improvement to the Golf Facilities…”  Section 5.4 states that no Special Assessments shall exceed five percent (5%) of the budgeted gross expenses of the Master Association for that fiscal year.  The budget for the Master Association is approximately $9.2 million so the Special Assessment is capped at $460,00 per year. If the capital improvements are for the golf facilities, the Master Association can elect to impose the Special Assessment on only those members who hold golf memberships.  Assuming there are 325 golf members, the Master Association can impose a Special Assessment of approximately $1,400 a year without a vote.

If golf members wanted to finance a capital expenditure larger than the Special Assessment procedure allows, there does not appear to be a mechanism for it.  Section 5.4 only specifies a vote of all members (i.e., homeowners) for major assessments.  The new Article 18 is silent on this type of assessment.

6.      BT argued the Developer could raise golf club dues at will.  BT did not say the HOA will have the same ability. The Developer, however, was able to moderate increases in golf dues by either using reserves or allocating Racquet Club dues to golf course related expenses.  The new golf club, however, will be formed without reserves and is barred from using Racquet Club dues.  Golf Club dues will be the cost of operations plus capital expenditures minus miscellaneous income (e.g., membership fees, guest fees) divided by the number of members.  The level of dues will be a function of the number of members.  If a golf member is replaced by a pickleball enthusiast, golf dues must increase.  If this cycle is repeated enough times, the golf club could enter a death spiral.

7.      Legally the HOA is responsible the liability of the member deposits. In actuality, it is the golf members who are responsible.  This is not made clear in BT.  The Board’s operating plan assumes member initiation fees exceed deposits refunds from 2020 to 2031.  In this case, the extra revenue is allocated to the Golf Club.  What if deposit refunds exceed new member fees?  The proposed CC&Rs are not clear on this matter.  From the tenor of the CC&Rs, the HOA could lend the Golf Club account funds to cover the deficit.  This loan, however, would have to paid back at some time by the Golf Club.

8.      In the Sales Agreement, the HOA gives an Honorary Corporate Membership to the Developer Group. This gift is not mentioned in BT.   The Developer can name the six members, but they can be changed with certain limitations.  This Honorary membership is given in perpetuity.  This represents a yearly gift to the Developer $99,240 at the present dues rate and trail fee.  Golf club members had no input in granting this membership but must bear the costs it will impose.  The CC&Rs do not provide a mechanism for the HOA to reimburse the Golf Club.  BT does not mention the honorary memberships.

9.      The Sales Agreement acknowledges the Developer will remove approximately 30 golf cart parking spaces that service the Racquet Club.  The Developer is obligated to provide parking at an alternative location on the property.  The sales agreement does not give the Board any approval authority on the location and size of any new parking area.  BT does not mention the inconvenience the elimination of the present golf cart parking area will cause.  Why was this very important provision omitted from the BT?



Perhaps the biggest fault with BT is that assumes a linear world. Membership and operating costs increases at the same percentage each year. The golf industry does not behave that way. There can be large swings in the financial viability of a club. The number of clubs that have been closed attest to that. To survive rough periods a club must have substantial reserves. This Club will not have substantial reserves. It will rely on the HOA increasing Golf Club dues to meet financial contingencies. Higher dues can mean the Club is less competitive in attracting new homeowners and golf members. Time will tell if this comes to pass.