How to Form a Homeowners' Association

Homeowner associations (HOAs) have become more and more prevalent. According to public policy professor Robert H. Nelson, condominiums, homeowners' associations and cooperatives "as recently as 1970 represented only about 1% of U.S. housing. By 2010, however, there were more than 300,000 community associations housing more than 60 million Americans, 20% of the U.S. population...Between 1980 and 2000, half the new housing in the United States was built and organized under the private governance of a community association."

HOAs manage issues affecting the entire community, such as safety and security, lack of property maintenance, local nuisances or the provision of services not taken care of by the local government. HOAs also can be a source of major strife because of the power they wield over homeowners.

HOAs are generally formed by developers when a new community is constructed. As a condition of acquiring property in many communities, buyers must join the HOA. As a result, many people wind up joining HOAs without truly understanding what they are or how they work, just because they fall in love with a particular home.

To help homebuyers and homeowners understand the intricacies of HOAs, this article will describe how they are formed and run.

State property codes set forth the legal guidelines for establishing a homeowners' association. In Texas, for example, property code chapter 204 says a three-person committee must form to petition for the formation of a property owners association (POA). The committee must file official written notice that it intends to create a POA with mandatory membership. All of the record owners in a subdivision must be notified, and the owners of at least 60% of the property must sign and approve the petition within one year. Once the POA exists, it can create restrictions through a separate petition process that requires approval of the owners of at least 75% of the subdivision's property.

The process for establishing an HOA depends on where the HOA is located, but the following steps will probably be required.

• Establishing a business structure by forming an LLC or nonprofit corporation
• Creating covenants, conditions and restrictions (CC&Rs) that describe how the HOA will operate and what rules homeowners must abide by
• Establishing a procedure for future modification of the CC&Rs
• Writing rules and regulations that put the CC&Rs into easy-to-understand language for community residents
• Drawing up governing documents, such as articles of incorporation and bylaws (which outline meeting frequency, voting guidelines, election of HOA leaders and other operating procedures)
• Electing qualified officers/board members (the treasurer actually needs to understand how to keep books and manage money, for example)

If the people establishing the HOA are not experts in real estate law, hiring an attorney with HOA expertise would be a sound decision at this stage. The HOA will not be able to enforce its rules if they are challenged and found not to be legal. A good attorney can also point out key issues HOA leaders should pay attention to, such as fair housing laws, to avoid legal problems once the association is up and running. Federal, state and local government regulations have precedence over HOA rules. (For related reading, see: How To Pick The Right Lawyer.)

The officers and board of directors are in charge of running and overseeing the HOA. Along with this high level of responsibility comes a high level of risk. The HOA needs a way to protect itself if a homeowner decides to sue.

Why might a homeowner sue? In Elk Grove, California, a resident sued his HOA over its suggested changes to neighborhood parking rules. A Houston, Texas man sued his HOA because it wanted him to remove the burglar bars from his home despite the high crime rate in the area. A fair housing organization sued a condominium association in Florida for refusing to allow children to live in the building. A board member could be sued for violating his or her fiduciary duty toward the HOA's residents and could be held personally liable.

Directors and officers insurance provides financial protection to the people running the HOA. It covers both legal defense costs and damages. However, it does not cover intentional misconduct. Employee theft insurance can protect the association if a director, officer or property manager embezzles HOA funds.

An HOA needs money to function, and that money comes from the community's residents. Some of the money funds the HOA's administration (e.g., legal, accounting and management services), but most of the money goes toward the upkeep of common areas. It might pay for landscaping services, pool maintenance and even garbage collection. A portion of the money is spent every month, and the rest is set aside in a reserve fund. Sometimes a major expense will arise that can't be paid for out of the HOA's reserve fund. In that case, the HOA will require residents to pay an extra fee called a special assessment.

A new HOA will need to perform a funding analysis and construct a budget to determine how much to collect in monthly dues from the owner(s) of each property. The analysis is based on which expenses will be paid by community members, how much they will cost, how much will be allocated to the reserve fund and the percentage of the community's property owned by each resident. Also, the reserve fund must be managed and invested to keep the HOA financially sound (for example, the fund's value must be preserved against inflation).

As members of the community who pay dues and are affected by the HOA's decisions, residents must be kept informed of the HOA's activities and any issues affecting the community. HOAs must hold regular meetings and notify residents far enough in advance that everyone has the opportunity to attend. They must also hold elections for directors and officers and ensure everyone has the opportunity to vote. A community newsletter, email and/or website can also help keep homeowners in the loop.

HOA officers and directors should keep detailed records of their activities, such as minutes from community meetings. Associations should disclose important financial information to community members on a regular basis. Members should be aware of their rights to view HOA records and be granted access upon request. (For more, see: Dealing With Your Condo Board.)

HOAs are rule-based communities, so from time to time, they must enforce rules community members are breaking. HOAs must also handle complaints from residents about existing rules they don't like or rules they feel should be added to solve an ongoing problem.

HOAs must enforce rules quickly and consistently. Homeowners refusing to comply should be fined. If a homeowner refuses to comply, the HOA may need to send the account to collections or sue the homeowner. HOAs should avoid selective enforcement—in other words, they shouldn't play favorites with HOA leaders or community residents with whom they are friends. Biased behavior can lead to a lawsuit.

Hiring a professional management company can reduce the burden on an HOA's officers and directors and eliminate a potential source of conflict between HOA leaders and other members of the community. The management company can take over much of the administrative work and deal with unpleasantries such as enforcing rules and collecting dues. It can also use its expertise in property management to ensure the smooth operation of the community and avoid mistakes inexperienced officers and directors might make. However, professional management costs money, which means homeowners' monthly HOA fees will be higher. 

The worst-case scenario for rule enforcement involves foreclosing on a homeowner's property for nonpayment of dues or special assessments. This extreme measure can create a contentious situation between the homeowner and the HOA. Foreclosures also bring down property values, which isn't good for the other residents in the neighborhood.

HOAs can be strictly about business, but they don't have to be. An occasional fun activity allows HOA members to get to know each other on a friendly, social basis, not just in the potentially adversarial setting of an HOA meeting. If neighbors know each other personally, the community can be a more pleasant place to live and conflicts can be easier to resolve.

Forming and managing a homeowners association is a huge task with significant responsibilities and major implications. If you're considering buying property in an HOA, understand what you're getting into before you buy. (For further reading, see: 9 Things You Need To Know About Homeowners' Associations.)