PUBLISHED BY THE ASSOCIATION OF PROFESSIONAL RESERVE ANALYSTS
Association of Professional Reserve Analysts (APRA) is a nonprofit corporation established in 1995 by principals of America’s leading reserve study companies. The purpose of APRA is to provide a forum to establish a common base of knowledge, standards of care and professionalism within the reserve study industry.
The APRA Advisor is a bimonthly publication designed to expand the understanding of reserve planning and increase awareness of Professional Reserve Analysts.
Safety, Yield & Liquidity
In recent years, reserve planning has become a long overdue reality for many older homeowner associations. The boom and bust mentality of deferred maintenance and special assessments has finally forced proper long range planning and reserve funding. For those that do these things, it means accumulation of hundreds of thousands of dollars and for some, millions.
With the reserve fund growth comes the need for better reserve fund management aka stewardship. With wise stewardship, member contributions are substantially reduced due to the miracle of compound interest. With properly applied investment principles, even a modest condominium can generate several hundred thousand dollars in interest earnings over a 30 year projection period. This means that the members will need to contribute that much less out of their pockets. Good news indeed.
The board of directors has a fiduciary responsibility to make sure reserve funds are invested properly and safely. The board should not invest in anything that a prudent person would consider risky unless there is a consensus among the members that doing so is okay
(better get that in writing). The investment strategy should also ensure that funds are available when needed.
To refine and define the HOA’s reserve obligations, a written Reserves Funding & Investment Policy is extremely important. That policy holds both current and future boards to a standard of accountability and helps prevent the Board from using reserves like a private piggy bank.
A properly prepared reserve study puts the funding issue in proper perspective. While, say, $50,000 or more may seem to be a lot of money to an individual, it’s a pittance to the average HOA when it comes to paying for major repairs and replacements like roofing, painting, siding and paving. Most reserve plans call for the accumulation of hundreds of thousands or millions of dollars. Even though the fund size seems large, it is rarely greater than what is necessary to cover real costs. To stay accurate, the reserve study must be updated annually to ensure that the HOA is on track and being adequately funded.
When the reserve study is funded properly, more money will result (Oh Joy!) but with that money comes the responsibility to invest it wisely. A Reserve Funding & Investment Policy will provide the philosophy but it’s up to the board to see that the philosophy is implemented. The larger the fund, the greater the need for investment expertise. While your banker will doubtless have some convenient options, that convenience may be very costly since it can come with a low rate of return.
A trained investment consultant can be hired to manage the reserve funds and maximize yields through safe and insured investments. If your reserve funds are substantial, this is a wise and profitable move. The added investment return will more than pay for the cost of the consultant.
Investment yield is directly related to the size of fund being invested. The more you have, the greater the yield potential. However, some banks don’t willingly offer their customers the best rates. As a matter of fact, your bank may not be the best place to invest reserves. For the best rates, you need to go shopping. Next stop, the internet. Bankrate.com is one of several online sources for local investment alternatives. You can search by state and city to locate higher CD rates right in your locale.
Fiduciary responsibility requires that directors handle reserves responsibility. When it comes to investing there are three considerations: safety, liquidity and yield.
Safety can be broken down into two categories: safety of income and safety of principal. Safety of income measures the likelihood that anticipated income from an investment will continue to be paid in the amount expected and at the time expected. Safety of principal refers to whether the principal value of the investment available at the outset will be available at maturity. Both categories of safety can vary in degree with specific investments.
Liquidity refers to investments that can be converted quickly into cash. Homeowner associations need a certain amount of liquid funds to address major repairs. With a properly prepared reserve study, most repair events can be accurately predicted years in advance. So, if the repair schedule indicates 95% of reserves won’t be needed for three years, those funds can be obligated for at least two years with little fear of being caught short. Yield is simply the return received on the investment. Generally, the longer the maturity period, the higher the yield. So, a three year CD usually yields more than a one year CD. Also, the safer the investment, the lower the yield.