HOA boards are faced with a challenge. They have limited time and resources, yet must meet the financial obligations of the reserve study by following a funding plan that provides adequate member contributions and additional revenue from prudent investment of reserve funds that reduce those member contributions.
HOA boards are faced with a challenge. They have limited time and resources, yet must meet the financial obligations of the Reserve Study by following a funding plan that provides adequate member contributions and additional revenue from prudent investment of reserve funds that reduce those member contributions. Here are four hurdles the board must jump when tackling reserves investment.
Hurdle #1: Failure to use the Reserve Study or not having one in the first place. Homeowner association boards have the duty to conduct long range planning to identify common elements, their current condition, their useful lives and current cost of repair or replacement. This exercise is called a Reserve Study. Some boards believe that a Reserve Study provides little benefit except to point out the obvious.
These same boards either elect not to pay the cost of one or put the one they have in a file to gather dust. Both approaches are foolish because without a clear road map to follow, the board is bound to get lost in the maze. Properly funding reserves for the standard 30 year projection period could amount to many hundreds of thousands of dollars. Larger HOAs with extensive common elements should reserve millions.
Failure to fund reserves adequately results in unfair and sometimes uncollectible special assessments. Prudent investment of reserve funds could partially offset member contributions and reduce the risk of special assessments.
Hurdle #2: Failure to understand investment choices. Some boards are under the impression that FDIC insured money market accounts or CDs are the only alternatives for reserve fund investments. There are a number of alternatives. State laws vary but in Oregon, for example, HOAs are limited to direct investment in issues of the Federal Government and/or FDIC bank accounts or CDs. HOAs are not permitted to invest in municipalities, mutual funds or indirect investments (investments to which the investor does not directly hold title, such as mutual funds, limited partnerships and Real Estate Investment Trusts). Non-FDIC insured money market accounts are not to be used for homeowner association reserve investments by law. This creates an opportunity to invest in longer term federal bonds.
As of the writing of this article, the going rate of a 10 year government bond is around 1.65% compared with bank checking accounts that average around 0.5%. This increased yield could go a long way to reducing the need for a special assessment. The challenge with investing in 10 year bonds is determining how much should be invested in them. Fortunately, the Reserve Study is very useful in determining the short and long term reserve cash needs.
Hurdle #3: Failure to utilize the Reserve Study when selecting investments. The first step in considering higher yielding investment opportunities is to put that Reserve Study to work. The Reserve Study can be used to match the repair schedule with the investments. This allows combining shorter term/lower yield CDs with longer term/higher yield Treasury Bills. This type of investment strategy is called a Duration Study. Even though a Duration Study costs money to perform, the extra interest return that can be earned by matching the investment duration to your specific HOA is well worth it. Duration studies and the investment mix need to be redone every time a Reserve Study is updated.
Hurdle #4: Not hiring a fiduciary. Regardless of how the board chooses to invest the HOA's Reserve Funds, time, expertise and professional ability are needed to manage them properly. It is in the board's interest to find someone that has the HOA's well-being at heart, such as an investment advisory company that is a fiduciary to the board. By better managing your reserve funds, you avoid the hurdles described and improve reserve investment yields. Leave the hurdling to the track stars.
Use a trained financial consultant to optimize your reserve fund investments.
SOURCE: Richard Thompson
The Regenesis Report