Reserve Fund Investment Strategy: Writing Your Investment Policy (Part 3 of 3)

You won’t be on the board forever. Craft an investment policy that will dictate how your community association saves for future generations of the Board.

By now, you should have read parts one and two of this article series, which explain why you need an investment strategy, what your options are, and how to create a sustainable investment portfolio. In this final part, we are going to focus on the investment policy itself: the who, what, when, where and whys that dictate how future board members will invest for the community’s future:

Percentage of Funding

When writing an investment policy for your Condo or HOA, the first major decision that you need to determine is how much of the money you’ll need to have on hand and when. Remember that your reserve study is a prediction of what assets you have when they are likely to need to be replaced, and how much that replacement is likely to cost.

If your reserve study predicts that the air conditioning unit for your condo building will need to be replaced in 10 years, you need to decide if you want to have the full amount of that replacement cost on hand today, within 5 years, or just squeak in by having it ready at the 10-year mark. There are three schools of thought when deciding on the percentage of reserve funding:

1. Fully Funded means that the full amount for replacement of all community assets is available now. The advantages of a fully funded reserve are fairly obvious. First, the community is prepared for just about any eventuality. Secondly, you are less reliant on the accuracy of your reserve study. Finally, assessments can stay low because you do not need to be putting anything aside for reserves unless the board adds new amenities or assets. While some communities do reach a fully funded reserve, it’s rare to have enough saved to cover all replacement costs. Getting to 100% often involves a heavy increase in homeowner assessments early in the community’s life, meaning early residents wind up paying for benefits they will never see.
2. Threshold Funded means that the board has determined a percentage of funding at which they want to maintain the reserves. This percentage is at the discretion of the board, but many communities aim for a 70-80% threshold. The idea with a threshold is that all of your assets are not likely to need to be replaced at the same time, so maintaining the reserve funds to a certain level provides enough of a financial buffer. The threshold is a goal, and the investment policy serves as a plan to meet and maintain that goal. With a threshold, the savings requirements are slightly less, and the burden on the homeowners would not be too high, should the worst happen. Opting to set a threshold for funding your reserves implies a certain faith in your reserve study, that the community’s assets will not break down before you have the chance to save up to the full amount needed.
3. Baseline Funded means that the board has opted to maintain only the minimal amount of reserves on hand. In a baseline funded model, the budget and the reserve study must be 100% perfect, because there is no margin for missteps, error, or acts of God. In a baseline model, only those assets that have been predicted to fail within the coming year have their replacement costs factored into the annual budget. Baseline models are often adopted when communities wish to keep assessments low. While low assessments are attractive to every homeowner, when problems arise, the homeowners are the ones that wind up having to cover the shortage, through a special assessment, which is painful for everyone. Choosing a baseline funding model is betting on disaster never striking your community. It is risky, dangerous, and fiscally irresponsible.

Threshold funding of the reserves is the most common savings model for community associations. Typically,  if a community is in financial distress, or have been running a baseline model with little savings to speak of, the board will set a sliding threshold, where they aim for a low savings threshold with a plan over the course of the next several years to meet that percentage, then move the goalpost to the next threshold percentage point until the board feels they have set a comfortable margin for reserves,  after which the budgeted reserves savings enters a maintenance mode.

Lending requirements

Lending guidelines for government-backed loans by organizations like Fannie Mae, Freddie Mac, and the VA require some community associations to have a minimum amount of money deposited into the annual reserves, generally 10% of the annual budget. Failure to meet these requirements could prevent new home buyers from being approved for loans to purchase a home in your community. You need to factor this requirement into your funding plans as this can severely affect the health of your community! Check with your financial advisors to see if your community association is meeting the requirements for government loan approval.

Whether your goal is to max out your reserves, to reach a threshold of reserve savings, or to keep assessments low, strategic investing is the solution. The further you can extend the moneys you save, the smaller the burden on the members of your association.

Checks and Balances

Depending on the size of your investment portfolio, you may find the need to hire a full-time financial planner to manage your investments. However, for most communities, this falls under the Treasurer’s umbrella. However competent your treasurer or financial planner may be, it is the fiduciary duty of the board to establish a system of oversight for the community’s investments. In your policy language, be sure to include guidelines on who is responsible for maintaining the portfolio, how they will report that information, and who will additionally be authorized to have access to confirm the status of the accounts.

For example, typically the treasurer is the primary investor, with the president of the board being named on the accounts for oversight purposes. Additionally, the treasurer must include investment status reports in each regular board meeting, and a full overview at the annual general meeting.

You may also wish to set a series of controls defining how funds may be accessed. For example, if you want to limit the ability to cash out a CD early, or auction a treasury, you may require a full vote of the board to take such action, or you may simply set thresholds of the maximum amount that may be accessed without board or committee approval.

Some Assembly Required

By now you should have all the building blocks you need to build a functional investment policy that will carry your community association through the future. Now it’s time to sit down with your advisors and the board and draft the actual policy. To help get you started, a sample investment policy can be seen here, or a more detailed guide to crafting reserve policies for nonprofits is here.

Remember that regular updating of your reserve study and subsequent review of your policy is vital to maintain a smooth investment plan.

Part 1 | Part 2 | Part 3

—

Need Help with Your Strategy?

Are you a Utah Condo or HOA looking for a management company that can help you implement a sound investment strategy for your reserve funds to safeguard your community association’s future? Take advantage of this free strategic evaluation to see if HOA Strategies is a good fit for your community.