NOTE: This post reflects our opinions and ideas and should not be taken as legal advice or professional guidance. References to language in the Florida Statutes or Florida Administrative Code are based on our reading and laymen’s interpretation of these documents. As always, we strongly encourage you to consult with legal counsel regarding the interpretation of law or your investment professional regarding investing Association funds.
Several weeks back I was skimming Becker and Poilikoff’s Florida Condo & HOA Blog, a fantastic resource for Florida condo association members. One blog post discussed an association board that had chosen to invest some portion of its reserve funds in stocks and bonds. After reading this I thought it would be worthwhile to discuss some of the key considerations when investing the reserve funds of condominium associations.
For a general overview of reserve funding, click here.
Fiduciary Duty: Chapter 718 of the Florida Statutes (f.k.a. Florida Condominium Act) provides no explicit guidance on investing reserve funds. This decision is left entirely to the board. That being said Chapter 718.111(1)(a) specifies that board members have a fiduciary duty to the unit owners and Chapter 617.0830 (applicable to non-profits) states that directors must act in good faith with the care of an ordinary prudent person. It is broadly believed that this fiduciary duty translates into holding only principal-protected investments (i.e., the initial investment amount cannot be lost) such as certificates of deposit (CD). While I don’t think this is always the case, I do think boards should be very cautious when investing in risky assets (e.g., equity, fixed income). I have provided some general guidance on investing in risky assets below.
Governing Documents: Some association governing documents prohibit reserve funds from being invested in certain types of instruments. The board must comply with these specifications.
Liquidity Needs: Before the board can decide how to invest the association’s reserve funds, the members must first understand their anticipated long-term reserve spending. This will help determine how much liquidity (i.e., immediate access to funds) the association will need at any given time. For example, if an association has $150,000 in reserves and expects to complete a $80,000 painting project in 12 months, putting $100,000 in a 2-year CD would be imprudent as there would be insufficient liquid reserve funds come painting project. A good reserve study will project the dates and costs of all required reserve expenditures.
Bank Selection(s): The management company generally dictates the association’s primary bank. The association will have a primary checking account (f.k.a. operating account) into which maintenance fees are deposited and from which routine expenses are paid. The association will also have a primary reserve account (generally a savings or money-market account) where contributions to reserves are deposited on a routine basis and from which payments for reserve projects are made. Outside of these two accounts, which must maintain sufficient funds to pay expenses, the association may choose to open accounts and hold reserve funds at any financial institution. Once the association has created an investment strategy for their reserve funds, I recommend shopping the local banks and selecting those that have competitive interest rates and products. Many banks have divisions specifically tailored to the investment needs of associations. Any reserve funds that will not be needed to pay for projects in the near term may be transferred to the association’s chosen bank(s).
Federal Deposit Insurance Commission (FDIC) Insured Investment Options: Prudent reserve fund investing begins with ensuring aggregate deposits remain under the FDIC limit. The FDIC limit is currently $250,000 per insured bank, per depositor. These limits apply to all types of deposits including checking accounts, savings accounts, money-market accounts (MMAs) and CDs. All of these investments are principal-protected.
- Checking Account: This type of account earns little to no interest and has no restrictions on how many withdrawals may be made in any one month. A checking account is typically used for an association’s primary operating account.
- Savings/ MMAs: These types of accounts offer higher interest rates than checking accounts but have restrictions on the number of checks written, or withdrawals made, in one month. MMAs tend to have higher interest rates than traditional savings accounts due to the types of investments banks may make with your deposits. These accounts may require a minimum balance to avoid a fee. These accounts are typically used for an association’s primary reserve account.
- CDs: CDs often provide higher interest rates than savings accounts or MMAs; however, funds can only be withdrawn upon maturity of the CD (unless a penalty is paid). CDs have varying lengths ranging from 3 months to 10 years. CDs are a common investment option for association reserve funds.
- Certificates of Deposit Account Registry Service (CDARs): A CDARs account is essentially a CD that provides exposure to many different FDIC-insured institutions. These can be very beneficial as they provide exposure to multiple banks with the convenience of only having to work with one bank. Learn more here.
If an association has more than $250,000 with one bank (operating + reserve funds), the association should reduce their exposure to this institution. The two common ways to achieve this are (1) to shift funds to an account at another FDIC-insured institution or (2) to invest in a CDARs account with your current institution.
Laddered CD Investment Strategy: Even with a well-structured long-term reserve project plan, there is always the possibility that reserve funds will be needed at unexpected times. As such, boards are often hesitant to “lock up” their reserve funds for any extended period. On the other hand, there is the desire to earn sufficient interest on reserve funds to, at a minimum, keep pace with inflation. As such, there is always a struggle between liquidity and investment return. One common way to achieve the “best of both worlds” while remaining within the principal-protected spectrum is to use a laddered CD strategy. This strategy allows the association to invest in multiple CDs with varying maturity dates so that some amount of reserve funds routinely becomes available. This strategy is best illustrated through an example. An association has $500,000 in reserve funds with no upcoming projects. The association chooses to invest $125,000 in four CDs all with the same start date. The CDs would be 3, 6, 9 and 12 months in length, allowing the association access to $125,000 (+ interest) in reserve funds every three months. If the association does not need the funds as each CD matures, the funds would be rolled over into a 12 month CD. This would allow the association access to approximately ¼ of their reserve funds every three months until the next reserve project. Once reserves are spent, the board would re-evaluate the structure of its laddered CDs.
Risky Assets: Some association boards may consider investing in risky assets (e.g., equities, fixed income, real estate), particularly in times of very low interest rates. I don’t generally recommend investing in risky assets; however, if the board decides to proceed in this direction, I recommend the following:
- Avoid volatile assets such as equities or highly illiquid investments such as real estate. Say focused on the fixed income spectrum (e.g., treasury bills/ bonds, investment-grade bonds, fixed income mutual funds, agency mortgage-based securities). Attempt to time the maturity of any fixed income instruments to expected reserve project dates.
- Hire a qualified investment advisor to provide guidance to the board on investment options and have the investment advisor help the board create an investment policy. Even if a board member is an experienced investor, there should be a 3rd party handing the actual trading.
- Every board member should be able to clearly explain the types of investments the association is making and their associated risk profiles. If the investments are too complicated for everyone to understand, don’t invest in them.
- Determine if the unit owners support taking on risk in their reserve fund investments. Consider polling the community and asking for feedback prior to proceeding with any risky investment. Offering unit owners the opportunity to voice their opinion helps limit criticism of the board should the investments lose money.
- Consider only investing reserve funds that are not expected to be used for at least 5 years in risky assets. This should provide the association time to ride out any minor market fluctuations that negatively impact their investments. Further, if the association sustains a loss due to a failed investment, this should provide enough time to recoup the funds without major impact on maintenance fees.
If your board is considering investing in risky assets, I would be happy to discuss an investment plan with you.
Please let me know if you have any questions on reserve fund investing.
Emily Shaw is a condominium homeowner in Tampa, Florida and a Director of VERA Property Management, a firm providing full-service community association management in the Tampa Bay Area as well as consulting, financial and legal services to all Florida community associations.