09/06/11: Reserve Funds Must Be Secured
By Benny L. Kass
Recently, I received a complaint from a reader who chastised me for writing that the reserve funds which Community Associations maintain must be deposited in safe, government backed securities. The reader told me that "this is the party line advice given by the elite to the naive middle class, and is stupidly followed."
According to the reader, he advocates maintaining a minimum of 10 years worth of cash to pay bills, and invest only long term reserves (12-30 year money) in blue chip equities.
I completely agree with the reader that if you had put $50 in a Certificate of Deposit three years ago, it might now be worth only $53. It is indeed unfortunate that banks are paying next to nothing in interest for checking and savings accounts as well as CDs.
But, there is one fallacy in the reader's position. He can invest his money as he sees fit. But boards of directors have a fiduciary duty to all of the unit owners, and must invest the association funds in a secure and safe manner.
I have often joked with board members that if absolutely everyone in the association is in agreement, the board can go to Las Vegas and try to hit a jackpot.
There is yet another fallacy. Community associations should obtain - at least once every five years - a reserve analysis study. This will tell the community how much money it needs to put into reserves on a yearly basis, so as to be able to make the necessary repairs down the road. For example, if the reserve study states that the elevators have a useful life of 20 years, and the estimated cost of replacement will be $60,000, the board must put $3,000 into the reserve account ($60,000 divided by 20).
One never knows when the reserve fund will have to be tapped to fix or replace a major component in the complex. If the funds are in equities (i.e. the stock market), they may actually be low on the day that the funds are needed. As I write this column, the market is headed downward. Should the association need money today to pay for those broken elevators, or to replace the roof, there is always the possibility that the association will have lost money.
And since there is that possibility, that should be a big red flag to all boards of directors that they can breach their fiduciary duty to the members if the funds are not invested securely.
The Community Association Institute (CAI) - a national non-profit association created to provide education and resources to our nation's residential community associations, has issued a publication entitled "Reserves". This publication should be on the bookshelf of every community association Board member and property manager. (It can be obtained from CAI, 6402 Arlington Blvd, Suite 500, Falls Church, Va, 703-970 9220, or on the web at www.caionline.org.)
According to CAI, "adequate reserve funding means more than just providing funds for roof replacements. In the long run it can contribute to the rise and fall of property values. For instance, if an association is in debt or has no reserve fund, educated home buyers may not want to invest in the community."
And now that such agencies as the Federal Housing Administration (FHA) are requiring associations to not only maintain adequate reserves but also obtain periodic reserve analysis studies, this becomes important if you want to obtain financing to buy or refinance a property in a community association.
Lenders were burnt badly in such areas as Florida, Nevada and California, and are looking very carefully at the financial picture of every community association. If a lender sees that the reserve funds are not invested securely, I suspect that the lender will reject any and all mortgage loan applications from that association.
No, Mr. Reader. What you do with your own money is your business; but don't lose even one penny of mine.