Managing Your Reserve Fund
Keeping it Healthy in Today's Tough Economy
In today's harsh economic times, maintaining a healthy reserve fund is more important than ever. A community association’s reserve fund can be used to cover any number of emergency expenses from sudden repairs to legal costs. In addition, a reserve fund can be used for ongoing maintenance projects or for anticipated future repairs.
How Much is Enough?
Though a robust reserve fund is highly desirable, there is too much variation in properties to have one specific formula to calculate how much money should be in a community’s reserves – at least not one that works across the board. That said, there are some rules of thumb and guidelines that boards can use to determine a healthy amount to keep in reserve. One way to get a sense of what your condo or association should have in reserve is to look ahead at the building’s needs. Conduct a survey to determine what systems might need to be replaced and what repairs might be necessary over the next five years.
Many times, surveys are done by qualified engineers who generate projections of cash amounts the building will need to put aside in the next one, two, five and ten years for that new roof, siding or furnace. These findings are typically bundled into a report prepared by the engineer called a “reserve study.”
Despite the usefulness of current reserve studies, many communities are stuck with outdated studies that are not that useful in generating precise repair or replacement costs, says Marie Shepherd, CPA, and a partner in Graham, Huckins & Shepherd, PC, in Worcester, Massachusetts.
“A lot of condos have very old reserve studies – especially considering the changing economic conditions and pricing of things,” says Shepherd. An updated study, Shepherd notes, would reflect recent fluctuations in the prices of labor and materials.
But what if the cash requirements that are generated after assessing all the projects and upgrades the condominium needs are so large as to be unrealistic? At this point, the board should determine a way to either raise the necessary funds, or change its plans.
Accountant David A. Levy, CPA, of Brookline, Massachusetts, says many condominiums with little cash and large projects are choosing to defer the work.
For instance, if a roof was scheduled to be replaced in 2009, an alternate plan might be to perform maintenance on the roof to stretch its useful life until the needed funds could be obtained, says Levy.
Shepherd says many of her condos that need repair right away are turning to borrowing from banks after getting board approval. Typically, says Shepherd, a condominium board will get approval for both a special assessment and loan at the same time. “Most of the condos I’m involved with have had to borrow to do some of the larger projects and then do the special assessments. Most of them don’t have large enough cash reserves [to undertake repairs].”
Levy says many of his associations are looking to bank loans to fund repairs, but that not as many banks are eager to lend these days.
Howard Himmel, vice president of business development at Rockland Trust, acknowledges that banks are looking more carefully at late condo fees (aging account receivables) before lending, but says his bank remains committed to condominiums. “Rock-land Trust is very interested in lending to any association,” says Himmell, who works in Rockland’s Community Association Banking Division.
Whether taking out a loan to perform work or deciding to defer it, community associations are taking a hard look at their financial picture andthe realities of today’s economy before committing funds to any project.
Unfortunately, Levy says many of his properties facing repairs will be “going back to the old [ways] – special assessments, and the unfortunate crisis management – dealing with things as they come up, putting things off.”
In today’s economy, investing with caution is the key for just about everyone. The same goes for reserve funds – although they need to grow, they are made up of, in essence, other people’s money and should be treated as such.
“If you want to invest them, you need to protect the principal. That’s the overriding concern for board members – principal preservation over growth and return,” says Levy.
Boards that have witnessed various market crashes have retreated from the mutual funds and money market accounts that were common holdings two or three years ago, says Levy.
“After the crashes, a lot of boards went back to simple savings accounts,” says Levy, who says they are attracted to the FDIC insurance on such accounts. “They acknowledge that it’s the board’s responsibility not to invest the funds aggressively but to invest the funds prudently.” But because inflation is outstripping return rates for savings accounts, condos are now seeing “nothing, absolutely nothing” in returns, Levy says.
Shepherd says her condos are putting most of their money in certificates of deposit (CDs) and a bit in regular money market accounts, the latter to have instant access to funds if needed. Boards are also staggering their CDs so they have different rollover dates, which allows periodic access to larger amounts, she says. Not content with their modest CD returns, Shepherd says her boards are “really shopping around for the best rate and the best terms they can get [on CDs].”
Looking to the future and the eventual recovery of the stock market, Levy says he envisions condos someday returning to diversified mutual funds. “I would like to see us, the [condominium} industry, get back in that investment mode again. But I can’t advise this is the time to do it.”
Checks and Balances
Reserve funds are usually handled or overseen by a building’s board, or a select few board members. In some instances, the management company also is involved in overseeing the reserve. No matter who is in charge, however, it’s extremely important that there be checks and balances in place to ensure transparency and that the board is always well aware of the state of the community’s reserve fund.
The checks and balances typically come in where copies of the monthly statements go to multiple parties: the board, management company and the accountant.
But receiving financial statements alone isn’t enough understanding them is essential.
“Boards and shareholders should be aware that most audited financial statements should include footnotes or references that discuss the issue of whether or not the building’s investments are insured,” says Gary Kokalari, a former president and treasurer of his co-op and a specialist in co-op finance with Merrill Lynch in Manhattan. “This is typically included in a footnote that refers to the concentration of credit risk. It discuses what investments the co-op or condo has and whether or not they’re insured,” he says.
Today, most financial institutions offer online access to financial statements, and a designated board member should be reviewing this on at least a monthly basis, says Kokalari.
And for added protection of reserves, when funds are needed, the board should request that money be put into an operating account and cut the check from there instead of directly out of the reserve fund.
As buildings continue to be conservative with their reserve funds, many boards have placed an emphasis on saving overall versus spending.
“It seems some buildings are being more conservative with expenditures. Just like individual investors, some are starting to become more savers than spenders,” says Kokalari, noting that low-risk investments give boards little reason to worry or panic. “If their reserves are in low-risk investments that are adequately insured, there’s no need to panic,” he says. “This does present a good opportunity to review reserve funds to understand what’s under the hood, however.”
Boards don’t have to go it alone when handling their reserve fund. The can consult professionals for help or advice when investing or structuring their reserve fund plan. Professional organizations, such as the Community Associations Institute (CAI), can provide a wealth of information for board members who want to become more knowledgeable. Education and knowledgeable investing are crucial, as the reserve fund benefits the entire community.
“Some people are handling significant money with little financial background,” says Michael Esposito, of Kleiman & Weinshank, LLP, an accounting firm based in Manhattan. “So understanding is key. Boards have to understand clearly what they’re investing in. Don’t be sold a bill of goods that’s not there.”
Education and speaking with knowledgeable professionals will go a long way in helping boards make financial decisions in the best interest of their community associations.
Stephanie Mannino is a freelance writer and author.
Managing Editor Jim Douglass contributed to this report.