Investing HOA reserves

I proposed to our BOD to invest that money in Treasury Inflation Protected securities by way of mutual funds that have typically returned between 6-8 % over the last 10 years.

The BOD on the advise of the property manager invests the money in laddered CD's with a maximum return of 1.5 % currently.

Most HOA's go with ultra-conservative CD's or MMF's with no protection against inflation currently at about 3 %, ergo requiring higher monthly assessments or more than the customary 20 % dedicated to the reserve fund.

I would not use a property manager to invest my money for sure!

Comments, John

PS Can I provide a link showing returne to an inflation protected mutual fund?

JohnH,

Investing your HOA funds in any mutual fund, including a fund that invests in TIPS, entails risk to your principal. While the underlying TIPS will always be redeemed at par at their maturity, the price of shares of the mutual fund fluctuate with market conditions, notably, interest rates. At the time you need to access your invested funds, the mutual fund Net Asset Value (NAV) may he higher or lower than it was at the time you made your investment. The potential loss that you could incur if the NAV is down could more than offset any interest paid by the underlying TIPS.

Our HOA investment policy limits investments to those carrying FDIC insurance or backed by the full faith and credit of the federal government. The TIPS in the mutual fund are backed by the full faith and credit of the USA but the mutual fund shares do not carry such backing or FDIC insurance.

Do you really want to take this risk?

Treasury notes and bonds are fully backed by the US government, ergo mutual funds holding them are insured better than CD's are and ever will.

Yes the principal may fluctuate some, but income averaging compensates for it as every month 10-20 % of the assessments are invested.

Over long periods of time,like eternity for HOA's (!), it is a no-brainer!

Your fiduciary responsibility as a director towards your members is to maximize returns and lower the asssessment accordingly.

John

No your responsibility is NOT to further returns and lower assessments. That is NOT the responsibility of an HOA or it's board members. That's something you would do in life if you were CEO of a corporation. A profit making one at that. A HOA is a NON-Profit Corporation. Meaning it collects enough money to spend on it's upkeep and maintenance. If your collecting too high of assessments, then someone didn't do the math correctly on what it takes to run the HOA. Which as a HOA gets older it will need MORE money as items age and need replacement/repair. A HOA normally over time does NOT gather a profit as much as keeping it's head afloat. The reserve fund is set up for those times when the HOA is needing a breath from drowning.

Can you invest your money in reserves? Yes, you can and many HOA's with large membership do it. However, they do it in CD's because of the short term access they may need to the money. Having your money invested just means more money to pay in taxes when you get it out. Plus the money may be needed in a short term immediate crisis. It takes time to get your money out and then can suffer a tax penalty for doing so.

Great you want to think long term investing for your HOA. However, a HOA is NOT where you do long term investing in a bank. The long term investing in a HOA is putting in a park, maintaining the pool, keeping the roads, having amenities, legal actions to collect debts, and making sure the place looks presentable for potential buyers. I'd rather see a nice fountain in a garden at the entrance than the HOA money locked in an account that no one but the directors have access to. All the owners would need to know what they are invested in and not just the people putting the money in. Talk about a nightmare...

JohnH,

You are also overlooking the fact that income of the type you are describing is considered by the IRS (and many states) to be non-exempt function income for an HOA and is fully taxable at a flat rate of 30%. You would be trading in exempt function income (dues, assessments) which is not taxable, for taxable income. That would effectively reduce some of the gains you are anticipating. Furthermore, if your non-exempt function income exceeds 10% of your annual budget, you would jeopardize your favored tax status as an HOA which basically allows you to put a portion of your assessments into reserves (which actually represents profit) tax-free.

JohnH,

By your logic why not invest your HOA's money in gold futures, master limited partnerships or some other high risk, high return investment? After all, most of that money is someone else's and maybe you will not be the one that will be sued for breach of fiduciary duty if the investments tank?

Does your HOA have a written investment policy? If not, it should. The first sentence in our investment policy is "The primary aim of our investment policy is maximum return consistent with preservation of principal." The simple fact is that mutual funds offer NO protection of principal and any return higher than the risk free return comes at the cost of higher risk to principal.

Of course, you can do what you think is best but I am glad that you are not handling my HOA's funds.

I personally would never invest HOA reserves into anything that carried any risk. What happens if it all backfires on you and you lose the money and now assessments have to be jacked up. You could be personally liable as a board for the money lost if you get sued.

I see absolutely no problem with looking for ways to capture additional revenue, in today's world there are many ways to do that within HOA's. But to invest in something that isn't a sure fire thing is not a wise decision with someone else's money. Just my opinion

I kind of think this post became a way for advertising...The poster sounds alot like a "day trader"...I've seen a few on this board in the past who have tried to create a variety of different schemes in their their head to supposedly improve the HOA's financial situation or their own. Sorry to say, but many of them get so wrapped up in their little world they never see the "big picture" until it falls on them. I wish John Luck in his personal financial endeavors but needs to leave the HOA's financial endeavor's alone except for paying the assessments. HOA's are NOT money making adventures nor are they set up to be. They are stand alone entities created to support just themselves and nothing more. Having money invested doesn't earn a dime for the HOA members. It just provides more money for the members to spend it on additional projects if that. The best long term investment for a HOA to have is enough money to pursue uncollected dues and a healthy enough reserve for future emergency projects. Please don't treat your HOA like it's got it's own retirment fund because the place is NOT retiring...That's what people do not corporations...

That's my rant...Done now. Thanks,,,

Melissa,

You may be more on that you realize. I've been doing some research and had planned on posting a response to JohnH (a rather lengthy one). One of the things I did was to look up the fund that John posted a link to (Vanguard Inflation-Protected Securities Fund - VIPSX). Guess what I found?

One of the managers of that fund is John Hollyer. Is it just coincidence? Or, is that our JohnH who is so enthusiastic about HOAs investing in mutual funds that invest heavily in TIPS?

JohnH,

I did say it could be coincidence, and you gotta agree, it is a curious one. Out of 50 or so similar funds you just happened to pick one that has a fund manager with the same first name and a last name that begins with the same letter of the alphabet. By the way, it is not my desire to engage in personal attacks, nor am I suggesting that your investment recommendation should not be considered. What I am saying is that there are other issues relative to HOAs that need to be considered which, in your enthusiasm, I don’t think you have thought about.

Seriously, though, I do find your suggestion interesting. As a result of your suggestion I’ve been looking at some of these funds and might give them serious consideration for my own portfolio. However, I am not convinced they are right for an HOA. Before I get into that, I want to touch on a couple of statements you made because I think they need some clarification,

Your recent statement, "As for risky, even CD's are ... the FDIC doesn't even have 5 % of the funds needed, and our government backing the FDIC is kaput" appears to conflict with an earlier statement, "Treasury notes and bonds are fully backed by the US government, ergo mutual funds holding them are insured better than CD's are and ever will." I don’t see how both statements can be true. If the "kaput" government cannot back its FDIC commitment to insure bank deposits, then I don’t see how that same "kaput" government can honor its commitment to "fully back" treasury notes and bonds. Furthermore, your claim that mutual funds holding Treasury notes and bonds are insured better that CDs is simply untrue. You are not suggesting direct investment in Treasury notes and bonds; rather, you are suggesting purchasing shares in mutual funds that hold such instruments. As you know, the price of those shares depends, just as with any mutual fund, on the Net Asset Value (NAV) which is not backed or guaranteed by the U.S. government. In fact, a look at the charts of such mutual funds over the last 10 years will show that the NAV of many of them have varied considerably, especially during the period of 2008-2009 (more on that later). So, while Treasury Inflation-Protected Securities (TIPS) may be backed by the U.S. government and be relatively safe, it does not necessarily follow that the NAV of mutual funds heavily invested in TIPS is equally safe.

In fact, the SEC, in its publication, "Mutual Funds – A Guide For Investors," offers this:

"Bond funds generally have higher risks than money market funds, largely because they typically pursue strategies aimed at producing higher yields. Unlike money market funds, the SEC’s rules do not restrict bond funds to high-quality or short-term investments. Because there are many different types of bonds, bond funds can vary dramatically in their risks and rewards. Some of the risks associated with bond funds include:" - - "…the risk that the market value of the bonds will go down when interest rates go up. Because of this, you can lose money in any bond fund, including those that invest only in insured bonds or U.S. Treasury Bonds. Funds that invest in longer-term bonds tend to have higher interest rate risk."

By way of example, let’s take a look at the chart for the fund whose link you provided, the Vanguard Inflation Protected Securities Fund (VIPSX). During 2008, the fund’s NAV dropped by about 15% between March and November. I compared this to the charts of a couple of other similar funds and, when normalized, their curves were nearly identical.

I will agree, over time, the ups and downs may average out, and with the reinvestment of dividends, the HOA may come out ahead. However, when the HOA needs to cash out some of its reserves to meet a future capital expense, it needs to do it then, and the only way to do that is to sell shares at whatever price (NAV) those share happen to be at that time. Furthermore, there is no way to predict or guarantee what that NAV will be at any specific point in the future.

Your statement, "Over long periods of time, like eternity for HOA's…." does not apply. An HOA sets aside money as reserves to meet unanticipated future expenses, cover the deductibles on insurance policies, and primarily, to repair or replace its capital assets when they reach the end of their useful lifetimes. These assets could include computers, recreational and exercise equipment, vehicles (primarily larger HOAs), pools, tennis courts and other recreational areas, clubhouses, clubhouse and poolside furniture, and so on. The HOA may need to take cash from its reserves at 3-year intervals for some assets, 5-year intervals for others, 10-year intervals, and so on. Such short-term needs are hardly anywhere near an eternity. When the HOAs reserves are insufficient to finance its needs, its only other alternatives are a special assessment or to obtain a loan. Neither is likely to make homeowners happy.

But, we could argue the foregoing all day. As a board member, I need to consider other issues that do not pertain to me as an individual, but that I need to be aware of for an HOA. Two that come to mind are state laws and mortgage underwriting requirements. 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. So, while your investment idea may be permitted in some states, it may not be permitted in others.

Mortgage underwriters such as Fannie Mae, Freddie Mac, and HUD, have very strict requirements regarding underwriting mortgages for prospective purchasers of homes in condo and home owners associations. Local lenders tend to follow these guidelines. Some are more restrictive, and some are less restrictive. There are restrictions on the percentage of homes that may be owned by one individual (or other entity), limitations on the number of non-owner occupied units, limitations on the number of delinquencies, adequacy of insurance, and so forth. Many of the requirements are centered on the financial health of the associations, including reserves. Some lenders may not be willing to provide mortgages if reserves are not in FDIC insured accounts. Although you might believe mutual funds holding TIPS to be a relatively "safe" investment, that does not mean that lenders will perceive them as such, and it’s the lenders’ perception that counts. If it is difficult to obtain mortgages, then it will be difficult to sell homes in the community, and home market values could suffer. I’m not saying that lenders will refuse to offer mortgages if reserves are not in an FDIC insured account. What I am saying is that these are points that need to be considered and investigated before making any investment decision.

Here are some additional points to ponder:

According to the law firm of Epsten Grinnell & Howell, "Losses from investments in riskier or speculative securities could be personally charged to the individual Board members who authorized those investments." And "Thus, safety of deposit and preservation of principle is the first and highest priority." "It is this firm’s opinion that all investments should be in federally-insured Certificates of Deposit or Treasury Bills backed by the United States Government." (and, the NAV of mutual funds is not backed by the U.S. Government.) Finally, the firm goes on to prioritize the investment objectives of an association’s reserve account: 1) Preservation of principal, 2) Liquidity, and 3) Return.

From HOA Leader "Practical Guide to Homeowner Association Management": "Some HOA boards place their funds in riskier investments, but that carries its own dangers. Without explicit disclosure and formal consent from association members, you could face anger and lawsuits if your reserves drop. Even if you get members' consent, you'll still likely face claims that the risks weren't adequately explained. All in all, risky investments are the surest way to invite trouble."

From Reality Times: "Because of fiduciary concerns, the Board should usually only invest in guaranteed and insured investments unless the membership votes to be more aggressive. In either case, there should be a clear and written investment policy for the Board to follow."

As I said earlier, your suggestion has caused me to study TIPS mutuals more closely, and I will likely discuss such investments with my financial adviser for possible inclusion in my personal portfolio. However, I am not ready to accept such investments as a wise choice for HOA reserves. So far, you appear to have considered this strictly from an investment viewpoint. I believe there are many other issues that need to be considered and investigated further before any investment decision is made.

Exactly what I was thinking.

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John H,

You're conceptually correct. (Although I would advocate for a different asset allocation strategy).

It baffles me that people can't understand the deleterious effects of inflation.

CD's are risky in the long term. Not because the number on the reserve fund bank statements decrease but because the purchasing power of those dollars gets decimated.

In my opinion, holding CD's for long term assets should be considered a break of a boards obligation of prudence.

No prudent expert in the investment industry would advise boards hold cash equivalents for projects 10 years out.

Any one who would like to discuss this matter further is welcome to contact me.

I have a team of advisors working with my building that has done a fantastic job providing us with the historical data and models needed to make informed decisions.

Can you PLEASE sight the violation?