W
hen considering the approach to funding reserves, we have three generally accepted approaches to consider: fully funding, threshold funding, and baseline funding. Fully funding reserves sees a board set a goal of collecting 100% of the anticipated reserves. Of the three options, this strategy carries the least risk of falling short of meeting communities’ obligations as the community will collect all the monies necessary to fund the needed capital repairs. As a result, the community will be able to resolve unforeseen emergency-type situations. However, this approach could put unnecessary pressure on owners struggling to meet their commitments in a challenging economic market. Therefore, boards should give careful consideration to these unintended consequences. Threshold funding is a compromise to fully funding the reserves. This approach aims to keep the reserve balance above a set limit approved via a published investment strategy. Baseline funding is generally discouraged as the community will have no capital for capital projects. In addition, this strategy might mean owners face special assessments that can be difficult to plan for, administer and pay due to the increased burden. Finally, baseline funding might necessitate using loans and other borrowings that can carry high additional costs.
It is essential during tough economic times to formulate a plan that meets the needs of your community. During uncertain economic times, community Associations may realize increased delinquency rates and unsteady cash flows. In addition, loans and other borrowing instruments that might be relied upon in the absence of a sound plan will have higher costs due to the now higher cost of borrowing. In the western world, inflation has reached near- record-high levels. As a result, governments have been raising base interest rates to try to lower the rising rates of inflation and their negative impacts.
With a plan to collect the necessary monies, it is crucial to put the funds in a safe place. Suppose the Board elects to put money into a nontraditional and risky investment tool. The Board could find itself falling short of its fiduciary responsibilities, leaving itself open to lawsuits, inadequate funding, diminished reputation, and accusations of impropriety. Therefore, you should follow state legislation when considering, managing, and reviewing reserve fund options and only obtain legal advice from a qualified attorney.
For community associations, a “safe place” is not a physical place like under a mattress or in a unit owner’s safe. Instead, community associations should invest in Certificates of Deposit and Money Market accounts insured by the Federal Deposit Insurance Corporation.
48 | COMMON INTEREST®
Certificates of Deposit
A Certificate of deposit will earn the community interest on the deposit for a fixed period. However, certificates of deposit can be more restrictive than other reserve account options. For example, any early withdrawals will result in a loss of interest and penalty fees. In addition, certificates of deposit will often have higher interest rates due to term length and liquidity restrictions. When considering certificate of deposit term lengths, you should consult with your reserve study, management professionals, accountants, banking partners, and attorneys to ensure adequate funds access when needed. Setting up a “certificate of deposit” can help associations manage their access to funds. For example, investing in three certificates of deposits for six, twelve, and twenty-four months will create staggering maturity dates. A laddered approach will help ensure you have enough money to pay for the community’s short-term needs and emergencies. This approach will also allow the community access to a higher rate of return that comes with longer-term certificates of deposit. However, the laddered certificate of deposit approach will have limitations. For example, the interest rate may increase after the certificate of deposit has been committed.
Money Market Accounts
Money market accounts are sometimes called money market deposit accounts.
A Money market account is used similarly to a regular savings account. The Federal Deposit Insurance Corporation should cover a money market account at a bank. A money market account will offer a higher interest rate than a standard bank account, but this comes at a cost. For example, there may be limitations, and you can only withdraw money or make payments up to six times a month. In addition, a minimum deposit requirement will likely be required to service a money market account. Failure to meet these obligations can result in penalty fees and lower interest rates.
• Winter 2022 • A Publication of CAI-Illinois Chapter
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