Keeping it Healthy in Today's Tough Economy Managing and Investing Your Reserve Fund

 In today’s harsh economic times, maintaining a healthy reserve fund is more important  than ever. A co-op or condo’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 a necessity, there is too much variation in  co-op and condo buildings to have one specific formula to calculate how much  money should be in a building’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 co-op or condo should have in reserve is to  look ahead at the building’s needs. Conduct a reserve study or a survey to determine what systems might  need to be replaced and what repairs might be necessary over the next five  years.  

 “Boards should do a study—formal or informal—of all the systems in their building,” says Michael Esposito, an audit partner with Kleiman & Weinshank, LLP, an accounting firm based in Manhattan. “A board, super or engineer can do this to get a sense of what needs to be  replaced in a five-year period, and what that cost will be,”  

 “The only way you could really calculate requirements are to conduct an  engineering study,” says Gary Kokalari, a former president and treasurer of his own co-op and a  specialist in co-op finance with Merrill Lynch in Manhattan. “A qualified consulting engineer should look at building’s useful systems and make a determination of what funds would be needed going  forward.”  

 Indeed, says Kokalari, the figure you arrive at after assessing all the projects  and upgrades you need, plus the ones your board would like to do might be so  large as to be unrealistic, or pose a major burden to residents. At this point,  the board should determine a way to either raise the necessary funds, or  reassess to determine a reserve amount that is both healthy and realistic.  

 “Once you’re comfortable with major capital improvements or major repairs, you have to  come up with a plan to fund them,” says Norman Prisand, CPA, who is with the firm of Zeidman, Lackowitz, Prisand & Co., LLP, in Plainview. “That determines the extent of your reserves. If the [reserve study] comes up  clean, it’s one thing—but if it calls for half a million dollars in the next few years, it’s a different picture. Then you have to go about figuring out how to raise it.”  

 If your board finds that the amount needed for your reserve is prohibitively  large, all is not lost, says Prisand. You merely need to sit back down, take a  hard look at the numbers, and reprioritize your needs, wants, and expectations,  paring down the list until you have something more feasible.  

 While looking ahead five years is a good rule of thumb, such a study should be  reevaluated on an annual basis. A yearly review will ensure that the board has  a clear picture of the most current state of the building and its operating  systems.  

 Investing Reserves

 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 represent the investments of individual  building residents, and should be treated as such.  

 “The reserve fund is other people’s money,” Prisand says. “There are three main considerations in [managing it]: safety, timing and  liquidity. To be safe, the reserve should be insured. And that restricts you to  bank accounts, to insured money markets and treasury securities. Yes, you will  earn lower returns but it has to be safe. It also has to be liquid so if you go  to sell it you’ll get something back. In timing, investments should coincide with your  five-year construction plan, so when you need the money it will be available.  You have to be prudent and conservative. You don’t want to be in a situation at the annual meeting where you have to say that  your investments are way down or that the building has money but can’t touch it.”  

 Protecting the principal is critical, so while a quick return might sound good,  make sure your investment strategy is insured, even if you’re earning less than you might be with another vehicle.  

 “You want to have a return while effectively protecting your principal,” says Esposito. “You don’t want that to waver. In a volatile market, you don’t want to risk any principal.”  

 Esposito notes that money market, treasury, and CDs are common investment  vehicles. “That’s what you basically see—usually short term treasury bills or sometimes five-year bonds,” he says. “But if you need cash and have to liquidate the bond, there could be a loss of  principal as a result.”  

 Staggering bonds so they mature at different times is one way to avoid having a  large chunk of your reserve fund tied up and inaccessible. “You can buy four bonds that mature every three months and have some money that  comes due,” says Kokalari. “The longer the investment, the less liquidity there is.”  

 Most reserve fund consultants feel that some investments—such as stocks—are much too risky for a reserve fund, and can result in the loss of principal.  

 “To invest for growth implies risk, and traditionally, investing for growth  implies investing in things like stocks,” says Kokalari. “I don’t recommend that. You shouldn’t do that with a reserve fund because most are inadequate to meet with a  building’s long-term capital expenditures based on an engineering study, and one never  knows when an emergency can arise.” A safer bet, says Kokalari, are insured investments with direct or indirect  government guarantees.  

 “It’s important to know what you’re investing in, what’s protected by FDIC and SIPC, and not concentrating money in any place that  exceeds FDIC or SIPC limits,” agrees Esposito. The Securities Investor Protection Corporation (SIPC) is a  governmental entity that provides customer protection should a  brokerage-securities firm become insolvent.  

 Other Options

 In addition to more traditional methods of investment, some co-ops and condos  are raising money through other means like a flip tax or a transfer fee.  

 “More and more buildings are instituting transfer fees, and dedicating that to  the reserve fund,” says Prisand. “Some condos are instituting a contribution each time someone buys a unit and  moves in. Usually this is two months of common charges that are contributed  into reserve fund. Condos can have a transfer fee but it is much harder to  enact. What we’re urging buildings to do is to get contributions when somebody new moves in.”  

 Shareholder assessment is another way to increase reserves, but in tough  economic times, many shareholders might be hard pressed to pay.  

 “Assessment can really become an issue in a time when people are concerned with  their income and their jobs,” says Kokalari.  

 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 to be reassured that the board is always well aware of the  status of the building’s reserve fund.  

 “In most cases, the board of directors or managers oversees the investments.  Sometimes it’s the management company. The checks and balances come in where copies of the  monthly statements go to multiple parties: the board, management company and  the auditor (CPA),” says Prisand. “The board, in conjunction with the management company, should be making  decisions and the CPA should be getting copies of everything.”  

 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 Kokalari. “This is typically included in a footnote that refers to the concentration of  credit risk. It discusses what investments the co-op or condo has and whether  or not they’re insured.”  

 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.  

 When money is 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. “You want to have checks and balances between parties. Every check should be  funneled through an operating account through the agent and whoever is  maintaining the reserve fund on the board,” says Esposito.  

 Current Economics

 As buildings continue to be conservative with their reserve funds, many boards  have placed an emphasis on saving overall vs. 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. Consult your  professionals for help or advice when investing or structuring your reserve  fund plan.  

 “You can consult with your attorney, accountant, property managing agent,  organizations or trade groups,” says Esposito.  

 Professional organizations, such as the Council of New York Cooperatives & Condominiums (CNYC) and the Federation of New York Housing Cooperatives & Condominiums (FNYHC), provide a wealth of information for board members who  want to become more knowledgeable. “The council holds an annual seminar in November at Baruch College,” says Prisand. “There are also seminars through CNYC on how to be a building treasurer and how  to accumulate and invest reserves.”  

 The Cooperator also holds an annual expo and a schedule of seminars to help  board members and property managers in the difficult task of successfully  running and managing a co-op or condo building. The Cooperator’s next expo will take place April 27, 2010 at the Hilton New York.  

 Education and knowledgeable investing are crucial, as the reserve fund benefits  the entire co-op or condo. “Some people are handling significant money with little financial background,” says Esposito, “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.”  

 “You’re in a fiduciary capacity, you have to be risk averse when you’re handling other people’s money and you have to be able to separate yourself. Don’t think of it in terms of a portfolio,” Esposito continues. “Education and speaking with knowledgeable professionals will go a long way in  helping your board to make financial decisions in the best interest of your  co-op or condo.”   

 Stephanie Mannino is a freelance writer and a frequent contributor to The Cooperator.

Related Articles

Capital Reserve Funds

How Much Do You Really Need?

Underfunded Reserves

The Dangers of Running Short

Planning for the Future

Keeping it All in Reserve