I recently interviewed with a local HOA seeking to replace their present property management. One of the questions I was asked was "Why does it matter that a property manager have a background in finance and/or economics?" My response was to take their financials which I had received copies of and use it as an Object Lesson. The HOA had approximately $157,000.00 in the Capital Reserve Account. A Reserve Study conducted in 2010 indicated that (at that time) they should have had approximately $210,000.00 in their Reserves. thus, a short-fall of $53,000.00. Move forward nearly three years and one can see that they remain behind.
Further, they had placed approximately 98% of the Capital Reserve Funds into a two-year CD earning approximately 1.75%. These funds were placed with a local bank. So, to that, I began my explanation.
1) Diversification: The funds were placed with a single bank and if the bank went in Receivership they might have difficulty obtaining their funds. Funds should have been spread among other local financial institutions.
2) Liquidity: The funds were placed into a commercial paper document that had an early withdrawal penalty of 10% and would be locked-up for two years.
3) Risk: There wasn't an indication that the funds were FDIC insured.
4) Return: The funds should have been laddered with various interest rates and lengths of maturity.
5) ROI: Based upon this scenario the rate of return (1.75apr) would have been lost if the association required the funds during the two year period. (Risk Aversion).
The Association's Reserve Fund policy required that the Association receive the highest rate of return (ROR) available. By not having a professional manage the funds, the present scenario resulted in an Opportunity Cost to the Association as the funds would be locked in and therefore not available for investing if and when rates began to move upward. Needless to say, the President of the Board of Directors and their former property manager devised this strategy. Neither of whom hold any formalized training in budgeting, finance, investing, and/or economics. As a result, our organization did not end up managing the property for two reasons: 1) I informed the Board Members that I didn't do STUPID, and 2) We weren't really interested in as much as the President was the one who convinced the other Board Members to go along with the strategy.
To that end, as part of a Reserve Fund Management Strategy, property managers, management companies, and board members should (as part of a Full Disclosure Policy) be required to refrain from such decisions if a friend of theirs is the Local bank President, or they have personal funds and/or loans with the Financial Institution.
David C. Stiver BA,MA is a Colorado Registered Investment Advisor, a FINRA member, and Property Manager.