ALTERNATIVE INVESTMENT OPPORTUNITIES FOR CONDOMINIUM RESERVE FUNDS
By Levin, Robert B | |
Proquest LLC |
While the 2013 cost of living rate went up about 1.5 percent, the rate on money market funds and certificates of deposit have maintained rates between 0 and 1.0 percent per year. Arguably, while condominium associations appropriately fund their reserve for capital improvements, the value of the reserve is decreasing versus inflation. Condominium associations have traditionally deposited reserve funds in money market funds and certificates of deposits as their only means of investment for decades. It is believed that this method is the most conservative manner to maintain the reserve capital. Except for longer-term CDs, this approach is guaranteed to lose value if inflation is taken into consideration. Other alternatives are available that are conservative in nature and offer higher returns to the associations.
MONEY MARKET FUNDS AND CERTIFICATES OF DEPOSITS
Unless money market funds are with banks, they are not guaranteed at all. One should look at the fund prospectus quarterly and review the investments of the fund portfolio. Bank money market funds and CDs are guaranteed up to
I advocate a condominium reserve allocation that includes mutual funds that include short-term federal or treasury investments and short-term investment grade corporate debt. They can be bought and sold on a daily basis and many financial institutions that have their own MMFs and CDs can purchase these funds for the association. Before discussing the efficacy of these alternatives, a few definitions need to be understood. For purposes of expediency, the
Average annual total returnFund performance after taxes on distributions and sale of fund shares.
Distribution yield-The interest paid versus the price of the fund.
Duration-The average maturity of securities in the portfolio. For this group of funds the average duration of the portfolios is between 2.2 and 2.3 years.
Of primary concern to the association treasurer and Board of Directors is the variance in the fund price. Safety of capital is the primary concern. For the three-, fiveand ten-year period, the Federal and Treasury funds have been very stable. The same is true for the Investment Grade fund except for a one year period from mid '08-'09. Regarding the Federal fund, the value is within 0.8 percent of the current value over a three year period; 6 percent over five years and 4.5 percent over ten years. The Treasury fund is within its current price by 0.15 percent over three years; 5.5 percent over five years and within 3 percent over ten years. The Investment Grade fund is within 10 percent of its current value over three years; 1 percent over 5 years and 1.5 percent over ten years.
We discount the value of the
The distribution yield is the interest rate current owners of the fund would derive if the value of the fund remains the same. This yield changes from month to month as securities mature and new ones are purchased. In a declining interest rate environment, the yield will slowly go down and in an increasing environment go up. With the average duration of the securities at approximately 2.3 years, one could surmise the rate change would be about 43 percent of the change in interest rates going up or down during a monthly period. As of
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Alternative investments include money market funds and certificates of deposits. The following are the rates offered by
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* One Year CD-0.40 percent
* Two Year CD-0.55 percent
* Three Year CD-1.05 percent
ANALYSIS
The rates of return from alternative investment funds outweigh the current theory of investing in money market funds and certificates of deposit. The following example shows how money market funds, one-, twoand threeyear CD rollovers (over
DISCUSSION
The benchmark to analyze all investment alternatives is how they compared to the cost of living index. If the reserve policy is equal or greater than the cost of living investment over a given period of time funding for future capital repairs could be viewed as adequate. Less than the cost of living implies that extra reserves would have to be added at future dates to keep up with inflation.
It is obvious that funds put into money market funds performed poorly over any period of time. Due to compounding over time, the difference escalates the longer funds remain in these accounts. Rolling over CDs offers a better outcome than money market funds and the longer the CD term the better the outcome. In fact, rolling over three-year CDs offers the best outcome of all investment alternatives over a ten-year timeframe. The alternative investments offer the greatest reward over a threeand five-year timeframe and better than CDs over a ten-year timeframe if the CDs are rolled over every one or two years. All of this makes sense because the average duration of the alternative investments is 2.3 years and the only investment with a greater duration is the three-year CD which offered the best result.
The Federal and Treasury funds have the strongest capital support because they are backed by the federal government or agency of the federal government. Bank money market funds offer
It should be noted that interest rates in
CONCLUSION
For decades, condominium associations have used the same methods of investing reserve funds. Given the current economic environment, many associations are in a position whereby the reserve funds are not keeping up with inflation, reducing the present value of the current funds if left in money market funds. Given a
Laddering three-year CDs offers the best result over a ten-year period. In this way, the Board of Directors annually can choose whether to renew the three-year CD or use the funds for some other purpose.
Alternative investments in a Federal or Treasury Short Term fund offer the best of all worlds. These funds are the most secure and have a very stable share value. They are totally liquid in that they can be bought and sold at any time. The current dividend rate for these funds is greater than money market funds (which offer no yield) and oneand two-year certificates of deposit.
If interest rates begin to increase, it would be advantageous for the association to transfer more funds to money market funds versus the other alternatives. The point of transference would be when the MMF has a higher dividend yield than the CDs or alternative investments.
Condominiums are businesses and they should take advantage of every income-producing opportunity and cost savings they can find. *
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Copyright: | (c) 2014 Institute of Real Estate Management |
Wordcount: | 1565 |
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