Reader Questions: How Should We Invest HOA Funds?Dec 06, 2021
By Kelly G. Richardson, Esq. CCAL
Mr. Richardson: HOAs face a financial issue with interest rates so low. My HOA and the vast majority of other HOAs play it safe with CDs and money market accounts for investment. I am opposed to this. Now that we are averaging something well below 1.5%, the risk to HOAs is enormous. It is easy to increase HOA fees to homeowners by 3% per year and that will cover annual operating costs and maybe some reserve replenishment. Those reserves overall, though, will lose value over time as it relates to inflation and increases in costs.
HOA management companies have financial advisors that warn against risk of going into stocks/bonds. But HOAs need to earn more. Otherwise, HOA fees will go up and up and up. And then property values will go down. T.S., San Diego
Hello Kelly: With the historic low interest rates in bank money market and CDs for our reserves, it seems to me that the board has a fiduciary duty to manage these funds like a trustee’s role in managing a defined benefit pension plan for its employees. I believe one could have a diversified fixed income portfolio to have safety and yield and value-oriented equity portfolio for income and growth and a small piece in growth. What are your thoughts on this approach? Respectfully, R.S., Palm Springs
Dear T.S. and R.S.:
The Davis-Stirling Act presently requires that managers deposit HOA funds in a federally insured account (Civil Code Section 5380(a)). Furthermore, beginning in 2022, AB 1101 (sponsored by the Community Associations Institute) adds to Section 5380 a further prohibition against investing HOA funds in “stocks or other high-risk investment options.”
There is no similar explicit restriction on the actions of the board on this regard, so theoretically a board could bypass management and invest funds in a way that is not federally insured, or even in stocks or mutual funds. So, it is tempting to seek higher-yield (and riskier) investments for HOA funds. However, it is important to remember that, as R.S. correctly notes, HOA directors are fiduciaries with respect to the HOA funds in their care, and they can be arguably held liable if there is a loss of the principal due to a downturn in the investment. If the HOA is to invest its funds in a way other than managers are allowed, boards will need to consult some investment advice and develop a written investment policy. That will help keep the board within the Business Judgment Rule (Corporations Code Section 7231.5).
Regarding the concern of erosion of accumulated reserve funds due to inflation, presumably the reserve study preparer takes that into account in their long-range financial recommendations.
R.S. and T.S., some HOAs are so large that they can’t keep all their funds in insured accounts, and so they must pursue investment strategies which reasonably protect the HOA funds while providing a reasonable return. Such HOAs should have outside financial advisors or companies to monitor their funds and advise them.
The federally insured approach may not be the best for growing HOA reserve funds, but it is the safest. That is why managers and lawyers typically recommend it for all but the largest associations, to avoid unpaid volunteers taking on personal risk in that regard.
Thank you, Kelly
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