Reserve Funds

September 9, 2024 Published by Toronto and Area Chapter - By Kale Wild

Reserve Fund Investing Needs to be Taken More Seriously

From the Summer 2024 issue of CCI Toronto Condovoice Magazine.

Recently increased interest rates now offer condominium corporations far more opportunity to generate significant returns on their reserve fund

Reserve fund investing is typically a topic placed near the end of the agenda for board meetings and may often be pushed to the following meeting as the debate over “replacing the pool table in the games room” often takes over the allotted time.

However, this topic should be taken seriously. As the reserve fund study assumes a rate of return on the reserve fund, if this rate of return is not met, the condo fees may have to be raised at the time of the next reserve fund study to meet this shortfall. With the rapid increase in interest rates over the past couple of years, we are now in a time that offers condominium corporations much more opportunity to generate significant returns on their reserve fund. This article will look at the following:

1. What can condominium corporations invest in?
2. What are currently attractive investments for condominium corporations?
3. Optimizing the reserve fund through cash-flow planning 4) Managing reserve funds in a decreasing- rate environment

What Can My Condominium Corporation Invest In?

Section 115(5) of the Ontario Condominium Act defines an eligibility security as: “eligible security” means a bond, deben- Reserve Fund Investing Kale Wild Senior Wealth Advisor and Portfolio Manager Reserve Fund Investing Needs to be Taken More Seriously Recently increased interest rates now offer condominium corporations far more opportunity to generate significant returns on their reserve fund ture, guaranteed investment certificate, deposit receipt, deposit note, certificate of deposit, term deposit or other similar instrument that,

1. is issued or guaranteed by the government of Canada or the government of any province of Canada, 
2. is issued by an institution located in Ontario insured by the Canada Deposit Insurance Corporation or the Financial Services Regulatory Authority of Ontario

High Interest Savings Account (HISA)

At minimum, cash that is not needed in the next few months should be placed in a HISA. Rates on cash are near five per cent at the time of writing, and these funds can be sent back to a chequing account daily. A very simple way to increase the return on your reserve fund (squeeze every penny!).

Guaranteed Investment Certificate (GIC)

GICs are the most common reserve fund investment and are issued by Canadian banks and credit unions. GICs typically pay a fixed interest rate and the funds are locked in for the term of the GIC. Apart from cashable GICs (typically lower rate), you cannot redeem these instruments early. GICs issued by Schedule 1 banks are insured against the failure of the issuing institution by the CDIC (Canadian Deposit Insurance Corporation) up to the limit of $100,000. Deposits at credit unions are insured by FSRA (Financial Services Regulatory Authority of Ontario) up to $250,000. A common misconception among condominium boards is that every dollar must be insured by CDIC or FSRA. This is incorrect - every dollar must be held at an institution which is insured by CDIC or FSRA (as per Condominium Act). You are allowed to have deposits above these limits, but in practice, the best rates are typically offered by smaller institutions, and it is prudent to keep deposits under the insurance limits at smaller institutions. The Condominium Act does stipulate that deposits can only be held at institutions located in Ontario, despite some very attractive insurance levels at credit unions in other provinces.

Condominium corporations are also able to invest in “market-linked GICs,” which offer a variable return based on the performance of an underlying asset (like a stock index). Principal is guaranteed at maturity by CDIC, but the price can fluctuate during the term (and can typically be sold during the term at a gain or a loss). These were much more popular in the low-rate environment when the opportunity cost of foregoing near-zero per cent rates was much less. Like bonds, these should be purchased with the plan to hold until maturity, and the risk if held until maturity is that they would generate a zero per cent return. The benefit is that the potential positive return is typically uncapped.

Bonds/Debentures

Bonds or debentures can be purchased by condominium corporations so long as they are issued by the Government of Canada or a province, or issued by an institution that is insured by the CDIC or the FSRA. This means that a bond issued by RBC would be eligible, but a bond issued by Telus would not. Bonds can be sold at any time during their term, but this could be at a gain or loss. Thus, the plan should be to hold until maturity, with the potential to liquidate early seen as a bonus. In this rapidly changing interest rate environment, there have been some opportunities in bonds, but GICs are still the much more popular option. Bonds are not insured by the CDIC or FSRA but are backed by the creditworthiness of the issuing institution. Bonds issued by CDIC or FSRA insured institutions can be seen as having the same security as GIC or HISA deposits at these institutions above the insurance limits (ie. Deposits above $100,000 at a CDIC insured institutions are not insured by CDIC, but backed by the credit worthiness of the institution).

Investment Plan - Cash Flow Planning

Section 115 (8) of the Ontario Condominium Act states:
Before investing any part of the money in the corporation’s reserve fund accounts, the board shall develop an investment plan based on the anticipated cash requirements of the reserve fund as set out in the most recent reserve fund study. 1998, c. 19, s. 115 (8). 

Not only is this required, but it is also simply good practice. Schedule 15 of the reserve fund study outlines forecasted reserve fund expenses and contributions. Of course, there are potential changes to the amount and timing of expenditures, but it is only the next five years that are of interest for reserve fund investment planning. The board must ensure that there is enough cash available to meet each year’s expenses (accounting for contributions) plus a reasonable buffer for projects going over budget or small emergencies (large, unexpected expenses do not need to be accounted for, as a special assessment may be required). By using cash-onhand to fund a major unexpected expense, you are essentially using funds earmarked for a future project, which will need to be replaced. Based on this cash flow plan, the board can strategically purchase terms to match required cash flow needs. Longerterm rates typically (but not now – more on that later) offer higher interest rates. So, by engaging in proper cash flow planning and being able to allocate to longer terms, the board can typically increase the return on their reserve fund.

Managing Reserve Funds in the “Interesting” 2024 Interest Rate Environment

Interest rates are up significantly over the past few years, which means we are in a new era of reserve fund investing. Rates vary daily, but for comparison’s sake, the below shows January 2021 rates and January 2024 rates:

	JAN-2021	JAN-2024
HISA	0.35%	4.75%
1 Year	0.85%	5.06%
2 Year	1.12%	4.63%
3 Year	1.40%	4.46%
4 Year	1.70%	4.35%
5 Year	1.85%	4.40%

Rates are currently much higher, but it is interesting that longer-term rates are now lower than shorter-term rates (this is a unique situation). This does not, however, mean that you are better off investing in shorter terms. If your cash flow allows for longer terms, by investing now in a shorter term at a higher rate, you are exposing yourself to reinvestment risk. When the shorter-term GIC matures, interest rates are likely to be lower and the yield curve is likely to have normalized, meaning that shorter-term rates are again likely to be lower than longer-term rates at that time. Moving forward, it is unlikely that rates will increase and, if we see more economic pain than expected, rates will also be cut faster than expected. It is reasonable to assume, then, that any surprise in interest rates will be to the downside and it would be prudent to lock in these higher rates for as long as possible. By the same token, although rates on cash are currently attractive, these can be cut at any time. Any cash that won’t be needed for at least a year should be placed in GICs.

Final Thoughts

Being a board member or a property manager is a very difficult job with endless fires to extinguish while managing numerous conflicting points of view. Many join the board of their condominium to help protect their investment in the asset. The reserve fund is an asset of the condominium corporation, and the management of this asset can certainly impact property values. Although not something residents are likely to bother you with, it is certainly worth setting aside some time to evaluate your reserve fund investment process. Whether it be through proper cash-flow planning or simply shopping around various institutions for better rates, increasing your yield by three percentage points is an additional $30,000 of interest on a $1,000,000 fund. That interest can be used to replace the pool table with ten pool tables, one of each colour to appease everyone’s point of view!

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Kale Wild, CFP, CIM, FCSI
Sr. Wealth Advisor and Portfolio Manager Wild Wealth Management of Raymond James

Information in this article is from sources believed to be reliable; however, we cannot represent that it is accurate or complete. It is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell securities. The views are those of the author, Kale Wild, and not necessarily those of Raymond James Ltd. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decision. Raymond James Ltd. is a Member Canadian Investor Protection Fund.