Managing Condo Reserves

Condo reserve funds are there for when you need them. Whether it’s a hailstorm, a flood or a new exterior, your funds need to be secure and available. It’s been the norm for decades for most reserve funds to be invested in GIC’s or other cashable securities. This seems like common sense and a low-risk way to approach managing condo reserves, however with the rise of underfunded reserves and an environment with very low yields, we think there is a better way to approach generating an acceptable return while maintaining an acceptable risk profile. The main tool we use to generate a 2.5%-4.0% return for our condo clients is corporate debt. There are a variety of different types of corporate debt, which we have extensive experience dealing with. These debt instruments are “investment grade” meaning we only invest in high quality companies that have little risk of default (not being able to pay interest or repay principal). These companies include real estate companies, Schedule 1 banks and infrastructure companies.

How we mitigate risk:

• We keep the duration fairly short, meaning we don’t buy bonds that have a maturity date that is too far away. We like to have bonds maturing anywhere from 2-7 years away.
• Coupons need to be attractive. Depending on the maturity most of the attractive bonds we find have coupons of at least 2.5%.
• We buy bonds that have good liquidity. Just because the maturity date is far away, doesn’t mean we cannot sell them for a good price if you need the cash for a project. Most of the issues we invest in are deal sizes north of $250M.

One part of the bond market that we really like is the LRCN market which are bank notes that yield 3.5% or more. These are issued by Schedule 1 banks and insurance companies that in affect replace preferred shares on their balance sheet. Last year for example, Royal Bank issued two of these notes yielding over 4% and now are trading at $108 (issued at $100). Not only are you getting 4% on your money, but, if we decide to sell, we are also capturing 8% upside from the original issue price. The one provision that makes these attractive is that they have a call date 5 years after being issued, meaning the company can give you your money back then or they will “float” the rate meaning you get a spread + the government of Canada bond yield. This provides us with a tight maturity, with the upside that if rates go higher our notes are protected from inflation. Below is an article that explains these securities further.

https://www.morningstar.ca/ca/news/212664/lrcns-set-to-overtake-prefs.aspx

With interest rates at all-time lows, the conversation about how to generate a real return needs to happen now. With our extensive experience in the fixed income market and access to the debt instruments themselves, we have been able to generate very good risk adjusted returns for our condo reserve clients. Our clients are in better shape now and for the future to ensure their condo reserve fund is viable to meet their needs.