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Vertical City Toolkit - Reserve Fund Forecasting

The Vertical City Toolkit is a collection of software tools offered by Vertical City; a suite of tools built for Condo Boards to help them manage their duties as board members. The tools primarily serve as support for the management of the Reserve Fund. This article delves deeper into how both the Report Card and Forecast Calculator pages work and how they are intended to be used.


Article Contents


  • The Report Card page, in addition, provides an overall health grade of the fund at present by using the calculator to simulate the fund through different pre-configured tests, gauging how it would preform under pressure.

  • The Forecast Calculator page allows users to play-out hypothetical market scenarios and investment strategies seeing how their reserve fund would be affected, allowing boards to create better investment decisions.

  • Finally, the Dashboard page brings this all together, giving condo boards the ability to manage their cash and investments in one place. See the 🌐Reserve Fund Dashboard article for more info.

The cornerstone of the Vertical City Toolkit is the Forecast Simulator which plays a role in all 3 of the Reserve Fund Toolkit pages. The following section explains how the simulator works.


Forecast Simulator


The Forecast Simulator follows a complex method that gives a more realistic and accurate forecast of the reserve fund (than that of the forecast in a Reserve Fund Study). The calculator uses a process based on data from a 🌐Reserve Fund Study which is required to be uploaded to the app before it can be used.


Here are some of the key features which make it more robust and accurate than the typical reserve fund study.


Available Cash


A major assumption that the reserve fund study gets wrong is that all the money in a reserve fund will be available to invest in cash every year. In practice, this is not always the case because investments typically have different maturity terms. A typical GIC, for example, will have a five year term, meaning the investment won’t be accessible for five years. This incorrect assumption results in studies systematically overstating available cash, and overstating the amount of interest earned as a result. When corrected, this will normally reduce forecasts.


Spot Investing


The most important thing to consider when investing the reserve fund as a condominium board is if by investing some money you will have the available cash needed to pay for upcoming future expenses. If the elevators are being repaired and all the funds are locked away in a GIC say, then a board will have to withdraw their investment before it matures; forfeiting the potential interest they could have earned and potentially costing additional penalties. For this reason our calculator always spreads investments out evenly such that the different securities being purchased in the simulator are maturing evenly every year, making cash continuously available.



By selecting five year maturing GICs every year, in five years time, the interest and principal of these GICs will be rolling in every year. By viewing the maturity chart in the Dashboard page, users can see what the maturity profile of their existing portfolio looks like, easily showing them if they are imbalanced or not. The image above indicates a relatively imbalanced investment profile where the blue bars (maturing investments) are not as even as they should be.


Evolving Interest and Inflation Rates


A common short-coming of most reserve fund studies is that they use fixed interest and inflation rates for their forecasts. Rates never stay fixed for 30 years and this causes the normal reserve fund study to be fairly inaccurate.


Vertical City's forecast process allows the rates to change every year, resulting in a much more precise forecast. Underlying the process is a math concept from probability theory called a Probability Density Function (P.D.F.), which is used to calculate a probability distribution of every possible increase or decrease in an inflation/interest rate each year.

This function uses a sample of historical data (interest and inflation rate data) to produce the distribution, represented as a shape known as a normal distribution (see image above). The Y-axis refers to probability and the X-axis refers to relative increase or decrease from the rate(s) of previous years. We can see that smaller changes are more likely and bigger changes are less likely.


The historical data offers us two variables that we will use for in our P.D.F. calculation; mean and standard deviation. These variables can be tinkered with in our Input Toolbox, but the default values are fixed; they come from historical market data from the T.S.X. index.


Eligible Securities


As far as actual investments go, our calculator uses generic investment options based on eligible securities for a reserve fund (🌐 The Condominium Act of Ontario stipulates that Reserve Funds must only be invested in CDIC insured securities). We do not assume to know where condominium corporations are choosing to invest with which investment products are being offered. Instead, by allowing the user to change the calculator inputs (as you will see in the next section), the user can adjust how the calculator works based on the products that are being offered to them. The generic investment options that are used by the calculator are as follows:


  • GIC – with an interest rate and length of term (e.g. 1-5% with 1-5 year term)

  • Market Linked GIC – same as above but with a higher variable return tied to the performance of selected Canadian banks or exchanges (e.g. total return potential 7.5% - 40%)

Both options have a 100% principal protection (since they are CIDC insured), meaning they won't return less than the principal invested, no matter what.


Simulation


When creating a forecast, a simulation is preformed, producing a range of calculated results (shaded green area) and the mean of those results (green line). This simulation technique is called the Monte Carlo method. Every simulation outcome will be different because of the probability distribution we are using to model how interest and inflation rates change every year. Using a probabilistic range to describe the forecast instead of a single exact outcome is more realistic because of the nature of probability; we can never exactly predict future outcomes, only use probability theory to help us say what is likely to happen.


The simulator was built to simulate a realistic management of a reserve fund, accounting for every part of the monthly process. By using the data in the reserve fund study (namely, receiving monthly contributions from owners and paying for the scheduled expenses) and the market assumptions (which are given by users on the Forecast Calculator page), it has all the information it needs to do this.


Report Card Page


This page uses the Forecast Simulator to give boards an overall health grade of their fund at present based on the more realistic simulation processed offered by the simulator. The page consists of 2 key parts, the Report Card and the Forecast.


Report Card


The Report Card simulates various scenarios that are considered stress tests, in order to see how the fund preforms when things don’t go as expected. A test fails when a fund goes below zero at any point during the forecast. Thousands of tests are preformed, producing a score (or a percentage of successful tests). For more details on each of the tests, a user can click on the report card to open a new window with more info.



Here is a list of the types of scenarios that will be tested:

  • Max Cash Holdback – condition that a large $100k - $500k amount be held in account at all times

  • Inflation Adjustment – vary the expected inflation in simulation from 5% to 25%, resulting in expenses effectively costing more

  • Expense Variance – vary the scheduled expenses from reserve fund study from 5% to 25% across entire simulation

  • Unexpected One Time Expense – single random $100k - $500k expense dropped into a random year in the simulation


Simulated Forecast


The forecast shown on the Report Card page is a comparison between what the reserve fund study forecasts (Study) vs. what our simulator shows the real forecast is (Simulated). Sometimes boards will be surprised to see that their study is not as robust as the study is claiming, and in many cases indicates to boards that action should be taken to reduce risks of failure.


The Forecast Calculator page is the next stop in most cases, where boards should be going to play out different investment approaches, and to find out which one is best suited to their fund.


Forecast Calculator Page


Now that boards know where their reserve fund truly stands, based on the blue Simulated forecast in the Report Card page, they are ready to improve their forecast by using the calculator, which gives boards the ability to play-out hypothetical market scenarios and investment strategies, allowing them to make better investment decisions based on their findings.


Custom Forecast


The forecast on this page compares the same Simulated approach from the Report Card page vs. a new calculated approach from user specific inputs (Custom).



The Input Toolbox


In this section of the page we expose all the variables used in our Forecast Simulator. Users can tweak the simulation as they choose by adjusting the sliders seen bellow as desired. If you believe, for instance, that interest won't change much in the next few years, or if it will change dramatically, both scenarios can be inputted into the simulator by adjusting the Interest Rate Volatility slider. The following is a list of all inputs:


  • GIC to ML-GIC composition - this is simply the percentage of ML-GIC that exists in the invested amount of cash in a reserve fund (as indicated with the slider labeled Marked Linked GICs)

  • Minimum Cash Balance – this a required minimum amount of the reserve fund that will always be available in cash

  • Standard GIC (P.D.F.) – defined using yield (mean) and volatility (standard deviation)

  • Market Linked GIC (P.D.F.) – defined using yield (mean) and volatility (standard deviation)

  • Inflation Rate (P.D.F.) – defined using yield (mean) and volatility (standard deviation)


Summary


Using the Investment Calculator to play-out hypothetical market scenarios can help condo boards strategize better. At the very least, boards can rest easier knowing that they have done their due diligence in creating an Investment Plan that is more tailored to the specific challenges their building and reserve fund may be facing.


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