How Do Sinking Funds Work?

“Very informative article about sinking funds and why they are a necessity.” – Zac Gleeson, Director

 

Article Written By Tim Falk at Finder

In a strata building like a townhouse or apartment complex, the owners need to spend money on maintaining and repairing common property. This includes areas of a complex used by everyone, like a car park or elevator. The money used for this is called a sinking fund. This fund is established by the owners’ corporations to cover the cost of future common emergency expenses or major capital works.

If you’re buying a strata property, check that the sinking fund includes enough money to finance any renovations or repairs.

What is a sinking fund?

A sinking fund is designed to help owners’ corporations of strata schemes accumulate the financial reserves they need to cover future capital expenditure. By regularly putting aside money in advance, a sinking fund ensures that property owners in a strata scheme don’t have to pay large, one-off levies whenever an expensive emergency cost arises.

Property owners in a strata scheme must pay regular levies. These levies go towards two areas:

An administration fund. This fund is used to cover the cost of any necessary insurances, budgeted repairs, and to pay contractors to perform ongoing maintenance tasks (lawn mowing, gardening etc.)
A sinking fund. The money in a sinking fund is used to cover the cost of major capital works or emergency repairs.
Depending on where you live around Australia, a sinking fund may also be referred to as a maintenance plan or a capital works fund. These funds ensure that your building functions correctly and always looks in the best possible condition, both of which are important considerations for both owner-occupiers and investors.

Finally, sinking funds also ensure that the financial burden for funding capital works and repairs is shared fairly and equitably among all owners in a strata scheme.

What expenses can sinking funds cover?

Sinking funds are much like a “rainy day fund” or savings plan for strata schemes. They ensure that when major capital works are required or emergency repairs need to be made to communal areas, the owners’ corporation has a sufficient capital reserve to draw from.

Sinking funds can be used to cover expenses such as:

– Painting of the building
– Overhaul of lifts
– Driveway refurbishment
– Replacement of fencing
– Replacing common property on the interior and exterior of the building, including carpets, roofing and guttering
– Any emergency expenses that may arise

Are there any legal requirements around sinking funds?

Not only do sinking funds represent good financial planning for owners’ corporations, but they’re also a legal requirement for strata schemes around Australia. Since July of 2009, all Australian strata schemes are required by law to have a 10-year sinking fund plan in place. These 10-year plans must also be in place for the life of the scheme, and the owners’ corporation must demonstrate how it is going to cover the cost of repairing and maintaining the common parts of the property.

For example, for new strata schemes in NSW, the preparation of a 10-year plan of anticipated sinking fund expenditure must begin at the first Annual General Meeting (AGM) of the owners’ corporation and be completed by the second AGM. Reviews and adjustments to the plan are allowed, but these must be finalised by the fifth AGM.

Contribution requirements can then be levied on property owners in the strata scheme in line with the 10-year plan. For example, if the owners’ corporation anticipates that it will need $150,000 in a sinking fund over the next 10 years, it will need to levy $15,000 for each year. If there are 25 apartment owners in the strata scheme, each owner would therefore have to pay an annual levy of $600.

What is a sinking fund forecast and how does it work?

A sinking fund forecast is a professional report that includes a budget and is designed to help an owners’ corporation budget for major capital works and essential repair and maintenance tasks. When putting together a sinking fund forecast (also known as a sinking fund plan), the owners’ corporation must identify defects and potential future expenses within a building so that they can be budgeted for and repaired.

When putting together a 10-year sinking fund plan, owners can do this themselves or engage the services of a firm that specialises in sinking fund forecasts. If you feel there is enough internal expertise within your owners’ corporation to compile an accurate and realistic sinking fund plan, there is no obligation to use the services of outside experts.

However, there are plenty of benefits to using a firm that prepares sinking fund forecasts. For example, sinking fund specialists are well placed to identify and accurately calculate the costs of the future common expenses for your building, as well as working out what works are required in which sequence so that later works do not damage earlier repairs.

Sinking fund forecasters can also help you develop a financial plan well into the future. While 10 years is the legal minimum for a sinking fund plan, a specialist firm can help you work out a plan for the next 15 or even 20 years and then calculate the levies that will need to be imposed on property owners.

Important information about sinking funds

Keep the following tips and pieces of advice in mind when preparing or managing a sinking fund plan for your strata scheme:

– Buying a property. If you’re considering buying a property in a strata building, ask whether the owners’ corporation has a long-term sinking fund plan or maintenance plan in place. Is the plan reviewed regularly to ensure that it remains up to date with changing circumstances? A well-managed building will most likely have a detailed and accurate sinking fund plan in place.

– Using the funds. If you have a project you think should be financed by the money in your strata scheme’s sinking fund, you will need to go through an approval process. In many cases, this will need to be put to the vote at an owners’ corporation AGM or extraordinary general meeting.

– Insufficient funds. If there is not enough money in the sinking fund to cover the cost of a project, a special levy may need to be raised. You will need to have support from the majority of owners and the corporation’s executive committee for this to occur.

– Older buildings are more expensive. As a general rule, the sinking fund for an older building will need to be larger than the fund for a modern building. This is because older buildings are more likely to need expensive repairs or works to update or upgrade facilities.

– Getting a plan prepared. If you own a lot in a strata scheme but the owners’ corporation does not have a 10-year sinking fund plan in place, you can apply to the tribunal in your state or territory that handles consumer and trader disputes. The owners’ corporation will then be issued with an order instructing it to meet its legal obligations.

Source: Finder

Falk, T. (2021, February 3). What’s a sinking fund and how do they work? | Finder. finder.com.au. https://www.finder.com.au/sinking-funds