What is the purpose of a Sinking Fund?
A sinking fund is a deposit of money, which allows for the body corporate of a property to pay for major building repair and maintenance expenses.
How does a Sinking Fund work?
The deposit of money within the sinking fund can be used in a few ways.
The sinking fund can be used on anticipated capital expenditure or non-recurrent items. A common example of this would be a large or one-off expense within a large strata scheme, like major structural repairs or painting the building.
It can also be used towards replacing major capital items including common property fences or carpets and flooring in a shared space like a lobby.
Another way the sinking fund can be used towards general expenses that can be reasonably met from capital that has been accumulated, include pool furniture.
Do I have to pay into a Sinking Fund?
The sinking fund can grow through the following ways:
- Direct contributions from the owners’, >which may be levied/raised quarterly by the body corporate.
- Interest that has been received or accumulated from the investments of the fund.
- Money that has been received from insurance pay outs for major or capital items that have been destroyed or damaged.
All contributions by the owners’ (sinking fund levy) are often managed by a Community Management company – who are acting under the instructions of the body corporate.
It is the responsibility of the Body Corporate to raise, as a minimum, 2 annual funds –
These being, an administration fund and sinking fund.
The administration fund differs from the sinking fund in that, money is set a side to meet day-to-day recurrent working expenses or regular operating and maintenance costs. This can include paying for common area electricity supply, testing and tagging of fire equipment, purchasing consumables such as, toilet paper, pool chemicals, light bulbs, fertiliser, mulch etc. The administration fund can also be used to pay for insurance charges and other professional consultancy and administrative fees.
It is important to note that no amount of money can be transferred between the sinking fund and the administrative fund.
Why is it called a Sinking Fund?
The term sinking fund was initially used in 18th century England to reduce the national debt. In today’s world, a sinking fund is a way to deposit money so that the amount of money owed can be paid off over time.
Another common reason as to why it has been referred to as a sinking fund, is because it is a sum of money that has been accumulated over time to prevent the property from ‘sinking’ when an unexpected cost may arise.
How is a Sinking Fund established?
A sinking fund is established by a body corporate through regular payments over a period of time to pay for a capital expense in future, or repayment of a long-term debt.
How much goes in a Sinking fund?
Every body corporate financial year, it is the role of the body corporate committee to prepare a proposed annual budget for the sinking fund. This budget is then presented at an annual general meeting of all lot owners for approval. The budget and it’s associated levy, allows for sufficient money to be raised to meet projected expenses in the upcoming financial year.
The body corporate is required to cover spending that may occur for at least 9 years after the current financial year.
The amount that goes within the sinking fund will vary across every property and will be up to the body corporate committee and ultimately, all lot owners to agree and determine.
Advantages of Sinking Funds
Depending on the amount within the sinking fund, it can usually either attract or deter any potential investor. If a property or building has a low amount of money in the sinking fund, it can be a red flag for many as it does not provide a high level of protection. It can also indicate that the property or building recently had to undergo a major repair or works.
However, if the sinking fund has accumulated a decent amount of money, generally speaking, it provides a good level of protection and indicates that no repairs or other works have been required for the property or building.
The most accurate assessment of a body corporate sinking fund is in fact the following –
- How often the body corporate is reviewing their sinking fund forecast to ensure that accurate costs are being met or budgeted for;
- Whether or not the body corporate is raising funds in accordance with the sinking fund forecast; and finally,
- Is the body corporate frequently consulting with service contractors to the scheme, to ensure that accurate and site-specific costs are being captured.
Opportunity for lower rates:
A property or building with a small sinking fund will struggle to attract investors. A higher sinking fund balance will naturally provide a greater level of protection. As a result, properties with a decent sinking fund are able to attract more investors. No-one wants to pay more than they have to, so having a decent sinking fund can go a long way.
Example of a Sinking Fund:
- An older building consisting of 6 units has started to reveal structural cracks along an external rendered wall. The tenants have flagged this with their landlords and have asked for these to be repaired. At a body corporate meeting, the structural cracks are discussed and the body corporate committee agree to address them if there is an adequate amount of money in the sinking fund. After checking the sinking fund, the committee realise there is a line item in the sinking fund forecast to allow for this projected expense and that the estimate of costs also fall in line with report and rectification quotes obtained. As a result, it is agreed that the sinking fund will be used to address the structural cracks in the upcoming financial year.
Sinking Fund Vs Savings Account
A sinking fund and a savings account are quite similar. They both require an amount of money to be put aside for money in the future.
The main difference between the two is that a sinking fund is created for a purpose at a particular time. A savings account is more flexible and can be established for any purpose and used at any time.
Sinking Fund Vs Emergency Fund or Special Levy
The conditions of a property or building are not always definite. From time-to-time, a body corporate may be faced with an unanticipated cost for example, new combustible cladding laws introduced in March 2019 may have resulted in unexpected building works. Unanticipated problems may come out of nowhere, so it’s important to always be financially ready.
The difference between a sinking fund and emergency fund or “special levy” is that a sinking fund is used for an expected or anticipated expense. While an emergency fund or “special levy” is typically raised at a general meeting of all lot owners to meet unexpected costs.
Balancing both body corporate building compliance obligations and building maintenance priorities does not have to be difficult!
Enrol to the “Strata Mastery” – Body Corporate Best Practice Workshop today and learn about how you can put together an accurate body corporate administration and sinking fund budget and avoid being hit with an unwanted and unanticipated “special levy”!