The term Sinking Fund conjures up all sorts of negative connotations.
Maybe because it sounds like something is sinking?
Or perhaps due to the similar wording to sunk costs – ie costs that are already incurred.
In reality though, it simply describes funds put aside to cover future expenses that are likely to arise, or replace an asset that has depreciated beyond it’s useful life.
In its simplest form, the MacMillan Dictionary describes a Sinking Fund as “money saved to pay for something later”.
It can be used for all sorts of expenses, although is most commonly used in relation to Government Bonds, or by Body Corporates.
If you’re in the market for an apartment or any form of strata property, the term ‘Sinking Fund’ is one you’d be wise to familiarize yourself with.
It’s one of the two types of funds or budgets that a body corporate is responsible for, and in to which you will be contributing each quarter (or as agreed) as part of your body corporate levy.
What is the body corporate responsible for?
Body corporates (or owners’ corporations) are legal entities designed to manage the operation and maintenance of the common property and shared areas within a strata titled development.
The Australian Tax Office categorises a body corporate as a not-for-profit organization, because it’s activities are funded entirely by its members, being the owners of each unit or apartment within the property.
Each year, annual budgets are set by the body corporate committee and voted on by the owners’ group, and levies are set as a proportion of the budget, based on owners entitlements (which may vary depending on size of apartments).
The body corporate is responsible for everything that falls outside each of the units (or lots). That is, anything that is not the responsibility of the individual owners.
Sinking fund vs administration fund
The body corporate is divided into two separate funds – the administration fund and the sinking fund.
The administration fund is exactly as it sounds – a fund set up for the ongoing maintenance (administration) of the complex.
Think of it as your transaction account, vs your rainy day savings account.
Out of the admin fund, the body corporate manager pays all of the day to day expenses – rates, water, electricity, gardening, general repairs and so on – relating to the common property.
The admin fund does not pay for capital works or capital expenses of the common property.
The sinking fund – and how to budget for it
That’s where the sinking fund comes in.
The intent of the sinking fund is to ensure that all capital replacements can be paid for as they fall due, without having to issue a special levy to the owners.
It also ensures that each owner contributes their share of the cost throughout their period of ownership, rather than the cost falling to the people who just happen to own the apartments at the time the repair falls due. This is particularly relevant for larger costs that may only be required every ten years or more.
Whilst the laws vary from state to state, by and large they dictate that a body corporate is required to have a detailed sinking fund forecast, with a future cashflow spanning a ten year period. This is a report of the building and common property, that states the projected lifecycle of each element and the anticipated timeframe for replacement.
Common examples of common area capital items include roof replacement, concrete driveways and paths, guttering replacement, building façade repairs, lift upgrades and pool facilities.
For example the building might be required to be repainted every ten years or the lifts may need an upgrade in the next three years.
The report is prepared by a Quantity Surveyor, who not only determines a simplified construction estimate for larger projects, or a replacement cost, but also generates a cashflow inclusive of inflation and likely cost increases based on market dynamics.
The forecast is generally required to be updated every five years, to take into account any changes in expected timeframes or any unforeseen costs.
I’ve worked with a lot of Property and Body Corporate Managers who think the best way to budget is to look at last years’ expenses and add 5%.
(This might get you by for the Administration Fund budget, although it would be preferable if a little more science went into those numbers as well.)
Luckily these managers are in the minority and most are lot more diligent.
Because the Sinking Fund is a effectively a savings fund for capital works, the type of costs it will cover from one year to the next will vary.
It’s important to engage the services of a qualified Quantity Surveyor to make sure you and your fellow owners don’t get caught out down the track.
Case in point – Mascot Towers
At the extreme end, take the case of Mascot Towers in Sydney.
You might remember the news reports in 2019 where the 132 residents of the property were evacuated after engineering reports came to light of extensive cracking and foundational issues that rendered the building unstable1.
The Bourke Street property was ten years old at the time, and concern was exacerbated by widely reported issues of a similar issues at Opal Tower only six months prior.
With the basic estimate for construction and repairs hitting seven figures, residents voted to raise a special levy of $7million for stage one of rectification, however at around $60,000 per unit, around 35% of the owners stated they were unable to afford the additional cost.2
Three years later, and the battle continues with owners and residents unable to occupy, lease or sell their units. Government assistance has been offered in the form of rental subsidies to cover alternative accommodation, however owners are still fighting for compensation and rectification of the building, with many facing significant financial burden as a result.
Fortunately cases such as this are rare but it does go to show the level of risk involved, and the scrutiny required thorough building inspections and comprehensive reports.
Having the right team in place can help.
Where does MCG come in?
As we all know, repairs and defects can develop at any time and as a building ages, it is inevitable that repairs and replacement of capital items will be required.
Careful planning is essential from the beginning to ensure that appropriate allowances for costs have been allowed for.
Many strata schemes, for a variety of reasons, find themselves in a position where money is desperately needed to pay for essential repairs or renovations but the bank account is empty.
MCG Quantity Surveyors have the extensive experience and knowledge required to ensure the sinking fund forecast includes sufficient allocations to cover all reasonably expected costs, whilst maintaining a realistic and feasible budget for owners.
We can calculate a simplified construction estimate for larger projects and determine the timeframe specific to each category of cost, providing a comprehensive cashflow for even the most complicated body corporate.
Contact us now for an obligation free quote on 1300 795 170 or go to our website mcgqs.com.au for more information.
1 Merlehan, Adam “Mascot Towers owners to pay $!m repair levy as residents remain shut out” 21 June 2019 <theguardian.com>
2 “Mascot Towers update – special levy” <sskb.com.au>