A sinking fund is one of the top things for you to consider as a property investor when buying an apartment in a strata scheme.
Why? It’s not necessarily the first thing a prospective apartment buyer might think about, but when you’re buying a strata property, a sinking fund is vital to cover the cost of repairs to common areas and facilities, including air conditioning, roofing and lifts.
Without an adequate sinking fund, you and the other owners could be walking into a major joint financing problem in future when a major expense is required for common property and there’s no collective plan on how to pay for it. This often results in very tricky situations to navigate. Some owners could be forced to sell, while potential purchasers are scared about buying into a building where there is a major expense for common property that needs to be collectively financed but no clear path forward on how..
This can often result in sales below market value, impacting the value of all the units in the strata regardless of whether or not you had enough money to cover your share of the expense.
In this blog, we go into detail about what a sinking fund is, the key questions you need to ask, and some of the challenges you might come up against.
What is a Sinking Fund?
From roof maintenance to lift repairs, building expenses can be very costly and add up over time.
A sinking fund, or capital works fund as they are now known in NSW, is an emergency fund set up by the owners’ corporation to cover a building’s future repair and maintenance expenses. The idea is for the owners’ corporation to have enough emergency money to pay for any future works that need to be completed.
This differs from an administrative fund, which is also established by the owners’ corporation but covers shorter-term or everyday expenses and regular maintenance such as gardens, pest control and cleaning.
Each owner pays for the sinking fund through regular contributions. It also aims to ensure owners won’t need to stump up extra cash when a hefty building expense comes their way – it’s a financial safety net for all the property owners in the strata scheme.
Sinking funds are not just a feature of well-managed buildings, they’re actually a legal requirement for some parts of Australia, including NSW, Queensland, the Australian Capital Territory, and the Northern Territory.
In these jurisdictions, it is a legal requirement for owners’ corporations to have a 10-year sinking fund plan or forecast in place.
Owners’ corporations get into trouble if the sinking fund isn’t replenished and the building isn’t adequately maintained when, suddenly, they find themselves trying to fund major repairs to a building that is unsafe, or which doesn’t meet the legal requirements.
In general, long-term planning for and maintenance of the building will help reduce the need for major expensive fixes later down the track. Remember, how well looked after a building is plays a key role in a property’s capital growth. Buildings that might need major renovations just to meet the legal minimum standard, costing every apartment owner thousands, are harder to sell!
Key Questions to Ask About a Sinking Fund
If you’re seeking to buy a strata apartment, here are three things about sinking funds you should be asking:
- How much is in the sinking fund? Is the amount of money in the sinking fund sufficient to cover all major, long-term expenses (aka capital expenditure items)?
- How often does the owners’ corporation evaluate the sinking fund plan? When was it last evaluated and by who?
- Is the levy/contribution amount being raised by the owners’ corporation enough to ensure that available funds can meet the forecast capital expenditure items and over what period of time?
These questions will help you to understand how likely it is that you might be required to stump up extra cash in the event of an unexpected repair bill or be left hoping that your fellow owners also have enough savings to cover their share of the expense. An insufficient fund, or a corporation that isn’t paying attention, are big red flags.
Don’t be reassured by a modern-looking building, either. If there’s minimal regular maintenance and no contingency fund, it doesn’t matter if the building is five years old or fifty.
Examples of Sinking Fund Expenses
Your sinking fund is essentially a building maintenance fund. Examples of expenses that could be paid for by a sinking fund include:
- Roofing
- Lifts
- Common air-conditioning
- Painting for external walls or internal common areas
- Replacing fixtures such as lights and ceiling fans
- Repairs for common property
- Structural repairs
- Plumbing overhauls
- Energy efficiency upgrades
All these factors give you as owners, and any prospective buyers or tenants, reassurance that the building is safe, meets the regulations, and won’t require a sudden repair bill or a hike in the rent. That in turn means that there is more demand for the property, increasing your potential rental income and/or sale price.
What is a Special Levy?
If the sinking fund isn’t adequate and unexpected problems do crop up within a building that need to be fixed urgently, the owners’ corporation might propose something called a special levy at their general meeting.
Special levies don’t get charged whenever there’s an emergency issue in the building, and the owners’ corporation can’t collect special levies from property owners without majority support from everyone in the strata scheme. This can be incredibly tricky to navigate.
The issue is they become necessary when the sinking fund hasn’t been properly maintained or planned for, especially if a major building defect is uncovered. That’s been the case for thousands of apartment owners in the wake of the Opal Tower debacle, with the cost of repairing building defects for affected apartments put at anywhere between $5,000 and $60,000.
In practice, a special levy means a big, probably unexpected bill for the property owner. Some owners might have the money to meet the special levy but others might not.
In any case, if and when you sell the apartment, your buyer has a right to know details of the sinking fund and any special levies raised. These are key due diligence items any well advised buyer is going to look at closely. That means they directly impact the salability of the property, the competitive dynamics, and the price
The good news is you have the same right to that information when you’re buying. That means you can make sure a well-funded sinking fund is in place, minimise the need for special levies, and reduce your risk.
Challenges and Solutions for Property Investors
Challenge: An underfunded sinking fund.
Solution: Work with your owners’ corporation to increase contributions and build up a more adequate fund. Identify the most likely issues and prioritise having the funds to cover those eventualities in the short term.
Challenge: Complacent or inactive Owners’ Corporations.
Solution: Call a general meeting and propose a motion to establish a fund, increase contributions, or engage a professional manager with a remit to oversee and maintain a fund.
Challenge: Sudden, unexpected repair bills.
Solution: Rather than putting yourself into debt, use Futurerent to get an advance of up to $100,000 without borrowing money or impacting your credit score.
Don’t Let Your Sinking Fund Sink Your Property Goals
As a property investor in a strata scheme, you can’t underestimate the importance of a properly maintained sinking fund. Without it, you face serious risk of a big, unexpected bill that either you or your fellow owners in the strata corporation can’t afford.
If you or other members of your strata corporation are in a position where you’re facing an unexpected repair bill, Futurerent can provide a fast and simple solution without the complexity of a cash-out refinance or credit impact. Get in touch today to find out how Futurerent could help you.
FAQs
How much should a sinking fund have?
A sinking fund should have enough to cover forecasted maintenance and repair costs for the next 10 years, as outlined in the owners’ corporation’s sinking fund plan.
Can a sinking fund run out of money?
Yes, a sinking fund can run out of money if contributions are insufficient or unforeseen expenses arise, leading to potential reliance on special levies to cover shortfalls.
How can Futurerent help with unexpected repair costs?
Futurerent provides property owners with an advance of their rental income of up to $100,000 for any reason without borrowing money or impacting their credit score.
