WHAT IS A SINKING FUND?
A sinking fund is a pool of money set aside for a particular task. Most Australian states have legislation requiring strata unit owners to contribute to a sinking fund to cover the cost of future common property maintenance and repair work. Some states also require sinking funds to cover the cost of future repair work in retirement villages.
Whilst sinking funds may not interest most private investors and property owners, they are beneficial where property is communally owned. Hence their relevance to strata property owners managing common property and community groups managing property such as clubs and child care centres.
The Benefits of Having a Sinking Fund
Collecting money incrementally over time to fund future expenses is a practice based on the accrual accounting principle. There are many advantages to maintaining an accrual accounting based sinking fund. Chief amongst them is the reduction of owner anxiety about being required to pay potentially large, future maintenance bills.
Implementing a sinking fund provides a solution to the problem of guaranteeing funding for the future expenses (some of them very large) associated with the maintenance and repair of buildings.
Not only does a sinking fund solve the problem of sourcing the money to pay for future maintenance costs, it also demonstrates to prospective purchasers (particularly of strata property) that they will not have to face large, lump sum payments.
The Reason Why Sinking Funds Have Become a Legislative Requirement
Prior to the introduction of legislation requiring strata owners to contribute regularly to a sinking fund, large maintenance expenses were typically met using one-off cash calls, in the form of a special levy. This sometimes meant that unit owners who were unable to meet the special levy payments were forced to sell their property. If this occurred in a down market, it could result in a net loss to a property owner.
A healthy sinking fund eliminates the need for bodies corporate and owner’s corporations to borrow funds. A body corporate or owners corporation which carries an ongoing debt is not an attractive proposition for a potential buyer. A strata scheme with a healthy sinking fund on the other hand, is a very attractive proposition.
The Advantages of a Healthy Sinking Fund
Because a sinking fund provides a readily available pool of money for maintenance tasks, this generally ensures the common property in a strata complex is well maintained. This, in turn, protects the property values for the unit owners.
Another advantage of collecting money incrementally in a sinking fund is that it demonstrates the application of equity principles, and that each owner will pay their share of the future expenses irrespective of when their period of ownership occurs.
How Sinking Fund Budgets are Forecasted
The professional budget tool used to determine how much money is required to be collected from each unit owner is referred to as a sinking fund forecast (or a maintenance plan or capital works plan in some states). This report is a modified form of life cycle costing, used by quantity surveyors to determine the total cost of building ownership over a set period of time. Sinking fund forecast reports were first introduced to the Australian strata management industry by Leary and Partners in 1990.
Using a sinking fund, based on a professionally prepared sinking fund forecast, to progressively accumulate funding for future expenses has many advantages over the alternative cash accounting approach, with its reliance on special levies or loans.
Most states and territories now require strata schemes to have a sinking fund account, as well as a sinking fund budget. An increasing number of states require the contributions into the sinking fund to be based on a formal, long-term maintenance plan. The legislation in some states also requires the use of sinking funds and sinking fund forecasts to fund future repairs in retirement villages.