The Risk of a Low Body Corporate Sinking Fund Balance

The risk of a low body corporate sinking fundHow much is in the body corporate sinking fund? This is the most common question when buying a unit.

Unfortunately the balance is only half the story. The more telling part is how much should be in the body corporate sinking fund?

This article is about how a body corporate sinking fund is accumulated, where the process goes pear-shaped and the implications for both owners and buyers.

The purpose of a Sinking Fund

The purpose of a body corporate sinking fund is to collect a small amount toward long term upkeep from everyone who has ever owned a lot.

The goal is to have funds available for major upkeep works, like painting or lift refurbishment, as and when they’re required. If funds are available it increases the chances the works will get done which extends the life of the building.

The concept is to have a set, gently upward trending levy, year in year out, so owners can budget with confidence and the body corporate can fund works as they’re required. The major fluctuations happen within the sinking fund balance.

Ideal Body Corporate Sinking Fund

Annual Sinking Fund Levies trend gently upwards over time giving certainty to owners and available funds to the body corporate when required

Where Do Special Levies Fit In?

The day to day costs of running the scheme are funded from the Administrative Fund and capital works from the Sinking Fund.

All expenditure is expected to be carefully planned and budgeted: the administration cost from year to year and capital cost over a continuous ten year time horizon.

With the best of intentions it’s impossible to forecast for every situation that might arise. Anything that isn’t included in the annual forecasts is considered “unbudgeted works”.

Unbudgeted works should be financed by raising a special levy.

It’s quite simple and clear cut: If you didn’t plan it, don’t do it. If you go ahead and do it anyway then raise additional funds to pay for it.

Where Sinking Fund Accumulation Goes Pear Shaped

There are two main ways that body corporate sinking fund accumulation gets distorted:

  1. Accumulated funds are spent on unbudgeted works;
  2. Sinking funds are incorrectly collected.

Accumulated funds are spent on unbudgeted works

When an unbudgeted situation arises the body corporate will often rectify the problem and fund the works from existing sinking funds.

There are many valid reasons why the works might be funded this way, despite the fact it’s contrary to legislation.

Speed is a key factor. It takes time to raise a special levy and sometimes works might be urgent.

Relative cost is another issue. It can be cheaper to just do it and pay with available funds than to hold an EGM and issue a special levy. Strata meetings can be pricey.

In most cases the works, though unbudgeted, can easily be absorbed by the scheme with no ill effects to speak of.

In practice all of that is fine. Right up until it becomes a problem.

For instance, say the scheme spent 10% of the fund five years ago to pay for unbudgeted works and made no effort to recoup. Now the scheme finds itself with 15% less than is required to undertake scheduled works. That’s the power of accumulation. Deficits accumulate too.

If unbudgeted funds are taken from the sinking fund some sort of allowance must be made. That can be done by replacing the funds, delaying works or reducing the cost of works.

Sinking Funds Are Not Collected Correctly

The key purpose of a Sinking Fund Forecast (SFF) is to give the body corporate clues as to what sinking fund levies to collect. Even with a forecast sinking fund levies are a ‘best guess’.

Bodies corporate are required to have a forecast but they’re not required to follow it. When sinking funds are incorrectly collected essentially strata schemes ignore their SFF and collect levies based on what they believe the owners will be willing to pay.

Consequently it is common to see a forecast estimating a levy of $500 per lot entitlement with only $400 collected.

Its pretty simple; If you don’t accumulate the projected levies then the projected balance won’t be obtained and funds won’t be available when works are required.

Supercharge Problems by Combining Causes

In practice it is relatively uncommon to see buildings under collect their sinking funds for long periods of time. It’s something that happens most often in smaller buildings where owner apathy or poor management is an issue.

What happens most commonly is that unbugeted works are paid repeatedly from the sinking fund yet the SFF projections for accumulation are still being followed. It’s effectively still under collection since no effort has been made to recoup previously spent funds.

Under collection and unbudgeted works together will lead to negative sinking funds quite quickly, especially when combined with apathy.

Body Corporate Sinking Fund Levy Corrections

A levy correction is a sharp change in annual sinking fund levies other than for CPI.

Corrections can be upwards or downwards.

Downwards Levy Correction

body corporate sinking fund

Sometimes annual body corporate levies are set too high and the strata scheme collects more than they need. Annual sinking fund levies then need to be corrected downwards

Some bodies corporate collect sinking fund levies that are too high. They achieve their capital accumulation goals too quickly and find themselves with extra funds.

Annual sinking fund levies need to be corrected downwards. So as an example, if the levy was $2,000 per annum it is lowered to $1,000 per annum moving forward and will trend upwards again from there.

Upwards Levy Correction

body corporate sinking fund

Setting the annual sinking fund levies too low will lead to a correction upwards; a large, permanent increase in sinking fund contributions required

It is far more common for bodies corporate to not collect enough sinking fund levies over the timeframes required.

The result is a major deficit in funds required and will eventually require a correction upwards.

An example would be annual levies of $1,000 per lot entitlement doubling to $2,000 per lot entitlement per annum.

Upward corrections often go hand in hand with special levies. Owners often object quite strenuously to large increases in levies so necessary decisions are put off, sometimes until the need for funds becomes critical. The scheme finds itself needing cash immediately (special levy) plus an ongoing increase (levy correction).

Why levy corrections Are An Issue

It’s pretty hard to see how a levy correction downwards would be a problem for anyone. Indeed, if you’re a buyer and your chosen scheme has had a recent downward levy correction it’s a cause for celebration.

Of course if you’re the seller its’ not such good news. What’s happened is you’ve paid more than your fair share of future capital works. When you sell you walk away from that. Not such a nice place to be.

By contrast it’s easy to see why levy corrections upwards are not a good thing.

For a start it’s going to put off buyers. Nothing say’s don’t buy me like a sinking fund in dire need of cash injection.

More importantly increasing the levy, or indeed issuing a special levy, is only the first step. The next step is to collect the funds and with large amounts that’s not always easy.

Large increases in levies lead to levies in arrears and additional costs to the scheme for collection. Additional costs means additional levies and further delays, which, you guessed it, leads to additional costs.

It can get to a point where everything becomes critical: the delays and the issues they cause become urgent and cash is needed right now! Owners end up feeling like they’re bleeding money and there is no choice but to continue through the process because the chance of attracting a buyer is slim.

Upward correction of sinking fund levies is a ‘red flag’ as it often goes hand in hand with a number of other issues like ongoing poor maintenance, building defects or dilapidation and poor financial management.

Conclusion

The body corporate sinking fund balance is part of your lot’s value. A sinking fund balance that is too low is a detriment for buyers. With good reason. It is an indicator of a risk that owners may be asked to contribute additional funds over and above the current levies.

NOTE: The question I haven’t answered here is “how do I tell if the sinking fund balance is too low?”

I did start writing the answer and it got … technical.

If you’re comfortable with and can access body corporate documents look out for another article in the next couple of weeks which will show you how to analyse your scheme sinking fund.

THE BASICS OF BODY CORPORATES

A little knowledge can go a long way


I see so many stressful and frustrating issues in body corporate records that result from simple misunderstandings it hurts my head. If I could do one thing to help it would be to teach everyone the basic rules, so they can avoid all these dramas.


With that in mind I've put together a short eBook that sets out the basics everyone owning in a body corporate really should know. It won't make those big issues go away, but it will give you a firm grounding from which to communicate.


It's completely free, so please, download it now!

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Comments

  1. Fantastic article thank you and very timely. I am the newly elected treasurer of an owner managed body corporate for a small scheme and we have insufficient funds in both sinking and admin accounts and have done for years. The situation is critical, such that a special levy is required but has not been actioned on as yet, much to my dismay. The other unit owners do not want an increase in levies of any form and I am finding it most frustrating and frankly alarming. I think every owner should read this and understand the importance of paying the correct amount of levies, not what they would like to contribute. Thank you

    • Hi Di

      Its quite possible I wrote this article especially for you. I often see schemes in the same positions as you’ve described and it’s frustrating for those of you who understand what’s happening to try and convince everyone else. I wanted to give you some ammunition to help!

      The problem with doing nothing is that eventually there will be a tipping point. Unfortunately some schemes leave it until then. In my opinion its better to take action when you can do it in smaller doses.

      Good luck with swinging the vote.

      • Thanks Lisa I couldn’t agree with you more about doing nothing. The tipping point arrived a long time ago, however I am a lone voice and see no way that I can swing the vote in a positive way. I guess the crisis will have to occur (when a massive injection of funds will be required) before I am taken seriously. With me luck! Cheers Di 🙂

  2. I liked your article but I have a question regarding the Sinking Fund and its use.
    We are Standard format Plan and have collected for Painting and Insurance (while technically we Should not) it has allowed us to keep the complex uniform and excellent condition. We have on owner who feels we should not be able to do this and the commission has apparently said that we have been acting illegally. He has said the managers work on the owners lots (mowing and gardening; as per his agreement) has to be reviewed and stripped from his agreement. I thought the Merrimac Heights (http://www.wolterskluwercentral.com.au/legal/uncategorized-legal/the-merrimac-decision-lot-owners-take-note/ then Costs http://www.austlii.edu.au/au/cases/qld/QSC/2012/79.html) would make this agreement valid.
    I believe the adjudicator has said that we can longer obtain insurance for lot owners (saves them money [$320/yr vs $800+/yr] and better excesses;$250/claim vs $600/claim) yet we have to pay insurance for the duplexes (can we recover this as a BC? Maybe a levy for the Duplexes Seems very unfair if we can’t). We also have to paint the common walls and gutters for the Duplexes again unfair.
    Also he has said we cannot organise the painting through the BC.
    It very complex and as owners we have been asked to write a submission regarding the painting passed at a AGM.

    • Hi Dave

      The foundation premise of body corporate legislation is that the body corporate is responsible for common property and the lot owner is responsible for the lot. Its the bedrock on which bodies corporate operate and everything else from there is about equitably sharing costs and assets.

      From what you’ve discussed here it seems to me that the body corporate has extended its responsibility to include painting of the scheme, insurance and lawn mowing. The problem is that areas being maintained are part of individual lots and consequently the body corporate is infringing on the rights of the lot owners. Further there is an unnecessary burden on the owners to fund these costs which should be paid by the lot owners themselves.

      Owners may certainly negotiate together and enter into contracts for insurance, painting and lawn mowing however it can not be made compulsory as the body corporate has no power to make decisions about what happens to a lot. Any agreements such as these negotiated by the body corporate require each owner to individually contract with the body corporate before proceeding.

      I understand it has given owners a sense of uniformity having the grounds maintained by one contractor and control of the exterior maintenance. Its come as a result of infringing rights however and should be stopped.

      With insurance, the body corporate is required to insure any lots where the buildings are joined. So the body corporate should insure the duplexes but not free standing houses. The cost of insuring the duplexes should be shared between the duplexes and all owners should contribute to the insurance of common property.

      I know that’s not what you wanted to hear Dave and I’m sorry about that. In a lot of ways a Standard Format Plan is more complex than a Building Format Plan though ultimately the costs should be cheaper because the common property is significantly less.

      • Thanks for that I hear what you are saying and I agree that is what the legislation says but why should the other owners carry the cost of the insurance for the 14 Duplex owners of Roughly $4500 so an added cost of $38 for each lot owner of which the duplex owners benefit. Are the body corporate able to get reimbursed for the Insurance payment?
        The other problem that is apparent is the manager is paid to do gardening on the owners lots as well as the common property. Note there is a difficulty here as the common property finishes in the middle of a garden. That is half of the garden belongs to the owner and half belong to the BC.
        So the manager hedges the front half of the hedge and the owner does the back?
        Because this caretaking contract is in place we will have some difficulty changing it. In the Merrimac Heights case the Supreme Court found for the manager against the BC when they tried to change this (stopped paying the manager). Any thoughts I know it won’t be a legal opinion this could get expensive.

        • Hi Dave

          I think we’re talking about the same thing with insurance. The duplex owners should pay their own costs. The other owners, if they’re insuring separately, should pay their own costs. Common property insurance should be split amongst owners via interest lot entitlements.

          The body corporate should raise an annual insurance levy, payable by the duplexes owners only, based on their interest lot entitlements, to recover the cost of their insurance.

          Re the garden maintenance: The Merrimac Case notes the body corporate had the power under s 158 of the BCCM Act and 167 of the Body Corporate and Community Management (Accommodation Module) Regulation 2008 (Accommodation Module) to enter into the lawn maintenance agreement.

          In the case of your scheme I would argue that the agreements weren’t validly entered into because the body corporate had no right to make arrangements around lot owner property.

          Dave, you’re quite right this is a legal matter and could get quite expensive. The agreements should be altered to remove the lot owner property maintenance however it will take some negotiation with the contractor because they will lose out through no fault of their own. Not a pretty situation at all.

          • Also the managing of common property and owners lot boundary is in the middle of the garden bed. As an owner I want the hedge at metres and the manager does the front at 1.2 metres. How do the BC cope with this?

          • Hi Dave

            Negotiation is what’s going to solve this one as well. Putting the hedge right on the boundary of lots and common property might have seemed a good idea at the time but it really would be much better if it was contained wholly within one or the other. So it’s either lot owner responsibility or body corporate.

            That said, you can only deal with what you have, in which case I would suggest that the rules regarding fencing are applicable, since the hedge is acting as a fence ie 50 / 50 cost share.

  3. Hi Lisa
    I emailed a few weeks back re manager of large complex going on leave for extended period ie 1 yr plus.
    I obtained documents from OFT and discussed with the mgr the necessity for particular licences etc for the relieving manager which is all fine.
    However our managers lawyer advised him that it is nothing to do with the body corporate committee and that the committee should not be involved at all even including interviewing the relief manager
    I must stress that there is no dispute with our manager and the committee supports his extended leave however the committee does feel an obligation to at least hold discussions with the relief manager to among other things ensure his qualifications and experience are suitable .
    Can you provide your opinion or view here please Lisa.
    Many thanks and appreciate your interesting site.

    • Hi Ronald

      I can see where the lawyer is coming from here. The replacement is a Caretaker issue. The terms of the agreement are not being altered in any way and the Caretaker is still going to be responsible for fulfilling the terms of the agreement. The relief is simply an employee of the Caretaking contractor.

      From the body corporate’s perspective, it’s not their business. Of course it would be ideal for the Caretaker to put the committee’s mind at rest, at least with regards licencing, but again, not compulsory. If there are issues with the relief it’s still the Caretaker who will be breached.

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