Understanding Sinking Funds in Residential Strata: Essential Guide for Property Owners

Date published: 28/01/2020, updated 30/07/2024

What is a sinking fund in a body corporate?

While different states have different rules, the definition is still pretty much the same wherever you own a strata unit. Some states and strata organisations are beginning to call them capital works fund or maintenance funds to make their meaning a bit clearer.

A “sinking fund” (also called a Capital Works Fund) in residential strata settings is a reserve of money that is collected from all unit owners in the complex.

This pool of money is set aside to cover future repairs and any major expenses related to the common property such as roof replacements, repainting, telecommunications upgrades, and structural repairs. Each unit owner contributes to the sinking fund via regular payments included in their strata fees.

An example of a sinking fund at work

Your body corporate develops a 10-year plan for major upgrades using the sinking fund. The plan includes revitalising the 30-unit property by replacing aging roofs, installing solar panels for energy efficiency, and upgrading the plumbing system. The total estimated cost is $300,000, which equates to $30,000 per year over a decade. If all units are the same size, each owner will contribute $1,000 annually to the sinking fund.

Why are sinking funds needed?

Firstly, a number of states and territories actually require them by law. But from a practical perspective, they’re also required to make sure that an owners’ corporation/body corporate has enough money on hand to cover emergency repairs and necessary ongoing maintenance. Without an adequate sinking fund, the owners’ corporation may need to raise a special levy every time something needs to be fixed. Not only would this be time-consuming and inefficient, but it also relies on each title-holder paying the levy in full and immediately – and given that no one likes unexpected costs, this can be difficult to achieve.

The sinking fund is a bit like an insurance policy, to ensure there are adequate funds to keep the building well maintained.

Why doesn’t strata insurance cover it then?

Residential strata insurance is designed to cover unexpected events like fire, accidental damage and liability. A good strata building insurance policy will pay for repairs, but there is usually an excess and it takes time to process a claim.,

What’s more, building insurance does not cover the ongoing repairs and maintenance costs of a property such as exterior painting, new fencing, replacing carpets in common areas, replacing old roofs and guttering, rewiring, fixing up driveways, gates and car parking, etc. All of these will eventually be required, and they’re paid for out of the sinking fund.

Always keep in mind that the sinking fund is not designed to be used for ongoing costs such as lawn mowing, utility bills, building manager’s salary and minor repairs.

How much should go into a sinking fund?

The amount that should go into a sinking fund varies based on the property's projected maintenance and repair needs over time. These projections are typically outlined in long-term maintenance plans, which forecast the likely expenses for various property components, such as:

Roofs and balconies
Doors and windows
Lifts
Shared laundries and bin rooms
Security systems
Sewage
Car parks
Exterior wall painting
Fences

The strata committee identifies things on your property that are most likely to require some attention (i.e. financial outlay) over an extended period. They then prepare a financial forecast and incorporate these projected expenses into the sinking fund.

The total amount required for the sinking fund is then divided into an annual fee, paid quarterly as part of the strata levies. Owners of larger apartments typically pay more due to their larger share of the property.

Here’s an example of how sinking fund works

The strata committee of a large apartment complex might decide that, over the next ten years, it’s likely the entry lobby will need repainting, some roof repairs will need to be done, the back fence will probably need replacing and the driveway resurfaced. The total cost is estimated to be around $300,000, which is $30,000 per year over ten years. If all the apartments are the same size then each of the thirty owners would pay $1,000 to the sinking fund or capital works fund each year.

Even if 10-year plans are optional (or not enforced) they’re useful to ensure owners aren’t paying too much or not enough.

How do you predict the amount needed for the sinking fund?

Many owners’ corporations turn to professionals to make an assessment of what will need to be done and how much it’s likely to cost. External assessors are highly recommended because Capital Works Plan legislation in a number of states, is becoming tighter and more onerous, particularly in respect to what needs to be determined and included. If you wish to do this yourself the information is normally on the office of fair trading site for your state. Here are some valuable tips to help you accurately determine the appropriate amount for the sinking fund:

Identify your future expenses: Make a list of all current and future maintenance needs that you know will need to be dealt with within the next ten years. Conduct an audit to get a comprehensive assessment of your strata property’s condition.
Estimate the amount needed for each expense: The next step is to estimate the cost of each expense on your list. If you know the roof will need replacing, get a quote from a roofing contractor to determine how much money you will need in your sinking fund.
Calculate how often you will need sinking fund contributions: Once you know how much money you need for your future expenses, calculate how much and how often you’ll need sinking fund contributions. E.g. if you need $50,000 for a new roof and want this money saved within five years, calculate the total amount needed ($50,000) and divide by the time frame (5 years) to find the annual contribution. Divide the total by the number of unit owners for an accurate annual figure.
Review past costs: Look back on past expenses and major repairs to help provide a rough estimate of future costs.
Take inflation into account: Factor in potential increases in material and labour costs to ensure your sinking fund will cover expenses.
Regularly stay updated with state legislation: It's crucial to stay informed about local regulations related to capital works plans, as these can affect how much you need to contribute and what should be included in your sinking fund.

Common Pitfalls and How to Avoid Them

To prevent issues such as non-compliance and cash flow problems, it’s essential to understand the common pitfalls body corporates face in managing strata sinking funds.

One of the biggest mistakes made is underestimating future costs, which can leave the fund short for necessary repairs or upgrades. To address this, it’s important to regularly audit and update your cost estimates. Review and adjust the sinking fund contributions annually to reflect any changes in your capital works plan or unexpected repairs.

Another common mistake when managing sinking funds is ensuring timely contributions from unit owners. Delays can lead to cash flow issues and potential disputes, so it’s best to implement clear payment schedules and follow up on overdue payments to maintain a steady flow of funds. Remain transparent with unit owners about the fund’s status and future needs to prevent any misunderstandings.

Finally, the failure to keep up with your state’s strata regulations can lead to legal non-compliance. To avoid fines and other legal issues, stay informed about your state's capital works plans and ensure you adhere to them.

Managing Sinking Funds in strata settings

In residential strata settings, the strata committee or body corporate is responsible for managing the sinking fund. This management ensures that there are adequate funds available for future repairs and upgrades to the strata property. Effectively managing strata sinking funds prevents any unexpected financial issues and helps maintain the property’s value along with the comfort and safety of its residents.

1. Annual review and process management

To ensure there are adequate funds for future needs, the sinking fund should be reviewed annually. During these reviews, the body corporate should update cost estimates and adjust contributions as needed as well as account for any new or unforeseen expenses.

2. Tools

Relying solely on manual audits of your sinking funds can lead to costly errors. Make use of budgeting apps and accounting software to track sinking fund contributions and expenses. This will help you gain a clear oversight of future repairs and the funds needed to cover them.

3. Transparent community engagement

It’s important to keep unit owners informed about their contributions and the fund’s purpose. Regularly updating them and sharing your long-term plans will help to build trust and ensure timely payments.

Paying a sinking fund is beneficial

While a sinking fund can seem like just an extra expense, it can actually save you money – or at least a nasty surprise – down the track. And if you are renting out your unit, payments made to a general purpose sinking fund (but not a special purpose levy) may be claimed as a tax deduction.

“Payments you make to body corporate administration funds and general purpose sinking funds are considered to be payments for the provision of services by the body corporate and you can claim a deduction for these levies at the time you incur them. However, if the body corporate requires you to make payments to a special purpose fund to pay for particular capital expenditure, these levies are not deductible.”

Body corporate fees and charges | Australian Taxation Office

The impact of a well-managed sinking fund on property value: A well-managed sinking fund ensures there are funds available for essential repairs and upgrades. Regularly maintaining your strata property increases its value and enhances its marketability. So, if you ever choose to sell your strata property, you may be able to fetch a higher selling price and faster sale.
Emergency preparedness and sinking funds: Having a sinking fund allows you to handle emergencies efficiently, such as urgent repairs or unexpected upgrades. This can help you address emergencies quickly without having to take on additional debt.
Financial stability: A skinking fund provides financial stability for the owner and strata community by ensuring there’s a robust pool of money available to cover major expenses. This reduces the need for sudden, large contributions from unit owners.
Improved long-term planning: A sinking fund improves future planning of large-scale items and can prevent impulsive spending. Furthermore, a sinking fund helps to spread out large expenses over a given period, mitigating the financial impact when these costs do arise. In the long-term, this not only improves your financial standing but helps maintain a well-kept property that continues to attract potential buyers or tenants.

FAQS

1. Can sinking fund contributions be used for anything other than maintenance?

No, sinking fund contributions can only be used for major repairs, upgrades, and long-term maintenance of the strata property.

2. How is the sinking fund different from strata levies?

Sinking fund contributions are set aside for long-term expenses such as major repairs and upgrades. Strata levies cover the ongoing operational costs and regular maintenance of the strata property.

3. What happens if there are insufficient funds in the sinking fund for a major repair?

In this scenario, the body corporate may need to ask unit owners for extra contributions. Alternatively, they may obtain a loan to cover the repair or even consider delaying repairs until they have adequate funds.

Conclusion

Sinking funds are an essential component of managing a residential strata property. They allow for effective financial planning and long-term property maintenance, ensuring funds are available for future major repairs and upgrades when needed. This approach helps maintain the overall value of your strata property, provides financial security for your investment, and ensures that residents enjoy a well-maintained and safe environment.

Moreover, many states and territories mandate sinking funds by law to ensure that an owners’ corporation or body corporate has enough money on hand for emergency repairs and ongoing maintenance. Adhering to your state’s legislation regarding capital works plans prevents any costly fines or potential legal issues related to non-compliance.

If you have questions about residential strata insurance or need help managing your sinking fund, Flex Insurance is here for you. Contact us today.