Are Sinking Fund Forecasts Useful or a Waste of Your Budget?

A sinking fund forecast is a report, drawn up to give an estimated forecast of a property’s budget. This kind of report takes into account past expenditures, along with future financial liabilities, such as building maintenance and repair work, to give an accurate suggestion for the building’s budget moving forward.

As of July 2009, all NSW strata schemes have been required to maintain a 10-year sinking fund plan, per the Strata Schemes Management Act. The Act requires all owners’ corporations to make plans concerning how they will maintain and repair common areas and how they will raise sufficient funds for all incurred costs.

How much money each strata scheme has to allocate for repair and maintenance will vary, dependent upon the age and condition of the building and property. Older buildings will require larger budgets for maintenance and repairs than newer constructions. For this reason, every sinking fund forecast must be different to reflect the individual needs of each scheme and building.

The 10-year sinking fund forecast must be approved by the owners’ corporation at the annual general meeting, and it must be revisited, reviewed, and adjusted as needed within the first five years.

Who Prepares the Forecast?

Traditionally, strata scheme executive committees or owners’ corporations have prepared these reports themselves, without the aid of expert assistance. Some schemes still do this, but more and more owners’ corporations and executive committees are choosing to seek out expert help to ensure that all potential future liabilities are accounted for in the plan.

Proper forecast preparation is an intricate process, involving special skills and access to relevant data. Strata schemes that have experienced the pains and hassles of ill-prepared budget reports in the past almost always choose to have their sinking fund forecasts prepared by outside experts.

Executive committees and owners’ corporations seeking this kind of help should beware that some sinking fund forecast providers claim to offer expert forecasting services but are not sufficiently qualified to perform the task. Always perform due diligence when choosing service providers, especially for budget forecasting.

What to Look in a Provider?

Here’s a handy checklist for qualifications to look for in sinking fund forecast providers.

• They hold memberships with relevant professional associations, such as Engineers Australia or the Australian Institute of Quantity Surveyors
• They hold a membership with the Community Titles Institute (ensuring that they are qualified to make forecasts for buildings with common areas)
• They have all appropriate qualifications and a significant amount of experience
• They are properly insured for public liability, professional indemnity, workers compensation, etc.
• They include a comprehensive inspection of your site in their condition assessment

The Preparation Process

Once you’ve chosen a service provider for your forecast, they will commence a process that involves three main stages: determining quantities, condition assessment, and replacement costs. Let’s walk through the basic elements of each stage.

1. Determining Quantities

In this stage, the quantities of equipment, plant, and components of your building will be determined by a quantity surveyor, along with their requirements for maintenance, renewal, and replacement in the coming 10 years.

2. Condition Assessment

Next, a condition assessment is performed of all of the components of your building and property. The surveyor will evaluate the level of consumption and/or degradation that has already occurred and predict future needs for maintenance and replacement by modelling a degradation pattern and predicting the remaining life cycle of all components.

This part of the process can be affected by the maintenance programmes you have in place for your site. Discussion with your site staff and facilities management team is essential for this part of the process to gain an accurate picture of the future. This stage is best performed either by a quantity surveyor or engineer, as they are most familiar with the processes involved in the mechanics and maintenance needs of building components.

3. Determining Replacement Costs

Replacement costs should be presented in the report in present value dollars.

Again, a quantity surveyor is generally the best choice to perform this task, as they have access to industry libraries with specific replacement costs, allowing them to provide the most accurate estimates for the report.

Benefits of a Sinking Fund Forecast

To demonstrate how valuable having an accurate sinking fund forecast and 10-year plan can be, let’s look at the example of a 20-year-old, refurbished commercial building. From inside and out, the building, which had been refurbished as a strata titled residential high-rise with about 100 units, looked brand new.

Because the building looked and felt so new, no one thought that the lifts might need to be replaced sooner rather than later. The starting balance of funds for its plan was set at zero. No one considered that the lifts might have to be replaced within its first 5-10 years as a strata scheme building.

In this case, the cost of replacing the lifts totalled an estimated $250,000 per lift. With three lifts, that was a grand total of $750,000. Though each lift was replaced separately, over a period of about 9 months, the project had to be budgeted as a single work, within a single timeframe.

If the building had been a strata scheme from the beginning of its life cycle, and a sinking fund forecast had been performed, the price of lift replacement would have been factored into the pricing of the lots and owners’ fees over the life of the building. At $750,000, taking inflation out of the equation, over the span of 20 years, with 100 units, each owner would have paid about $375 per year toward new lifts.

The building was not always residential, though. So, if replacement of the lifts had been factored into a sinking fund forecast when the building was refurbished and converted to a strata scheme, the owners would have paid for the replacements as part of their purchase prices. As it was, though, with the replacement cost not factored in, each unit had to pay closer to $1500 per year to cover the cost of the new lifts for 5 years.

$1500 per year may not break the bank for most owners, but levying extra fees on owners like this can be very detrimental to the value of the property. An accurate sinking funds forecast could save huge headaches, incurred fees, and decreased property values.

Tax Benefits for Investment Property Owners

As an investment property owner, you might be interested in how sinking funds can be beneficial to you. If, taking the same example as before, the lifts did not last the full 25 years as expected, but needed major work after 22 years, the owners would be required to submit to a special levy of $700,000, which would be $7000 per unit.

Because special levies are considered to be capital expenditures by the ATO, they are not claimable within the tax assessment year. This one-time payment, therefore, would not be considered a taxable expense against the property. It would, though, be written off over time, as per the ATO’s property depreciation guidelines.

However, while special levies are not considered taxable expenditures, yearly sinking fund payments are tax deductable. That means, if your building has an emergency that requires a sinking fund levy, you may or may not see write offs for it over the coming years. However, if you have a substantial sinking fund plan that requires annual payments, you can write those off on your taxes every year.

External Benefits of Sinking Fund Forecasts

A well-maintained building is likely to have a much better resale value than one that has been poorly maintained. Getting professionals to perform your sinking fund forecast can ensure that your building has the budget available to perform maintenance as it is needed and keep the property value of the building up throughout its life cycle. Getting this service performed can also lower your building’s risk profile, which makes it even more attractive to potential buyers.

In Summary

Enlisting experts to perform a thorough sinking fund forecast and implementing a good 10-year plan can benefit you and your building in a number of ways. These benefits include, but are not limited to:

• Better cash flow for maintenance and repairs
• Decreased risk profile, giving potential buyers more confidence
• Potential improvement in resale value
• Tax deductions for property investors as levies occur
• Identification of potential maintenance, repair, and replacements well in advance so that owners are forewarned of expenses

In conclusion, is a sinking fund forecast a waste of money? Absolutely not. These plans can reap serious benefits for the property and owners.