Sinking funds

This is not to be construed as providing legal advice, or as prescribing how any particular Owners Corporation (OC) should mange its affairs. It is a summary of how come important concepts are provided for in the legislation, and how OC's might take account of those provisions when formulating their management philosophies and procedures.

The Act

Every OC must maintain its common property, and those with 4 or more units must have a sinking fund plan for doing so. OC's must adopt a sinking fund plan compliant with the Unit Titles (Management) Act (Act) 12 months after the corporation's first AGM, (Ss 81 & 84 ). A sinking fund plan must be approved for at least the 10 year period beginning on the first day of the financial year after it is approved.

The concept of “expected sinking fund expenditure” means “expenditure for … purposes that the OC reasonably expects will be necessary to maintain in good condition the common property and any other property it holds.” So on the face of the Act, it does not mean money being spent this financial year but money that will need to be spent to maintain the common property now or in the future.  This results in the sinking fund being potentially more a savings plan than a spending plan in any one year and the contributions in any one year not totalling to a spending ‘budget’. (S 83)

A sinking fund plan must be based on what it will cost to maintain all that S 83 requires the OC to maintain as and when maintenance is necessary and provide a plan for the OC having the funds needed when they are needed.  This can lead to arguments that the money is better in your bank account rather than the OC’s because your self interest means that you handle your money well.  The response is that as all owners over time contribute to wear and tear, so all owners need to contribute as they go along so that when or if they leave they leave behind their share of the long term maintenance costs of those facilities they used.

Each OC must review (and if necessary update) its sinking fund plan at the end of the plan's first four years, and at the end of each five year period thereafter. (S 85) The plan can be amended at any time by ordinary resolution to reflect changes in expected expenditure and to ensure contributions are sufficient to meet the expected sinking fund expenditure stated in the plan. (S 86)

Expenditures from the sinking fund must be consistent with the sinking fund plan. (S 88)

Each year, an OC will determine the sinking fund contribution required from its members, levied in accordance with each member's unit entitlement. (S 89).

Owners corporations must pay into their sinking funds:

  • sinking fund contributions received from members,

  • any amount received that is not required or allowed to be paid into a general fund,

  • amounts authorized by ordinary resolution to be transferred from the general fund, and

  • amounts transferred from a special purpose fund to the sinking fund in accordance with the purpose for which the special purpose fund was established. (S87 (d)).

Formulating a plan

Sinking funds must to the extent possible cater for three classes of repairs and maintenance:

  • those that are carried out in most or all years and which are readily costed,

  • those which are predictable, but are required only at longer intervals, and

  • those that cannot be forecast but which nevertheless could require significant outlays.

The plan should identify each item of common property or other asset for which the owners corporation is responsible, and quantify the funds required from time to time to maintain the property or asset in good condition.

As a first step, the Executive Committee (EC) should prepare an inventory of the common property and other assets and obtain annual and long term cost estimates for necessary maintenance, repair or replacement for each asset.  Each item should also be classified as being once off or recurrent, and the time(s) at which each category of expenditure should be estimated. If possible, the cost and likelihood of contingencies should also be estimated.

The vast majority of OC's do not have the necessary expertise among the owners.  Professional advice is going to be needed to get all the facilities and assets identified and their eventual repair or replacement costed.

The plan must cover not less than the 10 year period with 5 yearly reviews prescribed by the Act and logically should cover the longest lead time item and likewise the shortest.  That way the OC can see the full scope of its financial obligations.

Funding a plan

Having documented the maintenance program (the plan) the owners corporation must determine the funding strategy that will best suit its needs, having regard to how much money it presently has in its sinking fund or other funds that might be available for transfer to the sinking fund.

Figure 1 is intended to illustrate a plan might look. The example is of a unit plan, two years old, with one major asset requiring refurbishment every 14 years, and another every 23 years. Also included, as asset 1, are those minor maintenance activities that occur every year and can be accurately costed. This example should serve to illustrate an approach consistent with the S 82.  In this hypothetical scenario, in year 9, the OC amends its plan to include the acquisition of some new property, which will require major maintenance every 8 years. No provision has been made in the sinking fund prior to that time. The new property will benefit owners from that time on, but owners have derived no benefit prior to the acquisition.

The strategy adopted in Figure 1 is that as each major asset is refurbished or replaced, the accumulation of funds towards its next refurbishment or replacement begins, with (in this case) in addition, the amounts required to service a loan taken out to finance the purchase of the new asset as well as the contribution for its maintenance which from then on will be catered for in the same way as the other assets. Figure 1 shows 4 separate elements:

  • Asset 1, in which it is assumed that the levy is collected and spent each year with no contribution to the accumulation in the sinking fund;

  • Asset 2, which starts with an opening balance of $6,500 and an estimated requirement to increase that balance to $50,000 by year 12; and then to start raising funds toward its next overhaul in year 26 and then towards its year 40 overhaul and so on;

  • Asset 3, which starts with an opening balance of $6,000 and an estimated requirement to increase that balance to $75,000 by year 21, and then commence raising funds towards its next overhaul, which will be due in year 44; and.

  • Asset 4, requiring expenditure of $25,000 in year 9, to be repaid over 15 years at 6% and with an expected maintenance expenditure of $5,000 at the end of 8 years, and each 8 years thereafter.

The chart also shows the effects of amendments to the plan to accommodate successive reviews and updating of cost estimates, and the benefits of interest earned on the accumulated fund. The total levy column shows how the major expenditures have been “averaged out” over the thirty years covered in the chart to arrive at the amount which each year should be divided among and levied on unit owners in accordance with their unit entitlements.

The unexpected

The best laid plans can go awry and a major facility could need major refurbishment well before it is expected.

The OC has two ways to deal with this.  Because the sinking fund contribution is to the fund not to a budget, the owners corporation has a strict liability under S24 to maintain the common property and the EC is required to rectify the problem speedily and major facilities maintenance will be part of the out years of the sinking fund plan or are at least consistent with it, the EC can spend up to the balance of the fund in any one year to rectify the unexpected failure.  A wise committee would tell owners what was happening and its implications for future contributions.

If further funds are required immediately, the EC can call a general meeting and request a further contribution, often called a special levy although this term does not appear in the Acts.

As the OC has a strict liability to maintain the common property and as a corporation cannot trade insolvent, owners must provide additional funds or the EC or a member of it should seek the appointment of an administrator to force the owners corporation back into financial probity. (Div 10 of the Act).