Articles

Rising building costs and sinking fund levies

Rising building costs and sinking fund levies

Bodies corporate are required by law to collect sinking fund levies (the sinking fund is a savings account), which will provide for at least 10 years of future capital repairs and maintenance.

This levy system allows owners to put money aside each year so that the body corporate can achieve major projects like painting, driveway resurfacing, carpet replacement etc and to fund that work from existing savings.

The law also requires that the body corporate set a budget each year, and set the sinking fund levies based on an expenditure forecast for the current year, plus nine future years. That expenditure forecast document is generally called a sinking fund forecast.

To recap:

  1. Body corporate must collect sinking fund levies.
  2. Levies must be based on a sinking fund forecast.
  3. Forecast must include 10 years of future costs.

Sinking fund levies typically increase every year

Sinking fund forecasts should be prepared professionally by a quantity surveyor or valuer. When preparing the sinking fund forecast, the quantity surveyor will take inflation into account. Predicting costs for the next 10-years relies on average construction cost increase data, and estimated figures.

For example, the cost of painting the building in 2032 is going to be higher than the cost of the same painting in 2022. Labour and material costs can be expected to rise, and that is factored into the sinking fund forecast report.

Annual levies are set to achieve the following goals:

  1. Make the payments as consistent as possible, with a gradual inflationary increase.
  2. Bring enough money in at the times when the body corporate is expected to need it.

Building costs are surging

At the time of writing this article, building and construction costs are reaching record heights. Generally attributed to the COVID-19 pandemic, the cost of labour and materials is increasing sharply across Australia, including in Queensland.

What does this mean for bodies corporate? The painting job that was expected to cost $120,000 when it was forecast in 2018 might now cost $150,000. That leaves a gap of $30,000 between the project cost and the available money in the sinking fund.

When the sinking fund forecast is updated with the new figures, the sinking fund levies will need to rise to catch up to the increased construction costs.

What can knock the sinking fund off-course?

Most bodies corporate reliably follow the sinking fund forecast income recommendation, however the ongoing balance of the sinking fund can be influenced by the following events:

Work came in over or under budget

The quantity surveyor would do a much better job of estimating costs than the average person, however these are still estimates and will depend on the individual contract at the time the work is required.

Work was brought forward or pushed back

Sometimes the quality of a building requires that work be brought forward or delayed. The quantity surveyor will base estimates on the average maintenance life of building elements, however ongoing maintenance work, original quality, weather exposure and many other factors can mean building elements can last a shorter or longer time than the estimate.

Unexpected work came up

The sinking fund forecast only considers capital repair/maintenance of the existing building. Any building upgrades (e.g. installing CCTV cameras, upgrading from chain-link fencing to timber) will be an additional cost which the sinking fund didn’t consider.

When the sinking fund forecast is reviewed every 5 years, the balance will nearly always be higher or lower (often lower) than the predicted balance. If the fund has a lower balance because of the factors above, then the next few years of sinking fund levies generally need to rise to catch up to the target.

Levy recommendations increasing

Our team and clients are seeing sinking fund levy recommendations increasing when the sinking fund forecast is reviewed every 5 years. Remember, the quantity surveyor sets the fund targets and the levies required to achieve those targets.

In the current economy, 5 years ago the quantity surveyor may not have anticipated that construction costs would have risen so sharply for the last 2 years. Those levy recommendations from the last report may need to increase substantially to catch up to the current construction cost reality.

What if the owners do not accept the sinking fund levies?

The committee is required to provide sinking fund budgets to owners, for approval at each annual general meeting (AGM).

It is a legal requirement that the body corporate maintain the common property, so it is generally not possible for the body corporate to reduce its capital repair and maintenance spending. Put simply, if the building needs to be painted, the body corporate is required by law to paint it.

If owners reject the sinking fund levies, the sinking fund may not have sufficient money in it when those jobs need to be carried out. Where there is an insufficient sinking fund balance, the body corporate will generally need to issue special levies to bring in the missing amount needed to fully fund the work.

Building maintenance costs what it costs, the only question is whether that money has been put into the sinking fund by owners over the last several years.

Stay up to date with BCsystems strata articles