Does your sinking fund cost you money

@PeterC said:
Not just who pays but whether they will pay! If you try to get people to pay for the required work via a levy or taking a loan there is a good chance people will vote to do nothing and spend nothing. If you have a sinking fund plan in place and the levy is planned and on a schedule etc. people get used to it and don’t complain (at least not as much). If the plan includes a contingency component and something unexpected needs doing, or you even propose an improvement to the common property, there is a chance it will be approved because the money has already left people’s pockets. 

There are savings to be made from attending to work in a timely manner as well. 

I agree.

My preference is to have slight increases in levies over the years than Special Levies, or Loans.  Now I am not working full time and prefer to have an idea of my quarterly costs if at all possible.  I realise there will always be emergencies and not enough money available, but at least there is some.

Loans have charges and interest rates do not always stay low.

I’m pleased to see the comments that the article Jimmy published has generated.  Sensible, educated discussion about strata economics is finally starting to become mainstream which is great.  There are too many ideas raised in the comments for me to respond to them all but here are some high level responses to some of the ideas:

“Who pays?” – the undeniable fact of strata is that everyone always pays, all the time.  During the 15 year life of a carpet, you’re either paying as you go in the form of regular levies to a sinking fund; or  later in its life with a larger, one-off levy to replace it; or in reduced capital appreciation of your unit.  The user is ALWAYS paying and you only have a choice about the form of payment.  If you have levies to a sinking fund, then you need to offset them against the appreciation in your property to work out the true return.  Ditto for a special levy.  If you’ve not had any levies, then you’ll have paid in the form of reduced appreciation.  If you’ve borrowed to fix the carpet, then you get the uptick in value from a better presented property and you have to offset the cost of borrowing against this.  Because you’ll always pay, it’s important to consider the relative advantages and disadvantages of each form of funding, especially costs and  borrowing is often a cheaper option.

“Why borrow?”  Strata corporations should borrow for the same reasons people and companies borrow.  First, it’s an enabler, you can do things you otherwise wouldn’t be able to do.  Most people don’t buy a property without a component of debt.  Many people don’t even buy shares without a debt component.  Many people wouldn’t renovate their house without some debt.  Next, it’s a tool for increasing your return.  Equity, your own money, your hard earned cash, is expensive.  The cost of debt goes through cycles, but it’s when you put debt and equity together that you reduce your ‘weighted average cost of capital’ and that increases your overall return.

“Is borrowing good or bad?”  It’s neither.  Or, more accurately, it depends on your situation.  If you’ve borrowed and the Return On Investment is positive (that is, the increase in value exceeds the cost of borrowing), then it’s clearly good.  If your project has negative returns, then borrowing will only put you further down the tube. I would be careful about the analogy with a car because a car is rarely an asset, it depreciates and the amount you put into maintenance serves only to keep it safely on the road and to prevent it depreciating more quickly.  Car maintenance is an expense, not an investment and it doesn’t turn a depreciating means of transport into an appreciating asset.

“Levies, planning and budgeting”  Strata borrowing isn’t a last ditch tool if you’ve no alternative.  Planning and budgeting doesn’t mean you don’t borrow, it means you consider the situation carefully and work out the right mix of debt and equity, just as you would do in any other important investment decision.  Sometimes it will be all debt, sometimes all equity.  Often it will be a carefully planned mixture.

People often get unnecessarily hooked up on Admin Levies, Sinking Fund Levies and Special Levies.  Sometimes the distinctions are important, especially when you look at the tax profile and the purposes to which various funds can be put.  But there are really only two kinds of levies in strata.  You can have a large number of small levies (such as to a sinking fund or to service a loan) or a small number of large levies (ie, a ‘special’ levy).  Each situation is different and requires owners to work carefully through the issue to work out which, or what mix, is right in their situation.

Finally, please don’t confuse strata finance with personal finance.  Personal finance is almost always for consumption – we ‘consume’ a holiday or transport (by buying a car).  Strata finance is invariably funding to improve the value of, and your return from, an asset.

By the way, if you’d like to talk through the analysis, give me a call on 02 9357 5371 or drop me a line at paul@lannock.com.au.

Paul Morton

Lannock Strata Finance

I don’t necessarily disagree with strata loans, although in general I am not keen on them, they may have a place in certain circumstances.

In terms of Why Borrow?  You refer to it being an enabler, i.e. to allow the OC to do something it otherwise can’t do.  The OC has an obligation under the Act to maintain the property, it doesn’t have a choice.  One thing I like about requiring contributions to be made to the sinking fund is the psychological effect, many owners don’t realise or don’t want to realise that they have an obligation to maintain and upgrade as necessary, and make sure they have funds set aside for that purpose.

@kiwipaul said:
I understand the process of a Strata loan for major expenditure but what I would like to know is can some owners opt out of participating in the loan and instead pay the required contribution for their lot, hence avoiding having to pay interest on the loan.

If certain owners have the cash available to cover a  special levy can they just pay it and not have to participate in the loan or once a loan is approved by the OC does everyone have to participate.

I would imagine this would apply the same throughout Oz not just in NSW.

I’ve heard of all kinds of weird and wonderful arrangements for opting in and out, but can’t recommend any of them. It comes down to the nature of OC funding and levies. 

If an OC needs funds, it can borrow or levy.  But levies are applied to everyone in proportion to their unit entitlements, there’s no provision in strata law to levy some owners and not levy others. 

Of course, the owners who want to pay upfront could lend the money to the OC, but that’s the beginning of a lot of hassle, complexity and uncertainty.  The OC will have to calculate interest and repayments, that’s not easy and people will get very upset if everything isn’t just so.

A better way to think of this issue is to pose the question:  “If I’m an owner who wants to pay upfront, why should I agree to the strata corporation borrowing?”

There are several reasons.  The first is just being practical.  The most important thing is to get the right works done by the right contractor in the right way.  The biggest bang for your buck, the best return on investment of money and time, comes from making sure you are doing the right works.  If you attempt to force a special levy, the works proposal might fall over because others can’t afford the special levy.

The second relates to your own cost of funds.  Money is never free, you have to find the cash for a special levy from somewhere.  If you have credit card debt at the end of each month, your cost of money is around 20%.  Or perhaps you have to sell shares to pay for the special levy, your cost of money is the lost return on your shares.  Or perhaps a special levy means you’ll have to delay that holiday, or not have cash to give to the kids, or not buy that car.  Many owners underestimate their own cost of money.

Paul Morton paul@lannock.com.au

I couldn’t agree more with just get on with it.  Strata finance companies aren’t lending money out of the goodness of their hearts and the interest rates are relatively high.  In terms of cost of money, it is usually cheaper and more efficient for each owner to raise the money themselves, and the OC isn’t carrying the loan on its books.