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Rod Laws at Tinworth has confirmed that the levy to the OC isn’t a financial supply. The levy to service the loan should be an “Admin Levy” which is worth discussing with your tax adviser when you talk to them about after-tax costs.
Paul
It’s likely that the loan was approved by a majority of owners in a general meeting.
You are correct that there’s no GST on a “financial supply”. However, my understanding is that the financial supply is between the lender and the owner corporation, not the lender and each owner (and not between the owner corporation and each owner). It’s an interesting question and I’m not a tax adviser and can’t give tax advice so you must seek your own advice on this one. While you’re doing so, if you’re an investor, you might ask your adviser about the impact of the strata loan on your after-tax cost of funds.
Regards
Paul Morton
CEO Lannock Strata Finance
$7,000 is on the low side for a strata loan. Lannock will lend it to you, but as a very rough rule of thumb, a strata loan makes economic sense when the special levy would be about $1-2,000 per lot for a large property and $5,000 per lot for a smaller property such as yours.
The suggestion about instalment payments might be suitable in your case, it depends what owners can afford and how urgent the works are.
To help OCs through the virus, Lannock has a Levy Assist loan that could help. We have waived all fees, including the establishment fee so that would resolve one of your problems.
We’ve also created a special Strata Premium Funding loan which also has no fees. We have pre-approved every OC in mainland Australia for this SPF loan.
Best to ask your strata manager about the legal requirements, as this isn’t really the place for legal advice. But, very generally speaking, you’ll need to hold a general meeting.
Hi Boxfree
It’s Paul here from Lannock Strata Finance.
My first question is the same as Jimmy’s – was there, technically, a quorum when the finance issue was discussed and voted upon? If not, it’s back to square one.
I think it’s quite common for corporations to think “ok, this is easy, we’ll borrow the money and pay it off over a couple of years”. Our experience is that people who can pay a loan off in a year or or two could almost as easily have a single special levy or a levy payable in a few installments.
Lannock will lend for as short a period as a few months, but in practice, most people borrow for 7 years with quite a few borrowing for 10 or more years.
As we are lenders to the corporation, our suggestion would be to talk with your other owners with a view to having the loan term changed at the next GM or to hold an EGM. in the meantime, you could ask the committee to consider drawings funds with an initial “interest only period” – this would halve the corporation’s cash outflows.
Whatever you do, don’t be in arrears as then you’ll be unfinancial and unable to vote in any meeting.
Please give us a shout if you’d like us to come and talk to the committee or to a general meeting.
Regards
Paul
paul@lannock.com.au or 1800 85 15 85
Hi Swoo
The owners could consider a Lannock Strata Loan – this would avoid having to pay large amounts of money upfront but still allow everyone to get the benefit of the works being completed now. Please click on the banner ad at the top of the page to check out our website (www.lannock.com.au) or call us on 1300 85 15 85.
Regards
Paul MortonHi Bonnie
It’s Paul from Lannock Strata Finance. The simple answer to “20% of what?” is “20% of the total capital works would come from the sinking fund”.
The real value is in understanding the reasoning behind this. Using a sinking fund to fund 20% of the works means that you would be using borrowed funds to supply the other 80%. Why is this good? The answer is all about risk and return.
We know from finance theory that equity is expensive and borrowing is cheap. But the problem with borrowing is that it increases financial risk. 100% equity (ie, 100% sinking fund) is the least risky but the most expensive option. Change that to 1% borrowing and 99% sinking fund and cost goes down and risk goes up. The trick is to find the optimal amount, the best ratio of borrowing to equity.
There are so many practical examples where we land on 80% borrowing and 20% equity – for example, buying a house is usually 80% borrowing and 20% deposit (equity). And large sophisticated finance structures such as leveraged leases which provide the funding for ports, ships, pipelines etc almost always come out at 80% borrowing and 20% equity.
You’ve probably heard us at Lannock say that there is no one size fits all in strata – there’s no single funding solution that is right for every body corporate because each situation (and every owner) is different. That’s worth repeating – no one size fits all because every property and every owner is different.
This means that in some cases it will be all borrowing, no sinking fund. In some others, all sinking fund and no borrowing. Mostly, it is a combination of the two that will produce the optimal mix of reduced cost without too much risk.
However, if in theory you just had to have a single rule for all strata, it would be to set the sinking fund of 20% of the anticipated major capital works. 100% sinking fund will be the most expensive option and is clearly inappropriate.
Sorry for such a long reply but I trust this helps.
Paul Morton
CEO, Lannock Strata Finance
@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’ve used these aps on an Android phone. I compared 3 aps and their readings differed by 20 decibels! They’ll be useful for owners wanting an initial handle on a problem and to get a discussion started. Anything more would require the independence and professionalism of a qualified third party.
paul@lannock.com.auThis discussion leads to several interesting areas.
For example, how many landlords are happy with their tenants?
Maybe this is a job for Bill Randolf and his team at the Faculty of the Built Environment at UNSW.
But there’s an important underlying issue here and a major fallacy. Most people think about strata in terms of residential owner-occupiers and that just isn’t so. Apart from the many commercial and industrial strata schemes, the majority of strata lots are owned by investors! About 53% in NSW and an estimated 60-65% in Qld and Victoria. Take away investors and you take away a lot of value. And take away investors and the housing stock in Australia suddenly plummets leaving people homeless.
And this leads to some interesting maths. Owner-occupiers deserve their say. And similarly investor owners. But so do tenants. So for every 100 strata lots, we have 160 people with a vested interest!
It’s been suggested in the past that tenants should have the same rights as owners which is clearly a nonsense. But, tenants (and investors) are the majority and need a better way to communicating their issues. The current link from tenant to property manager to owner to OC breaks down too often.
Scotlandx makes a good point about the psychological benefit of people realising they have to pay. I’m amazed how often people seem to think that cleaning, gardening, management and capital works all come free! Every funding situation is different and there’s no ‘one size fits all’ solution. The answers lie in planning and transparency, not in mandating one alternative or another. Special levies, sinking funds and loans all have their individual attributes which will apply more or less in each situation and each have costs and benefits that need to be weighed up in each situation. Paul Morton. paul@lannock.com.au
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