What is a sinking fund?
A sinking fund is an amount of money which is set aside to cover any major work which is needed on a property in the future.
Such funds are quite common with leasehold properties. The fund is usually part of the service charge that is payable by each leaseholder and is normally calculated as a fixed percentage of the service charge which is reviewed on a regular basis. The amount payable is usually then put into an interest bearing account, and the interest accrued is added to the account.
How is the amount calculated?
When calculating the amount to be taken, the service management company should take into account the potential replacement costs of certain items and the average length of time that passes before each type of repair.
By way of an example, a management company should consider the cost of replacing a door entry system of a property as well as the average amount of time before such a repair is usually required. This should then be calculated into a yearly figure and this figure will form part of the total yearly charge that each resident has to pay towards the sinking fund. Other examples of typical repairs and replacements that are taken into account and for which sinking funds are used include drainage, communal lighting, footpaths and certain access roads. Certain repairs which are considered minor are paid for by the service charge. Obviously such calculations can never be precise, but if all the different scenarios are considered properly, a sinking fund can mitigate the risk of incurring large costs on a property.
A sinking fund can also be set up by private landlords; simply by putting aside a certain amount of the rent received each month. When calculating the amount to be contributed, it is common for landlords to put aside anywhere in the region of five to ten percent of the rental income to allow to be used. Of course, the use of a sinking fund by a private landlord is different as it is managed by the individual and is therefore entirely flexible.
The main advantage of a sinking fund being collected as part of a service charge is that the expenses for repairs are pre-planned rather than a call for a large amount in one go which may come as a shock to leaseholders, some of whom may not have the funds to pay.
As well as the above, leasehold properties may be easier to sell if there is a sinking fund, which may avoid a buyer being overly concerned about major works expenses.
The obvious disadvantage is that contributing to a sinking fund increases annual costs. Further, if the property does not have the need for major repairs or replacements then the amount of money that has been put into the fund is not being used properly. There can be difficulties in getting money released when it has been paid and not used.
Sometimes there are also disputes over sinking funds where leaseholders challenge management costs charged by the Managing Agents or believe that the funds have been used on areas which were not necessary for the upkeep of the block or development.
Get in touch with me if you have any issues with sinking funds, estate management or problems with Managing Agents.
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