If you’re a leaseholder or first-time director, you might feel overwhelmed with the financial obligations a Resident Management Company (RMC) has to keep a development functioning to a high standard.
According to government statistics there were 4.6m leasehold properties registered in England in 2018/19 - nearly a fifth (19 per cent) of all housing stock. It’s therefore integral to the housing market that these estates are managed properly, with the correct reserves in place.
Enter the reserve and sinking fund. These two money pots are an integral part of any RMC’s budget to reduce financial risk and stop large, unexpected bills being put onto leaseholders. These funds can make all the difference in covering unexpected and large expenses.
We’ve got everything you need to know about reserve and sinking funds, why they’re important and how you can implement them into your estate’s budget.
What are sinking and reserve funds?
Sinking and reserve funds are like an emergency savings account and a long-term savings account in a household budget. The reserve fund is for one to two years’ worth of money to cover any emergency repairs or maintenance, like burst pipes or roof repairs. It’s a financial cushion that protects leaseholders from unexpected charges.
A sinking fund isn’t always a requirement in a lease, but it’s a vital part of any budgeting for an RMC. The sinking fund covers larger but planned expenses, which are often addressed in a property’s lease. These could include changing the carpets every 15 years, or external painting to be completed every five years.
Who sets the fund levels?
Reserve and sinking fund amounts are usually set by the RMC’s directors, a management company hired on behalf of the RMC, or the landlord themselves. Deciding on the amount of money in each fund depends on the size of the estate, what kind of works are in the lease and how much money is already saved up.
If it’s a large or complex estate, the directors could choose to bring in a financial advisor to help them make informed decisions about how much money is best for each fund. With many upcoming expenditures to budget for, directors and freeholders may consult on the leaseholders to give their views on what’s a priority. However, this isn’t a requirement.
Having these reserves in place takes some forward thinking about what might affect the property or development in the future. In a new build it can be tempting to assume everything is fine and skimp on the reserves, but then lack any funds when the 10-year NHBC guarantee is up. Scrambling to find the money for works pushes up the service charges for residents - and nobody wants an unanticipated bill.
Why reserve and sinking funds are important
These two funds go a long way in securing buy-in from residents. Sinking and reserve funds keep service charges steady for leaseholders - adding hundreds of pounds extra each month on service charges to pay for a bill is often unaffordable and always unpopular. Residents want and deserve stability, and having reserves in place offers this.
A well-stocked reserve and sinking fund allows for flexibility in the estate’s budget. Sometimes the emergency repair fund doesn’t need to be used for a few years and there’s a surplus available. This money can then be reallocated to the sinking fund, spent on improvements rather than maintenance, or even refunded back to the leaseholders.
Properly funded reserves will also eliminate any accusations of mismanagement towards directors and inspire confidence in leaseholders that the RMC is well-prepared to handle a range of situations. This can be helpful if residents have previously issued complaints about service charges, or to ward off any potential disputes in the future.
Finally, these funds can increase the value of a property and its saleability. This is especially true for smaller blocks with large upcoming projects, like a new roof. When conveyancers are looking through the lease and any Section 20 notices, having a sinking fund already planned for will reassure potential buyers they won’t be stuck with a large bill once they complete. Not to mention, it’s difficult to sell a property that has sky-high service charges each month.
Top tips for planning ahead
There are some simple steps you can take to ensure your development is properly budgeted for in the short and long term.
If you don’t have one already, a sinking fund will help with the bigger projects detailed in a lease. Both funds should be held in bank accounts that are separate to service charges. This is to avoid the reserve fund being used for any overspend in the budget - a further collection should be taken from leaseholders in this instance.
The next step should be to decide on a works schedule. If the carpets are needing to be replaced soon but there’s no stipulation for the work to be done in the lease, include it in the capital expenditure plans for the development. Assessing the condition of the property and getting quotes from reputable contractors can help this process.
If you’re not sure how much to allocate for each fund, take a look back at previous service charge records and see what kind of maintenance has been done before, and how much it cost. This should give you a starting point on how to split the sinking and reserve funds. Hiring a financial advisor to help with projected costs may be an expense, but a worthwhile investment if they can help set the estate’s budget up for success.
When in doubt, pay more into your reserve and sinking funds than you think - especially for the former. Planning for an emergency and having more to play with is better than falling short and asking residents to pick up the remaining bill.
On this note, communicating often with leaseholders about sinking and reserve funds so they understand the charges will be a huge benefit to all those involved. The world of leasehold is often murky and incomprehensible to the layman, so laying out which fund pays for what kind of things will help residents feel included in the decision-making process.
The importance of reserve and sinking funds shouldn’t be underestimated. They play a large part in keeping an RMC on a steady road, rather than constantly having to find the money. Landlords and residents alike should invest some time and potentially in budget for sinking and reserve funds so the estate management can work smoothly for years to come.
At Save My Service Charge, we’ve got years of experience in helping residents and directors establish these funds and much more. Get in touch if you need some advice on how to get started.
Ben Taylor, Director at Save My Service Charge
