This article about the reserve fund expenditure budget and the 10 year plan has been written by Kaylene Arkcoll, Leary & Partners.
The annual budget process requires lot owners to consider two separate questions.
1. What maintenance, repair, renewal and replacement work do we expect to do next year?
The answer to this question becomes the list of work voted on and approved by the lot owners at the annual general meeting (the approved reserve fund expenditure).
The 10 year plan will help identify work that should be considered for inclusion in the budget. However, the fact that you have a 10 year plan which predicts a work item will occur next year does not automatically mean the work item should be included in next year’s reserve fund budget.
The forecast timing of work in the 10 year plan is based on typical wear and tear levels and typical item lives. Your external painting may have weathered better than was initially expected. Conversely, your carpet may require early replacement because of staining. The annual expenditure budget should always reflect the actual maintenance
requirements of the scheme. Regularly updating the 10 year plan ensures that the variations between actual and forecast work do not create a long-term funding inconsistency.
2. What reserve fund levy should we raise to cover both the cost of next year’s proposed reserve fund expenditure and the future-year expenditure identified in the 10 year plan?
The purpose of the 10 year plan is to answer this question.
How do we use the 10 year plan to set our reserve fund levy?
Section 77(1)(h) of the Regulation requires the 10 year plan to contain “a plan or recommendation for the funding of the estimated costs for the maintenance, repairs, renewal or replacement” identified as occurring during the plan period.
Expressed simply, section 77(1)(h) requires the preparation of a cash-flow projection which shows the expected annual outgoings, along with the proposed funding/levies and then demonstrates that the books can be balanced.
The legislation does not specify that the funding plan must be calculated in a particular way. A strata company is free to recommend and adopt any funding plan which sets out a reasonable method of payment for the identified future costs. For example, a strata company can choose to take out a loan to pay for a major expense as long as they incorporate the finance costs into the funding plan.
However, section 100(2)(a) states that the purpose of the reserve fund is to “accumulate funds to meet contingent expenses… likely to arise in the future”. This reflects the expectation that most schemes will have a funding plan which is based on a progressive contribution toward future expenses. Our experience from equivalent interstate systems is that over time Administrative Tribunals increasingly default to requiring a planned progressive contribution unless there is a convincing argument for an alternate funding approach.
The unique feature of an ‘accruing’ reserve fund levy is that the levy in a particular year is not based directly on the approved expenditure for that year. In years when little maintenance, repair, replacement or renewal work is required, the levy builds up the reserve in the fund to pay for future large expenses. In years when high costs such as external painting occur, the fund reserve is used to off-set the expenditure and avoid a special levy.
The reserve fund balance must remain positive. The levies should equitably spread the cost over the plan period without accumulating excessive cash reserves. This requires careful financial modelling. Over a 10 year period, ensuring the accuracy of these calculations is at least as important as ensuring the accuracy of the initial inspection information.
If a professional consultant prepares your 10 year plan it should include a full cash flow analysis. The report’s funding plan and recommendations should:
- Recommend the amount of money the strata company needs to deposit in the reserve fund each year to pay for future expenditure without requiring major variations in levy amounts or special levies.
- Demonstrate how the recommended levies and fund balances relate to the ongoing future expenditure.
- Provide sufficient detail to enable you to adjust for minor variations in planned expenditure during the period between forecast updates.
This post appears in Strata News #431.
What’s the Purpose of My Reserve Fund’s 10 Year Plan?
After receiving their strata company’s 10 year plan, many lot owners ask us “What do I do with it now?”. They know the strata company must have a 10 year plan but they don’t understand its purpose or how this affects the type of report they should commission.
So, what is the purpose of a 10 year plan?
Section 100 (2)(a) of the Strata Title Act 1985 requires the strata company to establish a reserve fund:
“for the purpose of accumulating funds to meet contingent expenses… and other major expenses of the strata company likely to arise in the future”.
Section 100(2A)(a) requires designated strata companies to have a 10 year plan that sets out–
- “the common property and the personal property of the strata company that is anticipated to require maintenance, repair renewal or replacement (other than of a routine nature) in the period covered by the plan; and
- the estimated costs for the maintenance, repairs renewal or replacement; …”
“The 10 year plan is aimed at assisting the strata company in deciding how much money it should set aside in their reserve fund.”
How does the purpose of the 10 year plan influence its contents?
The 10 year plan is a budget document. Its primary function is not to act as a detailed maintenance manual or specification. Knowing this when preparing/commissioning the 10 year plan may save the strata company time and money.
Section 77(3) of the Regulations lists infrastructure items which may need to be included in the 10 year plan. Section 77(6) of the Regulations also contains a list of information about the infrastructure which, depending on their circumstances, the strata company may decide to include in the 10 year plan.
We are observing an overemphasis on identifying and assessing the current physical condition of the scheme (which is important) and not enough focus on the quality of long- term cash-flow calculations required to assist the strata company set reserve fund levies.
Many lot owners do not appear to understand that:
- Common property infrastructure only needs to be documented in the 10 year plan if it is likely to require maintenance work during the plan period (the “covered items”).
- It is only necessary to document the “covered items” in the detail and format required to broadly assess their condition and estimate the cost of future maintenance.
- The extent of section 77(6) discretionary information which the strata company includes in their 10 year plan should be determined on a scheme-by-scheme basis to match their specific needs.
The most important questions you should ask when you read your 10 year plan are
- Can I clearly understand what the major reserve fund expenses will be in each year of the 10 year plan?
- Does the 10 year plan provide clear advice about the levies we should collect annually to fund the future work?
This post appears in Strata News #417.
Have a question about the purpose of the reserve fund’s 10 year plan or something to add to the article? Leave a comment below.
- WA: Strata Reform Seminar Session 2: 10 Year Maintenance Plans
- WA: What is ‘Personal Property’ of the Strata Company?
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