Sinking fund planning in Commercial Property,
27th June 2017
The sinking fund is a widely occurring feature in residential property but it’s also a common element in commercial property service charges, particularly in multi-occupancy buildings. Many commercial leases provide that tenants in commercial property should contribute to a sinking or reserve fund (there is a difference), with the landlord then spending the accumulated pot of funds as they see fit.
The SCSI and RICS guidance notes give us the following definitions for sinking funds and reserve funds;
A fund formed by periodically setting aside money for the replacement of a wasting asset (for example, major items of plant and equipment, such as heating and air-conditioning plant, lifts, etc.). It is usually intended that a sinking fund will be set up and collected over the whole life of the wasting asset.
A fund formed to meet the anticipated future costs of maintenance and upkeep in order to avoid fluctuations, or an anticipated large, one-off increase in the amount of service charge payable each year (for example, regularly recurring items such as external cleaning and redecorations).
So, what happens when that day arrives when a new boiler is required or lifts need replaced and the fund doesn’t have adequate resource to cover the cost? Commercial leases, generally, are structured to the let the landlord go back to the tenants for more money to make up the shortfall. However, this generally doesn’t make for happy tenants and can lead to disputes arising which will impact both cashflow and landlord/tenant relationships. Occupiers in the Irish market are still very sensitive to service charge costs and are more likely to object to these additional costs being pushed on to them.
So how do landlords and their managing agents ensure the fund they are accumulating is adequate?
- Compile an asset register of the M&E and Fabric elements of the building
- Assess the condition of the assets
- Draw up a planned preventative maintenance (PPM) programme to identify the required cyclical maintenance and eventual replacement programmes in the next 5-10 years
- Implement the programme
2. Be Transparent
Whilst most of the cyclical maintenance that arises from the PPM will be catered for within the base costs of the service charge there will be, without fail, large items of future expenditure that need to allowed for within the sinking/reserve fund. This is where transparency is vital to ensure full recovery of the required monies for the fund.
Provide a clear explanation to your occupiers of what your sinking/reserve fund is for, and how much needs to be recovered through the service charge to provide financially for the future works. Give them a vision of the plan for the next 5-10 years to allow them to budget accurately within their own business.
From our own experience, we have found the approach of providing planning and transparency around sinking/reserve funds has produced three main benefits.
1. The frequency of service charge disputes at our managed properties has reduced vastly due to occupiers being able to understand their costs and plan effectively within their own business.
2. Buildings are standing up to acquisition surveys during the sales process. Potential purchasers are finding fewer opportunities to chip away at the sales price due to poorly maintained assets.
3. Increased lifespan of the fabric and equipment with less service charge expenditure on reactive maintenance.
If you have any questions or require some advice on sinking fund planning, please do not hesitate to contact our property management team