Reserve and Sinking Funds
Most leases will usually allow the building up of funds to give a safety net for both planned and unplanned long-term expenditure. One is known as a reserve fund and the other is known as a sinking fund.
A buildings surveyor can put together a capital expenditure (CAPEX) report which will highlight how much is required to place in these funds each year.
Although the terms are used interchangeably, they both work in completely different ways.
A reserve fund is used to put aside money over a short period (a couple of years or so). It doesn’t need to be a large amount and it can be drawn upon should the service charge account experience a shortage or if it is actually empty (which has happened to our block of flats in the early days of management). Whilst some leases may clearly state how much the contribution to the reserve fund should be, other do not and it will be up to the freeholder to determine how much leaseholders should contribute but of course, it should be reasonable. It is also easy to gain access to it.
There are several advantages to having a reserve fund:
- It helps deal with any overspend on the service charge account (like an overdraft) because estimating the costs of running building for the next year is not an exact science;
- It acts as buffer for leaseholders, reducing the chance of them being hit with a larger bill than they were expecting;
- It helps to recover unexpected costs such as through a sweeper clause in the lease, but such a clause does not necessarily means that costs can be recovered in this way.
A sinking fund, whilst similar to a reserve fund it is set aside for larger, less frequent repairs, such as replacing a roof, windows or lifts as a building ages. The lease should set out what the sinking fund is to be used for and it is usually paid on the same percentage charge as the service charge contribution. How much should be paid is usually determined by a cyclical maintenance report carried out by a qualified surveyor. This report will find the parts of the building that will need replacing over time and the prospective cost which in turn is divided by the years expected to pass before the work is required.
Holding the sinking fund in trust (with a Trust Deed) will avoid the consequences of an insolvent freeholder where the liquidator may try to seize the fund if it is not clearly designated as a sinking fund. The account should also give a good rate of interest (just like the service charges) but care should be taken of any limitations set down in the Memorandum and Articles of Association (or other documents).
The only time the sinking fund can be drawn on for any other purpose is when the lease permits it to be used temporarily to finance the cost of routine services.
Unless the lease states otherwise, both funds are not refundable when a flat is sold and even at the end of the lease term, the leaseholder is still not entitled to repayment of the contributions made during the time of ownership.