Funding Options Capital Works

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Funding Options Capital Works
Professor Chris Guilding of Griffith University presented a session on funding capital works on common property at a recent national conference.
These works might include painting, balcony repairs and roof replacement.
He looked at the merits and otherwise of three funding alternatives:

Special levy

Debt funding (bank finance) and
 Sinking fund (savings).
The professor looked at the costs over time of the options and concluded that sinking funds accumulated over many years were for most circumstances
the preferred funding option.
On the debt funding side, there are now more options and suppliers available. The cost can be high in accord with the risks taken by the financier.
He concluded that although one size does not fit all... the sinking fund option appears to rank highest..
We hope you find his research useful.
Call our office (08 8333 5200) if your management committee or group wish to discuss funding options.
Examining Common Property Capital
Expenditure Funding Alternatives
Chris Guilding
Griffith University
1. Introduction
Motivation
No academic paper providing analysis of common property
capital expenditure funding alternatives.
Objectives
1.
Identify strata title common property capital expenditure funding
alternatives available.
2.
Develop a criteria set for appraising relative merits of funding
alternatives.
3.
Use the criteria to assess the relative merits of the common
property capital expenditure funding alternatives.
2. Criteria to appraise merit of funding options
Broad, holistic criterion
The funding approach should facilitate common property
infrastructure being of a quality and functionality that is consistent
with the level of physical, social, aesthetic and economic amenity
provided by the property infrastructure at the beginning of a strata
titled scheme’s life or to a modified level of amenity, as agreed to by
the unit owners’ collective.
2. Criteria to appraise merit of funding options
Subordinate criteria





Cost efficiency
Temporal equity (user pays)
Financial distress minimisation
Speed of fund access in an emergency situation
Minimisation of disharmony
3. Alternative ways of funding common
property capital expenditure
1.
2.
3.
Special levy
Debt funding
Sinking fund
A Working Example
200 units in a complex where $1 million is to be spent on major lift
overhaul in 10 years time. Assume sinking fund earns 4% per year in trust
account and 5 year loan can be raised at 8% pa.
Years
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
0
0
0
5
0
0
0
0
0
0.4
0.4
0.4
0.4
0
0
0
0
0
0
0
0
0
1.2
1.2
1.2
1.2
1.2
Special levy: per unit cash flow in $K
0
0
0
0
0
0
Sinking fund: per unit cash flow in $K
0.4
0.4
0.4
0.4
0.4
0.4
Debt funding: per unit cash flow in $K
0
0
0
0
0
0
4. Appraising the relative merits of the 3 funding
options
a.
Owner cost minimisation
Special levy
Administrative cost is low (few collections) if things go well, but
administratively expensive if outstanding levies result.
Outstanding levies can trigger accelerated physical deterioration
costs if common property capital expenditure has to be deferred.
Sinking fund
Funds invested in a trust account earn low return relative to:
 Alternative returns available to wealthy unit owners (stock
market).
 Cost of raising money for less affluent owners living on credit
card debt.
Debt funding
So long as loan can be arranged at a competitive rate, this option
appears to be a strong performer on cost minimisation.
Tax implications of options need to be considered if an investor
owner.
4. Appraising the relative merits of the 3 funding
options
b. Temporal equity (user pays)
Special levy
Low on temporal equity as individual may sell a unit 5 years into life
of scheme and pay nothing toward common property deterioration for
this period, as rectification work may not start until 6th year.
Debt funding
Initially low on temporal equity for same reason as above. At end of
honeymoon period, degree of temporal inequity will lessen as capital
expenditures and resulting loan servicing costs are spread evenly over
time.
Sinking fund
Due to owner payment smoothing across time, the sinking fund approach
achieves high temporal equity.
4. Appraising the relative merits of the 3 funding
options
c. Financial distress minimisation
Special levy
Special levies are not conducive to conditioning lot owners to anticipate
the amount and timing of all of their property ownership expenses.
Highest association with unanticipated levies, therefore high propensity
for triggering financial distress.
Debt funding
At end of ‘honeymoon period’, first debt funding levies can be expected
to trigger some financial distress (albeit lower than for special levy).
Sinking fund
Payment smoothing effect results in low propensity to trigger financial
distress.
4. Appraising the relative merits of the 3
funding options
d. Speed of access in an emergency situation
Special levy
Delays in agreeing to raise the special levy and then longer delays in
collecting the special levy from all lot owners can be expected.
Debt funding
Likely to be a faster source of funding, although a series of steps will
need to be taken prior to the funds being available.
Sinking fund
Fastest in terms of accessibility as the funds are already raised and
available in an account. Practicalities surrounding whether the fund can
be drawn on for non-forecast expenditure need to be recognised,
however.
4. Appraising the relative merits of the 3 funding
options
e. Inter-owner disharmony minimisation
Special levy
The immediate cash flow implications for unit owners resulting from
voting on a motion to raise a special levy signifies a high propensity to
fractionalise owner groups within a scheme.
This fractionalisation will likely be exacerbated if the special levy triggers
a number of overdue accounts that delay capital expenditure.
Debt funding
The ‘moderate’ smoothing effect achieved by debt funding signifies a
moderate propensity to trigger inter-owner disharmony.
Sinking fund
The high smoothing effect achieved by SF signifies a low propensity to
trigger inter-owner disharmony.
SF levies would condition owners to expect common property
expenditure, thereby lessening disharmony arising around expenditure
decision process.
5. Conclusion
1.
Where sinking funds are invested in low return accounts (trust
accounts) and if a loan can be arranged at a competitive interest
rate, the debt funding option may be the most cost effective
common property funding source.
2.
At a general level of abstraction, the sinking fund option appears
to rank highest on the other 4 criteria.
3.
However, consistent with many facets of strata titled property
management, it appears misguided to expect a “one size fits all”
policy to satisfy the particular needs of all strata titled properties.
5. Conclusion
A special levy approach may well be optimal in a very small complex
with low per unit common property expenditure.
A debt funding approach may well be optimal for a small complex
with readily visible common property in a wealthy rental
neighbourhood and a tax regime benign to loan cost servicing tax
deductibility.
The sinking fund approach, based on a professionally prepared
common property capital expenditure budget, likely to be optimal in a
large complex managing the organisational challenge of getting 2,000
owners to commit to common property capital expenditure, especially
where infrastructure is expensive, technologically complex or not
readily observable.
Conclusion
In further theoretical examinations of this nature
it would be helpful to:
1.
Identify the relative weightings that should be attached to the five
criteria.
2.
Determine what strata scheme specific factors affect the relative
weightings attached to the five criteria. Possible factors include:
 Size of the scheme
 $ value of per lot common property capital expenditure
 Observability of common property status for owners
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