The key differences between Reserve Funds and Sinking Funds in Property Management

Residential blocks of flats

Reserve funds and sinking funds two concepts for block management. While both are important for the longer term maintenance of blocks of flats, there is a distinct difference between the two. Let’s take a closer look at what these funds are and why they are so important in property management.

What is a Reserve Fund?

A reserve fund is an account with money set aside to cover future costs related to the refurbishing or replacing of common elements of a property. This includes expenses such as structural repairs, painting, landscaping, or major replacement of assets like elevators, boilers, or gym equipment. The purpose of a reserve fund is to ensure that all common areas (e.g., hallways, gardens, etc.) remain in good condition over time and that the building will be maintained safely and properly for leaseholders, residents, and visitors alike.

The amount that should be allocated to a reserve fund depends on the size and age of the building, as well as the expected lifespan of its assets, like the ones we mentioned earlier. Additionally, any special features or amenities included in the building will also influence how much money should be set aside for reserves. The main goal for a reserve fund is to have enough money saved up over several years, through contributions via the service charge typically, so that when it comes time for repairs or replacements, there won’t be any unexpected financial surprises, making financial management for leaseholders much easier and more transparent.

What is a Sinking Fund?

A sinking fund functions similarly to a reserve fund but with one key difference—the money saved up in this type of fund is used exclusively to replace major assets of the property rather than just performing regular maintenance on them. This could include things like replacing roofs or windows after their expected life cycle has run out or even installing new mechanical systems if needed. It’s important to remember that this type of fund isn’t used for day-to-day repairs; instead, it’s meant to cover large-scale replacement projects that can’t be taken care of with regular maintenance alone.

Where are Reserve Funds and Sinking Funds kept?

Both Reserve Funds and Sinking Funds are still subject to Section 42 of the Landlord and Tenant Act 1987 which states that the money raised for these funds should be held in a trust account on behalf of the Landlord (which could be the Freehold Company or Management Company and so on). In some instances, like Strangford Management, we create a physically separate bank accounts for these types of funds to ensure they are entirely ring fenced, providing balance updates to our clients each month.

How much money should be in a Reserve Fund or Sinking Fund?

As mentioned earlier, this does depend on several variables including the size, age of the development, and overall lifespan of the asset that the fund is saving towards replacing. One essential way to equate how much should be in your fund/s is to engage a qualified RICS surveyor to undertake a ‘Capital Expenditure Plan’, or a CAPEX as we call them. They surveyor will attend the development to review all assets, from roofs and windows, to lifts and internal systems. They will then provide a detailed report, typically spanning 5, 10 or 20 years, to note how long each asset has before it’s expected lifespan comes to an end and will require replacement or at the very least, refurbishment.

You can then use this CAPEX plan, along with its costs, to formulate a long term financial plan for the development, which can then be the basis of the amount charged out to leaseholders each year. It is also worth saying that these plans do need to be reviewed and updated annually and whilst they give a good indication of what should be contributed, this is only an estimate and costs are subject to change over the years, especially with a longer term plan such as a 20 year CAPEX.

In Conclusion:

Reserve funds and sinking funds are both important concepts in property management because they help ensure buildings remain safe and well-maintained over time while also helping leaseholders prepare financially for potential replacements down the line. By setting aside money now instead of waiting until an emergency arises later on, owners can avoid unexpected expenses while still ensuring their developments stay in good condition long into the future.