A big question to address after you and your fellow flat owners have bought your building freehold is whether to create a Reserve Fund.
If you have collectively purchased the freehold of a large block of flats, you may be too busy in the first couple of years to tackle this issue, as you will be occupied with more
But, once you have caught your breath, perhaps in the third or fourth year after your freehold purchase, it's important to investigate whether to create a Reserve Fund for your building.
A Reserve Fund, also called a Sinking Fund, is a pool of money into which leaseholders pay and which is destined for future works at the building that have not yet necessarily been planned or even identified.
In short, a Reserve Fund is a kitty for a rainy day, an account into which flat owners pay money so that, when major works are required, these works can be carried out swiftly, without waiting months or years for the necessary funds to be collected.
In a converted house that has just two or three flats, a Reserve Fund is not normally needed. The two or three leaseholders simply pay for any works when the works need to be done.
But in a large block with, for instance, 50 flats, the creation and maintenance of a Reserve Fund is almost always a good idea. Major works in a big apartment building are often expensive, whether it's the replacement of a lift or repairs to the roof or redecoration of all the common parts.
By creating and paying each year into a Reserve Fund, leaseholders are able to smooth out these expenses over several years, rather than to have pay a huge bill all at once when the works are about to start.
Directors of resident management companies often ask me how much money they should instruct their managing agent to collect each year for the Reserve Fund. This is a how-long-is-a-piece-of-string question. The answer depends on the amount of money, roughly estimated, that the board believes will be needed for repairs in the coming years, after the board has been advised on this matter by the managing agent and any relevant structural building adviser.
Of course, a newly-constructed high-quality apartment building will require fewer major works than will a century-old mansion block that has been neglected for decades by the previous freeholder.
One building that I know and that falls into the latter category is presently collecting about £4,000 from each leaseholder in annual service charges to run the building and an additional £1,000 annual payment for the Reserve Fund. The resident management company is effectively building up a war chest with which it will address over the next decade the many areas of work that the old landlord should have, but never did get carried out.
There can be a problem with the lease, when creating a Reserve Fund.
Some old-style leases have no clause that gives the freeholder the right to create and maintain a Reserve Fund. The lease only authorises the freeholder to collect service charges on an annual basis that pay for identified on-going costs.
When you and your neighbours join forces and buy your building freehold, you can fix this defective-lease problem by inserting a clause into your new 999-year lease -- the new lease that, hopefully, you will create within the first year of owning the freehold -- that authorises the freeholder to create and maintain a Reserve Fund.
The Reserve Fund should always be held by the managing agent company that is instructed by the freeholder to run the building. The managing agent needs to identify separately in the annual service charges accounts the amount of money in the Reserve Fund. This money should not simply be mixed in which the general funds paid in to the service charge account by leaseholders.
Remember that the Reserve Fund is always held in trust by the freeholder on behalf of the leaseholders and that the funds belong to the leaseholders.
A Reserve Fund should never, repeat never, be held by leaseholders.
I recall the sad story told to me by a neighbour that lived in a different block of flats in London before moving to our building several years ago. He described how the head of the residents' association in that building disappeared with £180,000 from the leaseholders' Reserve Fund. The money and the head of the residents' association, who had also been the association's treasurer, were never seen again. The leaseholders were so embarrassed by their their stupidity in entrusting the money to one person in the building that they never reported the theft to the police.
The best way to avoid embezzelment of leaseholders' funds is to entrust the money to a reputable manging agent company and to require a written account of the Reserve Fund balance, including interest earned, at least on a quarterly basis.
When the managing agent sends the service charge invoice to each leaseholder, often on a six-monthly basis, the invoice should quantify the amount due for the annual building running costs and the separate amount that will go into the Reserve Fund.
Upon buying your building freehold, you inherit, unfortunately, the effects of any neglect by the previous landlord. I know one beautiful 100-year-old mansion block in London that was very badly mismanaged by the last landlord. Now the board of directors of the new resident-owned freehold company is having to work hard to plan and to get executed by the managing agent a whole series of major works repairs. It will take years for them to get the building into a proper state of repair and they know this. The creation of a Reserve Fund will help them, over time, to smooth out the annual costs to be borne by leaseholders in the building and to speed up commencement of each major works project, since the money will be there in the bank.
Some people think they should be able to get their Reserve Fund money back when they sell their flat. This is wrong.
It is important to include in the Reserve Fund clause within the new 999-year lease that the leaseholder's payment into the Reserve Fund is non-refundable. Any attempt to try to create a Reserve Fund that is like a savings account into which a leaseholder deposits money and then later can withdraw it would be a nonsense, as it would create an unworkable layer of complexity for the managing agent and a confusing mess of the service charge accounts.
The good news for a leaseholder that plans to move away from the building and that has already paid the latest service charge invoice, including a payment into the Reserve Fund, is that he/she is selling a flat in good standing, ie- one that is paid up. The buyer needs to know that. The resident management company that owns the freehold should not agree to the sale of any flat that is not fully paid up.
A final word on Reserve Funds. I have seen many blocks of flats over the years held hostage by a small number of non-payers of service charges. Because all monies for planned major works were not collected, these works were delayed by months or years, or sometimes the works were never carried out. All leaseholders suffered as a result.
The creation of a Reserve Fund enables a building to grow up and to free itself from the tyranny of one or two non-payers of service charges. With a Reserve Fund the resident-owned freeholder has the funds required to keep the building in good repair and well-maintained.
The resident management company still has a responsibility to pursue a zero-tolerance policy towards the non-payer and to take proper steps, legal action if required, to ensure full payment of service charges. But at least this pursuit of the non-payer becomes a side issue for the resident management company -- rather than a do-or-die legal battle that will determine whether that dangerous old lift ever gets replaced.
I'd love to hear your views on managing a Reserve Fund. Please send me your input by clicking on "Comments" below or by sending me a message from www.rosettaconsulting.com/contact.php. Thanks!
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