If you own a leasehold flat, you may see a contribution towards a reserve fund or sinking fund included within your service charge. It can sometimes feel like you’re being asked to pay today for work that might not happen for several years, but there is an important reason for building up money in advance.
A reserve fund is designed to help a block prepare financially for larger, less frequent expenditure, such as major roof repairs, external decoration or replacement of important communal equipment.
For leaseholders, a properly planned reserve fund can help spread the financial impact of major works over a number of years. For RMC directors, freeholders and those responsible for managing a development, it forms an important part of planning for the building’s long-term needs rather than simply responding to problems as they arise.
So, how does a reserve fund work, how much should a block have and what happens to the money you’ve contributed if you sell your flat?
What is a reserve fund?
A reserve fund is money collected from leaseholders and set aside to help meet significant future expenditure on a building or development.
It is different from the money needed to meet the block’s normal day-to-day running costs. A typical annual service charge budget might cover regular expenditure such as cleaning communal areas, gardening, buildings insurance, utilities and routine maintenance.
A reserve fund, by contrast, is intended to build up money over time towards larger or less frequent expenditure. Depending on the development and the terms of its leases, that could include:
- Major roof repairs or replacement
- External decoration
- Lift replacement or significant lift repairs
- Replacement communal doors or windows
- Major electrical works
- Resurfacing car parks or private roads
- Significant structural or building repairs
Reserve funds are also commonly referred to as sinking funds. The terminology used can vary, and ultimately the lease is important because it sets out whether contributions can be collected and what the money can be used for.
Why are reserve funds important for leaseholders?
One of the main benefits of a well-managed reserve fund is that it can spread the cost of major works over a number of years, rather than leaving leaseholders to meet the entire cost when the work becomes necessary.
Imagine, for example, that a block requires major roof works costing £60,000. If there is little or no money available in the reserve fund, a significant proportion of that cost may need to be collected from leaseholders when the work is required, subject to the terms of their leases and the relevant service charge requirements.
If money has been collected and set aside over a number of years, some or potentially all of that expenditure may already have been provided for. For an individual leaseholder, that can make a considerable difference. Instead of being faced with an unexpectedly large demand towards major works, contributions towards foreseeable expenditure have been spread over a longer period.
A reserve fund therefore isn’t simply money sitting unused in an account. When it is properly planned, it is part of the long-term financial management of the development.
One of the biggest advantages of a properly planned reserve fund is that it gives everyone a clearer idea of how future works are going to be paid for. A roof, lift or external decoration programme shouldn’t come as a complete surprise – these are parts of a building that we know will need investment over time. If you can identify those costs early and plan for them sensibly, it can help avoid putting leaseholders in a position where they’re suddenly faced with a very large bill.
What is the difference between a service charge and a reserve fund?
The easiest way to understand the difference is to think about today’s costs versus future costs.
The annual service charge budget generally deals with expenditure expected during the current financial year. Depending on the development, that might include insurance, cleaning, grounds maintenance, communal electricity, routine repairs and management costs.
A reserve fund is designed to put money aside towards larger expenditure expected in future years. The two are connected because reserve fund contributions are generally collected through the service charge arrangements, but the money has a different purpose. Rather than paying this year’s regular bills, it is being accumulated towards future expenditure permitted by the lease.
How much should a block have in its reserve fund?
There isn’t a single figure or percentage that is appropriate for every development. A small converted building with few communal facilities will have very different future expenditure from a large purpose-built block with lifts, extensive grounds, private roads and other shared infrastructure.
The amount a development may need to set aside can depend on factors including:
- The age and condition of the building
- The construction and materials used
- The number of flats
- The condition and expected lifespan of the roof
- External decoration requirements
- Lifts and other mechanical equipment
- Communal windows and doors
- Car parks, private roads and landscaped areas
- Previous major works
- Future maintenance requirements
- The amount already held in reserve
This is why good block management involves looking beyond the current year’s service charge budget.
How do you know what future work a block is likely to need?
Long-term maintenance planning can help those responsible for a development understand what significant work is likely to be required and when.
Rather than waiting for a roof, lift, external surface or other major component to fail, the building can be considered over a longer period. Its condition, likely maintenance requirements and anticipated replacement cycles can then inform financial planning.
For example, if significant external decoration is expected periodically, or a particular element of the building is approaching the stage at which substantial work is likely to be required, that expected expenditure can be considered when planning future reserve fund contributions.
Of course, nobody can predict every repair or know exactly what work will cost several years from now. Prices change and unexpected defects arise. The purpose is not to predict the future perfectly, but to make sensible provision for foreseeable expenditure.
Can a managing agent simply create a reserve fund?
Not necessarily. The lease is fundamental.
The relevant leases should be checked to establish whether contributions towards a reserve or sinking fund can be collected and what those funds can be used for. A managing agent cannot simply decide that it would be sensible to start collecting a reserve fund if the lease does not provide the necessary authority.
Likewise, money that has been collected for particular purposes must be dealt with in accordance with the relevant lease provisions. Contributions also need to be reasonable, which is why reserve fund planning should be based on the needs of the particular development, anticipated expenditure and the amount already available rather than simply choosing an arbitrary annual figure.
Where is reserve fund money held?
Reserve fund contributions don’t simply become the managing agent’s or landlord’s money.
For relevant residential service charges, service charge contributions are held on trust to meet the relevant costs. The funds need to be properly accounted for and dealt with in accordance with the lease and the purposes for which they were collected.
This is an important distinction. Money collected from leaseholders needs to be properly managed rather than treated as part of a managing agent’s ordinary business funds.
Transparent service charge accounting is therefore an important part of professional block management. RMC directors and leaseholders should be able to understand what money is being collected, why it is being collected and the financial position of their development.
Does having a reserve fund mean there will never be an additional bill?
No. A healthy reserve fund can reduce the financial impact of major expenditure, but it cannot guarantee that every future cost will be covered.
Unexpected problems can arise. The scope of planned works may increase once detailed investigations are carried out, prices can change and the existing reserve may simply be insufficient to meet the full cost of a particular project.
For example, if major works eventually cost £80,000 but only £60,000 is available and can properly be used from the reserve fund, there is still a £20,000 shortfall to address. Leaseholders may therefore still need to make additional contributions in accordance with their leases.
This is another reason why reserve funds need to be reviewed rather than simply established and forgotten. The condition of the building, future plans, anticipated costs and amount held in reserve can all change over time.
What happens to my reserve fund contribution if I sell my flat?
In most cases, an individual leaseholder will not receive their reserve fund contributions back when they sell their property, unless the lease provides otherwise.
The money remains in the fund for the future needs of the development. In effect, the new owner acquires the flat with the benefit of the money already set aside towards qualifying future expenditure.
This makes the reserve fund an important consideration when buying a leasehold property too. A purchaser and their conveyancer may want to understand how much is held in reserve and whether significant works are anticipated.
A block with substantial work approaching and little money set aside presents a very different financial picture from one where foreseeable major expenditure has been planned for over time.
Does Section 20 still apply if there is enough money in the reserve fund?
Potentially, yes. Having sufficient money available in a reserve fund does not in itself remove the statutory consultation requirements for qualifying works.
For qualifying major works, consultation requirements can apply where the contribution attributable to an individual leaseholder exceeds the relevant statutory threshold. Importantly, the requirement can still apply even if enough money has already been accumulated in the reserve fund to pay for the work.
The existence of the money and the requirement to consult leaseholders are therefore separate issues.
What should RMC directors know about reserve funds?
Directors of a Residents’ Management Company can find themselves making decisions today that affect the financial position of the development many years into the future.
Keeping service charges low can understandably be attractive to leaseholders, but focusing only on the current year’s expenditure can create problems if foreseeable major works are not being planned for.
RMC directors should therefore have a clear understanding of what their leases allow, the condition of the development, what significant expenditure may be approaching and how much is already available in reserve.
The managing agent has an important role here. Good block management should help directors understand the financial position of the development and make informed decisions rather than simply produce an annual service charge budget.
It’s very easy to focus on keeping this year’s service charge as low as possible, and understandably that’s often what leaseholders would like to see. But as managing agents, we also have to help directors look further ahead. If we know significant works are likely to be needed in five or ten years, the question is how we start preparing for that now. Good block management isn’t just about balancing this year’s budget; it’s about helping to put the development in a sound position for the years ahead.
What should you look for when buying a flat with a reserve fund?
If you’re buying a leasehold flat, don’t look only at the headline annual service charge. The wider financial position of the development matters too.
Your conveyancer can help establish what information is available, but useful questions can include:
- How much is currently held in the reserve or sinking fund?
- What does the lease allow the fund to be used for?
- Are any significant works planned or anticipated?
- Have major works been carried out recently?
- Are there any Section 20 consultations underway?
- How has the reserve fund changed in recent years?
- Are contributions expected to increase?
A high service charge isn’t automatically bad, just as a low service charge isn’t automatically good. What matters is understanding what is being provided, the condition and requirements of the development, and whether future expenditure is being planned for sensibly.
Good block management is about planning ahead
Effective block management isn’t simply about dealing with repairs, arranging contractors and collecting service charges as problems arise.
It also means understanding the condition of the building, anticipating future expenditure and considering how major works will be funded. A properly planned reserve fund can help spread foreseeable costs over time, provide greater financial certainty for leaseholders and put RMC directors and freeholders in a better position when significant work becomes necessary.
It doesn’t remove every unexpected expense, and it doesn’t replace the need to follow the lease or the relevant consultation requirements. But it can form an important part of responsible, long-term management.
Frequently asked questions about reserve funds
Is a reserve fund the same as a sinking fund?
The terms are often used interchangeably to describe money collected and set aside towards future expenditure. However, the terminology and the purposes for which a particular fund can be used depend on the lease and relevant property documentation.
Do all blocks of flats have to have a reserve fund?
No. Whether contributions towards a reserve or sinking fund can be collected depends on the lease. A managing agent or landlord cannot simply introduce contributions without the appropriate authority.
Can I get my reserve fund contribution back when I sell?
Usually not. When a leaseholder sells their flat, money they have contributed will normally remain within the fund for the future needs of the development, unless the lease provides otherwise.
Can reserve fund money be used for anything the block needs?
No. The fund must be dealt with in accordance with the lease and the purposes for which the relevant service charges were collected.
Can leaseholders still receive a large bill if there is a reserve fund?
Yes. A reserve fund may cover some or all of the cost of major works, but there can still be a shortfall if the work costs more than anticipated or insufficient money has been accumulated.
Does Section 20 apply when major works are being paid from the reserve fund?
It can. Having enough money in a reserve fund does not remove the requirement to consult where the statutory Section 20 consultation requirements otherwise apply.
Looking for professional block management?
At Oakfield, we work with RMC directors, freeholders, developers and leaseholders across East Sussex, providing professional block and estate management.
Our work includes service charge budgeting and financial management, maintenance planning, contractor management and the day-to-day administration involved in looking after residential developments.
If you’re an RMC director or freeholder reviewing the management of your development, or you’re considering changing managing agent, speak to our Block Management team about how we can help.