Knowledge is power: the 3 main models for funding cladding rectification in strata

We usually find that our clients have been issued with a building notice or a building order for cladding replacement and they don’t really know where to start. You might be under pressure to install compliant cladding with a deadline looming. What you really need at this point is to connect with industry specialists who can examine your situation in detail and lay out your various options before you proceed.

Firstly, if you’ve been issued a building order to get cladding replaced and need more time, we can assist with getting an extension. Navigating the process of getting your building compliant is a stressful enough proposition, without the added stress of feeling as though you are being rushed into making decisions without all of the relevant information in front of you.

With reports of property owners being quoted between $40,000 and $200,000 by different cladding installers – for the same job – there is the additional worry of being taken advantage of when replacing your non-compliant cladding with a non-combustible alternative. It is essential that you have the right team in your corner to ensure the best outcome for all stakeholders.

We can help with identifying non-compliant cladding and end-to-end management of the cladding replacement process for the best price in Melbourne. This still leaves the whole question of funding models unanswered. Let’s take a look in broad terms at the three main models that will be on the table for strata owners who are seeking to get their building compliant. The three main funding options are:

  1. Capital Works or Maintenance Fund (also known as a sinking fund)
  2. Remortgaging (to fund a special levy)
  3. Strata Finance

1. Capital Works/Maintenance Funds

This type of fund is allocated to anticipated major capital works. In most cases it is collected over a long period of time.

An owners corporation may intend to use existing funds in the capital works fund but this will be unlikely to cover the total costs associated with cladding rectification and may delay completion of the project as a result.

Capital works/maintenance funds are generally understood to be an inefficient model due to high costs and low returns. The following considerations are likely to be discussed with a financial institution when deciding whether to use existing funds (or put aside monies) into the capital works fund:

  • Tax – returns in a capital works/maintenance fund are subject to income tax in the owners corporation
  • Scope of works – potential for it to increase – the amount of work that needs to be done may increase while waiting for the balance of a fund to reach the required level
  • Inflation – the cost of the work is likely to increase while waiting to accumulate sufficient funds

An important point here is timing – if your fund doesn’t have adequate funds now for the replacement of cladding, you’ll need to access other sources of funds in order to meet government deadlines.

2. Remortgaging for a Special Levy

Special levies tend to be a once-off levy, especially when funds are required urgently, but they may be raised in instalments.

Special levies may cause delays in commencing works as a lot of people believe an owners corporation should not engage in a contract until it has the funds to make payment. If a significant number of owners are late in paying the levy then the required works may be delayed.

Special levies can impose a significant financial burden on owners, especially for those who are cash poor. Owners who cannot meet the payments required for a special levy may be forced to sell or to remortgage which is becoming ever more difficult in a more tightly regulated market.

Strata owners are likely to be asked to consider the following when deciding whether to use a special levy as a funding option:

  • Tax – from a tax perspective, a special levy may be less beneficial for investors – you will need to consult with your tax adviser
  • Scope of works – potential for it to increase – the amount of work that may increase while waiting for the agreed special levy amount to reach the required level
  • Inflation – the cost of the work is likely to increase while waiting to accumulate sufficient funds

3. Strata Finance

  • Enables an owners corporation to access funds immediately
  • The financial institution makes an unsecured loan directly to the owners corporation
  • No mortgages, liens, caveats, charges or any registration of interest on the title of any individual unit or the title of the body corporate
  • Owners do not need to provide personal information or a personal guarantee
  • Enables an owners corporation to complete work right away rather than wait for funds to accumulate
  • Owners get enhanced capital and rental returns
  • The financial burden caused by raising a large special levy is reduced
  • Rather than relying on all owners to pay the special levy on time, there’s a guarantee that the funds will be available
  • Flexibility – an owners corporation need only draw down what is required when it is required
  • Ability to undertake additional capital works at the same time
  • The rectification works can be completed right away, allowing corporations to comply with legislative deadlines

Our intention here in outlining the 3 main models for funding cladding rectification in strata is to equip owners corporations with a general overview that may be of benefit when approaching a financial institution for services and advice. While we are not in a position to provide specific financial advice, we are more than happy to offer prospective clients the opportunity to leverage our professional network of industry leaders who specialise in this area of finance.