Do I Need a Sinking Fund?
I noticed recently there have been some significant repair bills coming through as the age of my buy-to-let portfolio creeps up. Many of my properties which I refurbished early in the last decade are starting to show signs of wear and tear. This raises the question about whether I should start a sinking fund.
What is a sinking fund?
The idea of a sinking fund should be familiar to surveyors or property managers.
As any body who has managed property knows the interior and exterior of you beautiful buy-to-let will not remain so for that long when faced by a series of marauding tenants. But should you prepare financially for the day when you need to replace the kitchen, the roof the carpets a new boiler? This is where a sinking fund comes in. Think of it as a landlords piggy bank for the inevitable big expenditures that will come down the track if you hold to your rental property for a number of years. Remember that the average rental property is held by a landlord for 19 years before being sold. Therefore, there will be alot of big ticket repair bills during this time.
A landlord’s repair liabilities
From day one with a new buy-to-let property, it starts to deteriorate.
A landlord will perhaps get 5 years out of a carpet. You should get 10 years out of most appliances and budget on giving the interior decoration a spruce up every 3 years to keep your property in prime lettable condition. Exteriors will need repainting every 5-7 years if the woodwork isn’t going to deteriorate. Roofs should last 100 years but even then a landlord will need to be prepared to perform a series of running repairs as tacks that hold the roof tiles in place rust and require replacement.
Where a property has gas central heating then a landlord should bank on replacing the boiler every 10-15 years.
A sinking fund is effectively a landlords saving scheme; where a landlord or property manager can put away a proportion of their rents to cover future repair liabilities.
Without a sinking fund then where a landlord has a portfolio of property then they can suddenly be hit by a significant cost which they may not be able to fund out of their cashflow.
How much should I put away?
If a landlord is tempted to set up a sinking fund then how much such they put away? There are various methods you could use to calculate your sinking fund requirements. Probably the simplest is working out what your gross rent is and then place a percentage of that into a separate account each month. For most landlords a fund of between 5-10% of gross rents should suffice to cover you against any future maintenance liabilities.
If you want to get more technical about it then you can start working out the expected lifespan and replacement costs of various aspects of your buy-to-let property. For example; if the cost to replace all your appliances in your property work out at say £1200 and you estimate that they have a life expectancy of 10 years; then a sinking fund of £10 per month should cover you for the ultimate replacement costs. You would then need to do the same for other aspects of repair and maintenance on your buy-to-let.
The sinking fund principle has many parallels with the concept of depreciation used within manufacturing and industry.
Is there an alternative to having a sinking fund?
There is an alternative to putting money to one side. A landlord can use an insurance policy to cover themselves against certain maintenance liabilities. For instance where a boiler is involved there are specific policies that will cover repairs and replacement.
There are also other more comprehensive schemes run by companies like Homeserve that are aimed at landlords that aim to cover them for a range of potential maintenance costs such as a burst, drain and electrical problems and damage to locks.
These schemes on there own do not negate the need for a sinking fund but would reduce the size of the fund needed and also take the panic out of getting the work done if you suddenly have a failure in your heating or drainage system.
Whether you use a sinking fund or not depends on your cash resources and cashflow. What a landlord needs to avoid is to run out of cash just for basic running repairs that will then have a serious impact on the properties lettability resulting in a downward spiral of reduced rents or voids and declining cashflows in your rental business. This could seriously put your rental businesses viability at risk over the long-term.
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I totally believe in the sinking fund. A couple of years ago I decided to start putting 10% of my net income into a saving account each month and naturally it has built up quickly. I use it for any cost over £100. It was very handy this year when a Periodic Inspection Report highlighted £5000 of electrical work that needed doing and the boiler packed up 2 months later (it was 30 years old to be fair, they don’t build them like that anymore) costing another £2500. Of course my sinking fund didn’t cover all of these expenses (about half), but it made a big difference by preventing a huge blow to my personal savings accounts. Before I created this fund, my monthly income would fluctuate wildly as there is always something that needs doing, but now it’s stable because I can draw from the fund and not my current account.