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As if maintenance, parking, mortgage and home insurance issues aren’t troubling enough, many homeowners may have to add another item to their list of problems. According to real estate specialists, a large number of jointly owned residential buildings in Dubai have insufficient reserve funds for their upkeep, which could force homeowners to shell out significant amounts to cover for such expense.
A reserve fund, also known as sinking fund, is collected by an owners association (OA) from individual unit owners of a residential building as part of the service charge. A portion of the fund is set aside for daily maintenance and management expenses, while the rest is used for long-term expenditure on repairs and replacement of building equipment.
“Owners of jointly owned property contribute to two funds through the service charge — the reserve fund for ‘wasting assets’ [those that will eventually expire within the building’s design life], and the general fund, which covers common area cleaning and maintenance, utility costs and items of a recurrent nature,” says Craig Ross, Partner and Head of Project and Building Consultancy at Cavendish Maxwell.
Preparing for all eventualities
“It’s important that the correct reinstatement insurance premiums are taken into account through the service charge, which should be sufficient to pay for the total demolition, redesign and rebuilding of the entire property in the event of major damage. Owners should also know if their temporary relocation is covered.”
Industry insiders, however, say the reserve fund in many residential buildings is inadequate, which they claim is a pressing issue in Dubai’s real estate sector.
“In many buildings in Dubai, reserve fund contributions may be insufficient, or a few property owners who do not pay service charges,” says Ross, who is also a board member of the Middle East Real Estate Inspection Association, a non-profit that advises government and private organisations on real property. “These are the primary causes of insufficient cash reserves.”
Problems with the collection of reserve fund are compounded by the failure of building developers to conduct a property condition audit and reserve fund analysis to assess their reserve fund requirements, says Douglas Ralph, CEO of Snag & Inspect.
“[The regulations on] reserve funds of a jointly owned property came into effect along with the formation of the Strata law,” says Ralph. “However, we have found many buildings do not have a proper reserve amount on hand to meet the future needs of the building.”
Without sufficient amount for long-term maintenance expenses, which could run into millions of dirhams, Ralph says the property manager could demand from each unit owner to pay an equal share to cover for the cost. “The challenge here is will the owners have the money [when it’s needed]?” says Ralph. “This scenario could occur more frequently as more buildings start to age and [especially] if a property has not been maintained well.”
Impact on investment
Without an appropriate reserve fund for the upkeep of façades, mechanical systems and other critical maintenance work, the value of a property could drop rapidly, says Ralph, emphasising the importance of a reserve fund is in achieving an investor’s return on investment goals.
“If a building is under financial stress, most of the time only the visible areas such as the reception, gym and swimming pool are maintained, but the back-of-house areas such as plant rooms, equipment, etc. that the unit owners do not see will start to degrade,” says Ralph. “Eventually the owners would have to contribute [an amount] for emergency maintenance work or replacements in those areas through a special levy.”
Ross says the reserve fund is one of the most important factors to consider when buying a property under a strata title. “The condition and maintenance of the common areas is also incredibly important when it comes to the value of individual units. If the [value of the] common [areas] drop, so will your unit value,” he says.
Fire detection systems, including smoke and heat detectors, fire suppression systems, alarm sounders and control panels, can potentially malfunction if not properly maintained, increasing the risk of fire in a building.
Need to reduce the margin of error on fire breakouts
Without proper maintenance, a jointly owned building will need a much bigger reserve fund when it reaches around 7-10 years old, says Ross. In such a case, a considerable hike in the service charge may be needed.
“Some property owners in Dubai do not have a long-term approach towards their property,” says Ross. “A proper reserve fund study needs to be done to determine how much capital is required 10-20 years into the building’s life cycle to ensure the value of the property and the well-being and safety of the occupants are maintained.
“Once a building is completed, it is the responsibility of the OA to get this study done, but I believe the correct way to deal with the situation is to carry out a reserve fund study at the planning/design stage of the building.”
In Dubai, the short-term investment view of some developers and buyers exacerbates the problem. “Some buyers do not want to retain the property for an extended period, and a few developers are not concerned about the long-term costs of the property, so they are happy to go with cheap initial solutions,” says Ross. “However, those who have a long-term interest in the property are more likely to consider initially expensive options, which are less costly in the long run.”
According to a Cavendish Maxwell report, the asset type, location, fittings and quality of maintenance are among those taken into consideration when calculating the reserve fund contributions. “The objective is to reveal a forecast of expenditure over a time horizon of around 60 years and to show this as a 10- or 20-year window,” the Cavendish Maxwell report states.
However, while the Strata Law suggests that an OA would have legal personality, no OA has so far been licensed. Bayzokova says this creates complications as it remains unclear how reserve funds and maintenance claims can be enforced given that OAs are currently unable to open a bank account or hold assets.
Source: Hinda Navin, Special to Property Weekly