The Cost of Legislation for Sectional Title

This is not the topic I would have liked to choose for this newsletter, but the information is só important that I do feel that I want to share it with you.

The Sectional Title Schemes Management Act and the Community Schemes Ombud Services Act came into operation on 7 October 2016. These two pieces of legislation had an enormous effect on the sectional title scheme management requirements, for managing agents and also for owners and trustees.

It was known from the beginning that things would change dramatically and that the effect on levies and the work involved in managing schemes would greatly increase, but the extent to which it has caused expenses to increase, could not really have been foreseen at that time.

A major driver in costs is the requirement for very large Reserve Investments, to cover the ten-year maintenance plan and the projects planned. The reasons for the legislation are known as many bodies corporate would not increase their levies to provide for sufficient funds for future maintenance, which caused buildings to fall into disrepair. This is very bad for the value of properties and with the economy under pressure and an aversion to levy increases had become a very serious issue.

The new requirements are that if a scheme’s reserve fund (a ballpark figure is all the money shown in the balance sheet at year-end, minus one month’s ordinary expenses) at the end of a financial year is not equal to the total amount of levies collected for that previous financial year (actually the full budget of the previous year in reserve), specific formulas have been prescribed to be added to the budget as a reserve fund.

The worst-case scenario is that If the reserve fund is less than 25% of the previous financial year’s levy income, the body corporate must budget for 15% of the budget for the new year, just for the reserve fund! That is an immediate levy increase of 15%, over and above any other levy increases due to rising costs and a higher budget than the previous year! This is a serious levy increase for any owner!

If the scheme had sufficient reserves, but due to large maintenance expenses, or projects done from the ten-year maintenance plan which cause the reserves to drop to below 25%, the scheme will face the same outcome!

In my opinion, those schemes that do not have a 100% reserve fund, must aim for above 25% of the previous year’s levy, and try and keep it above that level, to prevent the scenario described above. Raising it annually to increase the reserve fund, to prevent large projects and maintenance expenses to deplete the reserve fund to where it falls below 25%. The minimum requirement for reserve funds at the end of the previous financial year, of between 25% and 99% of the levy income for that year, is an amount equal to the ordinary maintenance component of the budget, to be budgeted for the reserve fund.

Proper planning and control must be done by the trustees, but even with the best management, something can still happen that will largely deplete the reserve fund. It can force trustees to increase levies substantially or institute a special levy. It is VERY important that owners understand this, as most people in the current economic conditions are very averse to increased levies and sudden special levies – with good reason! However, trustees will have to do this when necessary and timely to have the least effect on owners.

Should the body corporate not comply, the auditors will qualify or make notes in the financial statements. The financial statements form part of the documentation to be submitted to the Community Schemes Ombud Services annually, which gives oversight for community schemes. The legislation now not only regulates but can effectively enforce.

Another major driving factor is new expenses like the COS levies and additional insurance requirements. These expenses bring a significant increase in the budget and accordingly the levies.

The third major driving factor to my mind is the additional work that is required from auditors and managing agents. As their costs go up and they become less viable, their fees will have to increase to recover at least some of their expenses. We are already seeing this effect in auditors and managing fees increases over the last two years.

Where in the past, one person from the managing agency was enough to attend a general meeting and manage the voting at meetings, it has now become the norm that two people from managing agencies attend the meetings. This is due to the fact that quorums and voting are not done according to the number of owners present or represented anymore but must be done according to the value of the participation quota of the section of each owner represented. This is the proportion in the floor area of a section, to the total floor area of all sections together. The larger the section, the higher the value of a vote will be.

A lot of other functions has also been added, with a lot more responsibilities, which affect both managing agents and auditors. The budget is now very complicated due to all the requirements that must be met.

Another, fourth serious driver of the increase in levies, is the security requirements that have become a large portion of body corporate budgets. Guards are expensive and the smaller the scheme, the higher the effect will be on the levies. Gates and access control are also expensive to maintain.

What I want to bring to owners’ attention is that there are no easy answers! All of us are struggling with the drastic increases in levies and municipal accounts, as well as the increases in living expenses. Body corporate budgets are different from household budgets. A household budget is adjusted according to the income, a body corporate budget gets funded by levies, and there are very little savings to be made in a body corporate budget. Different from household budgets, levies are prescribed and demanded by the budget requirements.

It is never easy to present a large levy increase to owners! But if the situation is understood properly, the numbers make sense and an owner can become part of the solution, instead of aggravating the situation. Insufficient increases in levies will have serious consequences and hardship. Do not even think about the official inflation percentages – it is in no way applicable!

My intention in this document is to bring an understanding to the levy phenomenon and while nobody can make the challenge easier, facts and understanding will at least help with making the tough choices needed – and do it in time!