Initial Budgeting: How hard is it to get initial cost and levy estimates right?

Quite topical and in the cross hairs of strata legislators and consumer lobby groups is a way to bring greater accountability for initial budgets, most notably in the levy estimates presented as part of sales campaigns and at initial strata meetings. This is necessary as levy estimates form an important ingredient for buyers when assessing a property purchase. Steep levy increases can severely curdle a new buyer’s experience and put heavy stress on owner finances once they settle on their purchase.

Low levy estimates may be an initial sweetener for sales but are not a good way of building relationships, repeat business or confidence in the development. Plus, penalties apply for developers if it’s shown unrealistic levies were presented at initial meetings.

There are a number of ingredients that flow into accurately estimating strata costs for new developments. In this article, we stir the pot to look at why levy estimates can end up undercooked and how to get them right.

Why are levy estimates often underdone?

Low levies make for easy sales

Let’s face it, there is often pressure applied to produce low levy estimates to make for an easier sale and to minimise discussion for sales agents on building running costs. But this is a missed opportunity for a deeper discussion with the purchaser about the development, which could actually help build the bridge for a sale.

Estimates may be based on benchmarking rather than specific project budgets

Once the development consent is through, there are often tight timeframes for a market launch putting pressure on the production of initial levy estimates. The temptation is to avoid the work needed to produce estimates for the actual development and default to benchmarking neighbouring developments or similar sites.

But every site is different and benchmarking from other sites may simply repeat errors using what is likely to be out-of-date estimates. The result, regurgitating erroneous numbers.

Levy estimates should be taken from the specific plans, designs and the make-up of each development, which will be mostly known following the issue of the development consent.

Insurance can often be underestimated

Initial build costs are commonly used to obtain insurance estimates and often for insurance placement on project completion.

Build costs, however, may not account for demolition, professional fees, rebuild period cost escalations, and other expenses that are required inputs for the correct levels of strata insurance. This means insurance estimates may be well under for initial strata budgets.

Plant and equipment costs may be excluded

To keep initial levy estimates low, maintenance costs for plant and equipment that will be under a maintenance warranty are excluded from the estimates. Technically this is correct for an initial estimate of year 1 outgoing costs but it does not represent the real costs for the building operation once fully up and running. Excluding these costs can reduce outgoings by 20-30% for initial estimates but it will mean steep increases for year 2 of the building’s operation.

There’s little to no accounting for capital works funds

An easy way of keeping levy estimates low is to not apply any capital works funds contributions or minimise these amounts. This is bad practice but allowable as the Strata Act does not stipulate a capital works fund plan is required for initial estimates.

For residential buildings, you would expect capital works fund levies to account for 20-40% of total administrative fund costs. If this is not the case on initial budgets it is likely they are undercooked!

Levy estimates are out of date

A number of building operational costs have been increasing well ahead of inflation. Building insurance and electricity costs can account for up to 50% of a strata budget and have been increasing by approx. 20-30% a year.

If you don’t update costs during the development cycle it is likely steep increases will be required once the budget is finalised on project completion risking severe levy shock for the initial strata meeting.

It’s much better to provide regular levy updates to purchasers as part of a marketing strategy through the development construction period.

No sales price list or UE valuation has been provided

If no Unit Entitlement (UE) valuation or sales price list is provided the calculation of levy ranges will be derived from Gross Floor Area (GFA) or apartment type. This won’t represent the range of UE on the strata plan. A much more accurate levy range can be provided if the sales price list or an initial UE valuation is provided.

Bad budgeting

All of the above means bad or poor budgeting and levy estimates which will leave a bad taste in the mouth of purchasers once the development is completed. It sets the strata scheme up for friction from the outset!

So how can we get levy estimates right?

The costs are the costs

The natural inclination is to want to bring down costs for levy estimates. Don’t do this by removing known essential costs. The outgoing costs need to reflect the build, design and structure of the development and if these costs need to be reduced it may mean design or specification changes or a reduction in the desired on-site services are needed. Have these discussions early.

Obtain accurate initial estimates for the core budget ingredients

The largest inputs for levy estimates will be insurance, electricity and on-site services such as cleaning, building management, security and the like. These are likely to make up over 60% of your administrative budget.

For insurance estimates obtain a replacement cost valuation or QS assessment that includes an allowance for demolition, professional fees and rebuild period cost escalations. The replacement cost also needs to be inclusive of GST. Don’t use the construction cost alone.

For electricity usage the common area supply should have been worked out by design engineers and if there is an embedded network the embedded operators. Use these numbers to obtain accurate estimates from energy retailers.

For on-site services be clear on what is required and marketed for the development. It’s important to deliver what is promised and price accordingly.  Involve strata and facilities managers to advise what should be provisioned that meet desired service levels at the right price point. Tender for these services early in the development and construction phase to provide realistic service costs. Once these key contractors are appointed they become invaluable advisors leading up to project completion.

Undertake annual budget updates

There can be a long period from project launch to completion which means levy estimates made on project launch will be well out of date on completion. Make sure budget and levy estimates are reviewed at least annually. These revised estimates can be communicated to purchasers when providing project updates.

Reference development consent conditions, by-laws and the strata plan boundaries

Make sure the development conditions that impact the operation of the owners corporation are considered in initial levy estimates. Conditions such as waste management, landscaping maintenance, VPA obligations, on-site detention and stormwater filtration all can have significant ongoing cost implications.

The by-laws and the strata plan will detail what is lot and owners corporations responsibility so should be scrutinised to capture the outgoing costs for an owners corporation correctly.

Obtain a capital works plan forecast during the construction phase

Rarely done before completion but highly beneficial will be obtaining a capital works fund plan that informs initial capital works fund estimates. The provision of a detailed forecast will facilitate far greater accountability for initial levy estimates as it programmes out the common property requiring replacement, refurbishment, and replacement over a 10-year period.  Having a consultant prepare a plan gives certainty on what is likely to be 10-30% of ongoing levy contributions.

Prepare an initial maintenance plan as early as possible

As highlighted in an earlier article there is no better document than the initial maintenance plan to detail inputs for repair and maintenance of a development. A properly prepared plan gives certainty for the repair and maintenance costs which make up between 20-30% of a strata administrative budget.

The provision of this plan is now required 14 days prior to the date of the First Annual General Meeting but it can be drafted as soon as the development consent is issued. That way the plan is referenced and updated as contractors and construction is finalized throughout the project.