Long-term FM thinking would benefit UAE residents
Longer lifecycle cost analysis periods for reserve fund forecasts would result in a fairer deal for Dubai residents, according to Macro Mace International’s Brett Stanion
A service charge is the method by which the costs of maintaining and operating the common areas of a multi-occupant or multi-owner building or community are recovered from users.
There has been a growing interest by investors and occupiers in the service charges applied to residential and commercial developments in Dubai. The cost and quality of services are being constantly scrutinised to ensure owners and occupiers receive value for money.
A number of developments now undertake their service charge calculations and reporting in accordance with international best practice, such as the Royal Institute of Chartered Surveyors’ (RICS) codes and guidance, with the aim of providing greater transparency to users on the operating costs of their building or community.
One of the key elements of a service charge should be a contribution to a reserve fund, sometimes called a sinking fund or a capital lifecycle replacement fund. This is an amount of money regularly set aside to pay for the planned replacement of the diminishing assets within a building. These assets include items that have a shorter life expectancy than the building structure, such as air-conditioning plant, lifts, fire alarms, doors, and wall, floor and ceiling finishes.
The cost of replacing diminishing assets can be substantial. Where multiple items need replacing during the same period, the overall cost could be hundreds of millions of dirhams. To ensure fairness, where possible, all owners and occupiers – both current and future – should contribute to the reserve fund equitably. In short, all those who benefit from a common system or asset should pay towards its replacement, regardless of who is occupying the building when the replacement occurs.
A proper reserve fund should be estimated using lifecycle costing analysis, which is a modelling technique that sets out the cost of the building’s assets and the estimated cycle of replacement in years.
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Best international practice is to use a 25- or 30-year lifecycle cost analysis period for the reserve fund forecast, as this covers the replacement of most major mechanical, electrical, and plumbing (MEP) items, such as chillers, lifts, and fire alarm panels. However, in Dubai, it is common practice to use a shorter analysis period, such as 1 years, or to estimate based on arbitrary values rather than a building-specific lifecycle cost model.
The problem with basing your reserve fund forecast on a shorter analysis period is that, for a new building, the lifecycle costs are minimal in the first 10 years, and only start to increase from around year 15 onwards. The average reserve fund contribution based on a 10-year forecast could therefore be too low to cover the costs of asset replacement in later years. As such, there either isn’t enough money in the fund to cover the costs of asset replacement when higher-cost years occur, or the contribution has to be greatly increased to cover the lower contribution in earlier years.
Where no reserve fund is in place, the full value of the asset replacement costs will need to be recovered at the time when the assets need replacing. This would likely be done through large, one-off special levy service charges, especially in the case of owner-association buildings. This approach is likely to be very unpopular with occupiers and owners, who suddenly face substantial, unplanned service charges. The model is also very challenging to manage from a service charge recovery perspective.
Therefore, the implementation of a proper reserve fund is in the interests of all users to ensure provision for the costs of replacing a building’s diminishing assets. This will enable the building to continue to operate as desired, with no interruption to critical services like cooling, lifts, and fire detection and protection systems.
Macro has helped a number of clients to identify and manage their reserve funds, with Dubai Multi Commodities Centre (DMCC) providing an example of the use of best practice for its JLT Master Community development. DMCC has implemented a clear and documented reserve fund management policy that provides a framework for the operation, management, and review of this fund. This has included a recent review and evaluation of the original reserve fund forecast against the existing master community assets and their condition, to ensure that reserve fund contributions are aligned to expected lifecycle costs.
I hope that as the Dubai market matures, all developments will adopt best practice reserve fund management, and avoid the ticking time bomb that is the cost of replacing failing assets in an operating building.
The above article was written by Brett Stanion, associate director at Mace Macro International.