What needs to be budgeted for in body corporate loans?

One of the most common misconceptions in sectional title financial management is the belief that loans should be “budgeted for” like regular expenses. This misunderstanding often causes confusion at Annual General Meetings, affects levy calculations, and leads to poor financial planning.

A frequent mistake is assuming that when money comes into the bank account from a loan, it must be income. After all, it feels like money is arriving, not leaving. But this creates a dangerous financial misconception. A loan is not income, and it is not an expense either—it is simply a way of accessing cash now, with the obligation to pay it back later.

Consider a practical example: if a body corporate takes out a R500,000 loan for roof repairs, two things happen. The bank account increases by R500,000, which is an asset, and the loan account also increases by R500,000, which is a liability. The scheme’s financial position remains unchanged overall. The real expense only appears when the money is used to pay for the roof repairs—not when the loan is taken out.

Can we do this?

So, what needs to be budgeted?

The answer is the cost of borrowing. This includes interest, capital repayments, and any once-off setup costs. Interest is a true expense and reduces the scheme’s financial resources.

For example, a R500,000 loan at 12% interest will cost R60,000 per year in interest payments. Capital repayments, on the other hand, are not expenses but cash flow requirements. They represent paying back the borrowed money, not a new cost. Using the same loan, repaid over ten years, the body corporate would need R50,000 each year for capital repayments. Finally, banks often charge setup costs, such as legal and registration fees, which might amount to around R15,000 in this example.

This makes cash flow management crucial. Trustees and portfolio managers must ensure there is enough money coming in—usually through levies—to cover both day-to-day operating expenses and the obligations of the loan.

Loans also directly affect how levies are calculated. Without a loan, major projects often require a special levy. For example, if a roof replacement costs R500,000 and the scheme has 100 units, each owner would need to contribute R5,000 immediately. With a loan, however, the cost is spread over time. A R500,000 loan might translate into monthly repayments of R7,200, or R86,400 annually. Spread across 100 units, this means an extra R72 per unit per month. Instead of a once-off hit of R5,000, owners pay smaller amounts over a longer period.

The benefits of loan financing are clear: owners enjoy improved cash flow, urgent repairs can be done without delay, future price increases are avoided, and budgeting becomes more predictable thanks to fixed repayments.

Of course, trustees, portfolio managers, and owners each need to understand the implications. Trustees must distinguish between interest (an expense) and capital repayments (a cash requirement), ensure repayment plans are realistic, and secure member approval where required. Portfolio managers should build these repayments into budgets, monitor collection rates carefully, and time loans to minimise costs. Owners, meanwhile, should remember that loans don’t eliminate costs but spread them out, and improvements funded by loans often increase property values.

Another practical case illustrates the trade-offs clearly. Suppose an 80-unit complex needs R800,000 for wooden window replacement with aluminum. If owners fund this through a special levy, each must pay R10,000 upfront. With a loan over ten years at 11.5% interest, repayments would be about R11,200 per month, or R134,400 annually.

This equals roughly R140 per unit per month. Over the ten years, however, the scheme would repay R1,344,000 in total—R544,000 more than the original amount, due to interest. Trustees and owners must weigh the benefits of spreading the cost against the extra money spent on interest.

Another crucial consideration is insurance. When improvements are made with borrowed funds, the building’s replacement value must be updated in the insurance policy. If the R800,000 project isn’t added to the insurance valuation, the building could end up dangerously underinsured. In the event of a total loss, the insurer might pay out less than the true rebuilding cost—while the loan repayments would continue. Similarly, fidelity insurance should be increased when large loans are taken on, as more money flows through the scheme, creating higher risks of mismanagement or fraud.

Ultimately, loans are neither good nor bad in themselves—they are tools. The decision between a special levy and a loan is not simply one of convenience but of strategy.

So ask yourself -

How urgent are the repairs?

Can owners afford a lump sum?

Is the cost of interest justified by the benefits?

And will the improvements enhance property values enough to offset the long-term costs?

By understanding these principles and carefully planning, schemes can use loans to their advantage, maintaining financial health while protecting the interests of all owners.

While the loan principal doesn't appear in your income statement, the cash flow implications are very real and must be carefully managed.

This article provides general guidance on sectional title loan considerations. Always consult with qualified financial professionals and ensure compliance with relevant sectional title legislation before making borrowing decisions.