Mainly for Students: Service charges and commercial property

Jen Lemen and Don Lemen explain the nature of commercial property service charges and the new RICS guidance which will become effective on 1 April 2019 What are service charges? The Royal Institution of Chartered Surveyors (RICS) defines a service charge as “a means by which a landlord can recover from tenants the cost of maintaining and repairing a building and providing certain services”. These are effectively the obligations retained by a landlord, so 100% recoverability can be pursued on a “not for profit, not for loss” basis. This helps to maintain the quality and value of the landlord’s investment, while ensuring that tenants can benefit from reasonable enjoyment of their premises at a fair and transparent cost. They are typically charged in relation to multi-let commercial properties, eg offices, retail parks, shopping centres, business parks and industrial estates. Why are service charges contentious? As with most disputes relating to commercial property management, tenants want to minimise occupational costs, while landlords want to ensure full recoverability. These two objectives are often at odds to one another, leading to conflict within the landlord and tenant relationship. What is the legal basis of service charges? There is no legislation relating to commercial service charges, unlike for residential property. This means that surveyors must turn to the contractual obligations included within the lease, combined with the relevant RICS guidance. When considering lease obligations relating to service charges, surveyors should ensure that they check all relevant deeds, including any licences to alter, deeds of variation, side letters and superior leases. What might a service charge include? Typical costs could include: Maintenance and repairs Hospitality and security Cleaning and refuse collection Heating and lighting Air conditioning Car parking management Pest control Event management and displays Property management fees Sinking fund contributions to set aside money for the replacement of a wasting asset (for example, lifts, escalators or heating). What advice would you give on service charges? When advising a landlord on appropriate management of service charges, ensure that you read the lease in detail and adhere to the RICS guidance. When advising a tenant on limiting their service charge liabilities, typical ways to achieve this would include: agreeing a service charge cap (ie maximum amount payable); agreeing fixed-increase or index-linked (RPI or CPI) uplifts; and ensuring that the service charge services are fully understood and agreed. How are service charges apportioned? There are various apportionment bases for distributing the overall cost between occupiers, including by floor area, fixed percentage, rateable value or weighted floor area. The usual method of administering a service charge is to agree a budget prior to commencement of the service charge year. Quarterly billings are then based on this, before the annual accounts are audited at the year end. A balancing payment is usually issued subsequent to this depending on the difference between the actual and budgeted amounts. How can service charge arrears be recovered? Service charge arrears cannot be recovered using Commercial Rent Arrears Recovery, which can only be used to recover rent. Other methods could include agreeing a payment plan, securing a court judgment or a statutory demand. A good landlord and tenant relationship goes a long way to ensuring that costs are paid on time. What RICS guidance is there on service charges? The RICS has published two key pieces of guidance, which all students and APC candidates should be aware of: Commercial property management in England and Wales (guidance note, 2nd edition, October 2011) Real estate management (global professional statement, 3rd edition, October 2016) Both cover service charges in a relatively limited level of detail, in the context of a property manager’s wider duties. Current, more detailed service charge guidance is published by RICS in Service charges in commercial property (code of practice, 3rd edition, January 2014). However, this is being replaced on 1 April 2019 by a new professional statement: Service charges in commercial property (1st edition, September 2018). The new guidance has already been released, so surveyors can prepare for the upcoming changes next year. Note that as the new guidance has the status of a professional statement, practicing surveyors must have regard to it in their work. The professional statement cannot override the terms of a lease. However, it can be used to interpret a lease to provide effective service charge management. It can also be used to provide a basis for service charge clauses in renewal or new leases. In addition to the mandatory principles, Chapter 3 of the professional statement provides in-depth guidance relating to the core principles of service charge best practice. Chapter 4 provides further best practice guidance to support the core principles. This includes principles such as: Service costs – should be transparent so all parties are aware of how the costs are made up Management fees – should be on a fixed-price basis with no hidden mark-ups Occupier responsibilities – occupiers should ensure prompt payment of all bone fide on-account and balancing charges Alternative dispute resolution (ADR) – all renewal and new leases should include ADR provisions in the event of a service charge dispute. Furthermore, appendix A provides a compliance checklist and appendix B contains the Standard Industry Cost Classifications (SICC). SICC is used to classify costs consistently across service charge management. Appendix C contains a service charge accounting sample report, while Appendix D provides guidance on handover procedures when a property is sold or the managing agent is changed. What does the new professional statement set out to achieve? To increase standards, it sets out specific mandatory requirements for the first time for RICS members – there may be legal and/or disciplinary consequences for members departing from these professional statements. To improve general standards and promote best practice, uniformity, fairness and transparency in the management and administration of services charges in commercial property. To ensure timely issue of budgets and year-end certificates. To reduce the causes of disputes, and provide guidance on the resolution of disputes if they arise. To provide guidance to solicitors, their clients (whether owners or occupiers) and managers of service charges in the negotiation, drafting, interpretation and operation of leases, in accordance with best practice. What are the mandatory principles of the professional statement? All expenditure that the owner and manager seek to recover must be in accordance with the terms of the lease. Subject to section 4.2.7, owners and managers must seek to recover no more than 100% of the proper and actual costs of the provision or supply of the services. Owners and managers must ensure that service charge budgets, including appropriate explanatory commentary, are issued annually to all tenants. Owners and managers must ensure that an approved set of service charge accounts showing a true and accurate record of the actual expenditure constituting the service charge are provided annually to all tenants. Owners and managers must ensure that a service charge apportionment matrix for their property is provided annually to all tenants. Service charge monies (including reserve and sinking funds) must be held in one or more discrete (or virtual) bank accounts. Interest earned on service charge accounts – or, where separate accounts per property are not operated, a proper and reasonable amount of interest calculated on normal commercial rates – must be credited to the service charge account after appropriate deductions have been made. Where acting on behalf of a tenant, practitioners must advise their clients that, if a dispute exists, any service charge payment withheld by the tenant should reflect only the actual sums in dispute. When acting on behalf of a landlord, practitioners must advise their clients that following resolution of a dispute, any service charge that has been raised incorrectly should be adjusted to reflect the error without undue delay. Summary Service charges are an essential part of property management. Ensuring you understand the terms of the lease and the RICS guidance is key to providing prudent advice to both occupier and landlord clients. Furthermore, knowing about the major changes to the RICS guidance next year will ensure that graduates are able to provide a high standard of service in line with the RICS ethical and professional standards. Further reading For more about the new RICS guidance, see What’s with the new service charge code? RICS: Service charges in commercial property (code of practice, 3rd edition, January 2014) Jen Lemen, of Property Elite provides support, training and CPD to RICS APC candidates, qualified property professionals and students. Don Lemen FRICS is a consultant to Property Elite Mainly for Students is edited by Paul Collins, a senior lecturer at Nottingham Trent University. He welcomes suggestions for the column and can be contacted at paul.collins@ntu.ac.uk