Ellen Cole

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Service charges and commercial property: best practice for new leases

Property / 29 November 2018

On 17 September 2018 RICS published the much-anticipated professional statement, Service charges in commercial property (1st edition) commonly known as the Service Charge Code. The professional statement means changes need to be on agendas before the effective date of 1 April 2019.

With the recent flurry of legislative changes including GDPR and EPC Regulations, landlords and tenants are no strangers to updating clauses to modern standards and the professional statement will be no different.

The Service Charge Code has been introduced to address the market shift for greater transparency and efficiency and is much like already-established residential guidelines. The statement sets out best practice and minimum standards and provides nine mandatory obligations (see below) for RICS members and RICS-regulated firms.

The aims of the Service Charge Code are pretty straightforward – potential or future changes to service charge costs should be made clear and obvious to tenants at the outset so that any costs not specifically mentioned in a lease are not recoverable from tenants.  Although the code is addressed to surveyors, it won’t fail to influence the wider commercial property audience and impact on the wording of service charge clauses to meet what is considered best practice within the industry. As a result, we don’t see this requirement shortening service charge clauses any time soon!

One stand-out requirement to show best practice is for a service charge apportionment matrix to be provided annually to all tenants. The matrix should be flexible to incorporate fluctuations in service costs to ensure the owners recover no more than 100% of the proper and actual costs.  While it may be tempting to most to continue with the tried-and-tested fair proportion or fixed amount regime, it does create a risk of less than 100% recovery to the landlord. Will producing a matrix solve this problem though?

Planning for large future expenses

A key consideration for landlords and managers will be the reintroduction of sinking or reserve funds. These forward-planning measures fell out of favour due to tax planning complications but are tipped to resurge following the professional statement.

The message is to be explicit.  Where the lease is silent, a sinking or reserve fund cannot be insisted upon.

All payments made from such funds should be clearly communicated to occupiers and included as part of the annual reconciliation of the service charge. RICS has released guidance on what should be considered best practice as part of the professional statement, including advice on creating a clear policy as to the reason for the fund.

Current leases

Existing leases may contain service charge provisions that differ from what is required by the code. RICS advises that the code cannot override the lease, but existing service charge clauses should be interpreted in line with the principles and practices if possible.

The nine mandatory requirements

Professionals involved in the management of service charge accounts must act in accordance with the following principles:

  1. All expenditure that the owner and manager seek to recover must be in accordance with the terms of the lease.
  2. 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.
  3. Owners and managers must ensure that service charge budgets, including appropriate explanatory commentary, are issued annually to all tenants.
  4. 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.
  5. Owners and managers must ensure that a service charge apportionment matrix for their property is provided annually to all tenants.
  6. Service charge monies (including reserve and sinking funds) must be held in one or more discrete (or virtual) bank accounts.
  7. Interest earned on service charge accounts must be credited to the service charge account after appropriate deductions have been made.
  8. 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.
  9. 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.

You can access the full Professional Statement here.

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