Service Charges Explained

Service Charges Explained

Services Charges Overview

Landlords should be explicit in their offer about any service charges, including how these costs are calculated, what they cover (and don’t cover) and the extent to which they will be obliged to pay towards any capital improvements and long-term repairs or replacements of structure, fabric, machinery and equipment. During negotiations landlords must provide best estimates of service charges, insurance payments and any other outgoings that tenants will incur under their lease and provide details including contact details of any management company where appropriate. Tenants should expect landlords to be transparent in terms of these costs and how they are calculated. Furthermore, tenants should be aware of any imminent capital improvements, long term repairs, replacements or changes in fabric, machinery and equipment which will incur additional capital costs over and above the existing service charge. Landlords must disclose known irregular events that would have a significant impact on the amount of future service charges and any provisions regarding the sinking fund.

There are two key documents we recommend you take a look at:

  1. SCSI Service Charge Code for Commercial Property
  2. MUD Act

These Professional Guidance documents outline best practice in terms of transparency and equity when dealing with service charges and budgets.  Landlords can reference these documents to check if their agent is conforming to industry best practice and if they observe its guidance in drafting new leases.

Download SCSI/RICS Code of Practice Service charges in commercial property

9 Mandatory Requirements for Professionals

These 9 mandatory requirements represent what is considered an acceptable standard of performance for SCSI qualified professionals and regulated firms. To provide a service which represents best practice in the management of service charges, practitioners should also have regard to the core 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 5.7, 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 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, 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.
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

11 Core Principles

These core principles underpin and support the mandatory requirements listed above.  It is acknowledged that some of the following principles may be difficult to quantify, and in rare circumstances strict compliance may not always be possible. The appropriate level
of compliance may be based on the professional judgment of all parties as to what is appropriate and reasonable considering all the circumstances.

The Service Costs

  1. All costs should be transparent so that all parties, owners, occupiers and managers, are aware of how the costs are made up. Management fees should be on a fixed-price basis with no hidden mark-ups.
  2. Best practice recommends that services are procured on an appropriate value-for-money basis, and that competitive quotations are obtained, or the costs benchmarked.
  3. Owners should not profit from the provision or supply of services. Save for a reasonable commercial management fee that reflects the actual costs of managing the services, the amount an owner may recover is limited only to the proper and actual cost incurred in the provision or supply of services

Allocation & Apportionments

  1. Costs should be allocated to the relevant expenditure category. Where reasonable and appropriate, costs should be allocated to separate schedules and the costs apportioned to those who benefit from those services.
  2.  The basis and method of apportionment should be demonstrably fair and reasonable to ensure that individual occupiers bear an appropriate proportion of the total service charge expenditure that clearly reflects the availability, benefit and use of services.

Communication & Consultation

  1. While the owner has the right to set the standards by which his or her investment will be managed and has a duty to manage, managers should consult with occupiers with regard to the standard and quality of service charge provision required.
  2. Managers should communicate with occupiers to ensure services are delivered effectively for the benefit of all, and to ensure that occupiers understand what they can expect to receive and how much they are required to pay.
  3. Managers claiming compliance with the principles of this professional statement should be transparent in demonstrating how they comply with it.

Duty of Care

  1. Certified accounts of expenditure are to represent a true and accurate record of expenditure incurred. Those certifying service charge accounts should recognise that they have a duty of care to both owners and occupiers to act with professional care, diligence, integrity and objectivity.
  2. The owner and/or manager has a duty to manage the property, as well as a duty of care to both the occupiers, who entrust the spending of their own business overhead and cash flow by funding the services, and to the owner whose investment they are servicing.

Financial Competence

  1. When incurring costs in the provision of services, the manager is spending the occupiers’ money. Managers are therefore expected to demonstrate a high degree of competence, professionalism, integrity, diligence, objectivity and transparency in dealing with the service charge accounts.
  2. When issuing statements of accounts and/or certifying expenditure, managers should do so in a non-partisan spirit, acting as experts. The manager will therefore endeavour to ensure that all costs have been incurred and are properly recoverable in accordance with the leases.
  3. Service charge monies for each property must be held in one or more separate and discrete bank accounts in recognition of the fact that the monies are being held to provide for the procurement and delivery of the services.
  4.  All interest earned on service charge accounts must be credited to the service charge account after appropriate deductions have been made (e.g. bank charges, tax, etc.)
  5. Annual statement of service charge expenditure should be supported by an independent accountant’s review in line with the ICAEW Technical Release (Tech 09/14).
  6. The industry standard cost classifications should be used in reporting budget and actual expenditure.

Occupier Responsibilities

  1. Occupiers should ensure prompt payment of all legitimate service charge on-account and balancing charges. Where a legitimate dispute exists, any payment properly withheld
    should reflect only the actual sums in dispute – both parties are expected to proactively engage to resolve the dispute.
  2. Occupiers should recognise that the service charge provision of any lease has legal effect, and should ensure that any representatives involved in discussions, meetings, etc. have an appropriate level of responsibility and authority to make decisions concerning service charge matters.
  3. In recognition that value for money and maintenance of quality standards will be enhanced through partnership, occupiers should be proactive in assisting owners in the
    operation and utilisation of services and service systems – for example, by separating waste to facilitate appropriate and cost-effective recycling, adopting energy-saving measures, etc

Rights & Responsibilities/Alternative Dispute Resolution (ADR)

  1. All new leases (including renewals) should make provision for either party to require the resolution of disagreements through the use of ADR as a cost-effective alternative to court action.
  2. If the parties cannot agree a mediator, or an independent expert to determine the dispute, the President of the SCSI should (on request) nominate a suitable person. Where leases do not allow for ADR, parties are reminded that there is nothing to stop them agreeing to use ADR to resolve a dispute.

Timeliness

  1. Communication and consultation between managers and occupiers should be timely and regular to encourage and promote good working relationships and understanding with regard to the provision, relevance, cost and quality of services. Timely and regular communication and consultation will help avoid disputes and resolve them quickly should they arise.
  2. Managers should issue budgets to occupiers, including an explanatory commentary at least one month prior to the start of the service charge year. Detailed statements of actual expenditure, together with accounting policies and explanatory text, should be issued within four months of the service charge year-end

Transparency

  1. Transparency is essential to achieving good communication. By being transparent in the accounts, the explanatory notes, policies and day-to-day management, the manager will help prevent disputes. Prompt notification of material variances to plans or forecasts ensures better working relationships between owner, manager and occupier.

Value for Money

  1. Service quality should be appropriate to the location, use and character of the property. The manager should procure quality service standards to ensure that value for money is achieved at all times. The aim is to achieve effective, value-for-money service rather than merely the lowest price.

Exclusions

Service charge costs should not include any of the following:

  1. Any initial costs (including the cost of leasing of equipment) incurred in relation to the original design and construction of the fabric, plant or equipment.
  2. Any setting up costs, including costs of fitting out and equipping the on-site management offices that are reasonably considered part of the original development cost of the property.
  3. Any improvement costs above the costs of normal maintenance, repair or replacement. Service charge costs may include enhancement of the fabric, plant or equipment, where such expenditure can be justified following an analysis of reasonable options and alternatives, and with regard to a cost-benefit analysis over the term of the occupiers’ leases. Managers should provide the facts and figures to support and vindicate such a decision.
  4. Future redevelopment costs.
  5. Costs and fees relating to the owner’s investment interest, for instance, asset management and rent collection, cost of letting units and matters between the owner and an individual occupier. This last category may include activities such as enforcement of lease covenants, dealing with landlord consents for assignments, sub-letting, alterations, rent reviews, additional opening hours, etc. unless demonstrably for the overall benefit of the property
  6. Costs attributable to void premises and the owner’s own use of the property.
  7. Any costs arising out of the failure/negligence of the manager or owner.

Compliance checklist

This compliance checklist is a basis to enable owners, managers and occupiers to self-assess their compliance with the core principles set out in this professional statement. However, merely ticking the boxes does not constitute full compliance with the professional statement, which also entails adhering to the further recommended best-practice recommendations as provided to support the core principles.

Download Checklist

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