Service charges just got teeth – how will the new rules affect you?

Joanna Crofts, Head of Property Asset Management for the South West and South Wales at Knight Frank.

How will the new rules on commercial property service charges affect you? Joanna Crofts, Head of Property Asset Management for the South West and South Wales at Knight Frank, explains the changes:

If you are a tenant or a landlord of a commercial property, you’ve no doubt spent too much of your irretrievable, precious time mulling-over service charges.

As a tenant, you want to make sure the charges you’re paying are fair and reasonable. As a landlord, you want to ensure the costs of running your building are covered and are paid on time.

Service charges are the cement that holds the tenant-landlord relationship together. And, unfortunately, that adhesive can too often become a sticky issue. One of the main reasons for this is a lack of clarity for both parties around what can be charged for – and how much can be charged.

Industry guidance on service charges was first published in 1996 by the Royal Institution of Chartered Surveyors (RICS) and has become known as the ‘Service Charge Code’. Until now, this has only been guidance. But, that is about to change.

‘Service charges in commercial property – a Professional Statement’ has just been published by RICS and it now has teeth. It sets out some mandatory requirements for landlords and property managers and if they don’t comply with them, they may face legal and disciplinary action. The new rules will be effective from 1 April 2019.

It’s hoped the Statement will improve standards, fairness and transparency in the management of service charges and reduce the causes of disputes.

What are the advantages for tenants?

Making the guidance mandatory is in everyone’s interest. It will make service charges clear and transparent for all tenants – rather than just to those whose landlords followed the guidance as best practice.

For example, in the past, it wasn’t set in stone who should be responsible for paying for things like marketing events held in an office building or a shopping centre. Now there’s clear guidance that says the landlord should contribute 50% towards the cost of such events.

Another example is, where a landlord has agreed a capped or fixed service charge as an incentive to secure a new tenant, the landlord must pay for any shortfall, and not simply try to hide this and recover the shortfall from the other occupiers. The service charge matrix showing the basis for recovery of costs must be completely transparent and disclosed.

Service charges on different commercial buildings will now also be easier to compare. So, if you’re looking for a property to lease or buy, this will help you make the right decision on which premises to choose, in relation to service charges.

What will be the biggest change for landlords?

The change that will have the biggest impact for landlords will be the new mandatory – much tighter – timescales for budgeting and settling service charge accounts. They now have to be reconciled annually.

Until now, unless the lease states otherwise, there was nothing stopping a landlord going back several years to recover costs owed. This can have a significant negative impact on a tenant’s cash flow. Similarly, if too much time elapses, a landlord risks losing their chance to recover money owed because a former occupier may have since become insolvent.

If you are a landlord and are up-to-date with your service charge accounting, this won’t be an issue but, if you have a backlog already, you really need to get up to speed now.

What has become mandatory?

  1. All expenditure that the landlord wants to charge for must be in accordance with the terms of the lease.
  2. Landlords must recover no more than 100 per cent of the costs of the provision of the services.
  3. Annually, landlords must give tenants service charge budgets, including appropriate explanatory commentary.
  4. Annually, landlords must give tenants an approved set of service charge accounts showing a true and accurate record of actual expenditure.
  5. Landlords must give tenants a service charge apportionment matrix for their property each year.
  6. Service charge monies must be held in one or more discrete (or virtual) bank accounts.
  7. Interest earned on service charge accounts must be paid into the service charge account.
  8. Practitioners must tell tenants that, if a dispute exists, any service charge payment withheld by them should only be the actual sum in dispute.
  9. Practitioners must tell landlords that, following the resolution of a dispute, any incorrect service charge should be adjusted straight away.

How can you find out more about the changes?

You can read and download ‘Service charges in commercial property, 1st edition’ on the RICS website