On Monday the 17th of September 2018, the RICS released a Professional Statement on Service Charges in Commercial Property. After four editions of the document as a Code of Practice, the much-anticipated present iteration is a step in the right direction towards the more robust and transparent handling of service charges.
Bellrock Group is in the enviable position of having the top two service charge consultancies within its team; Profile Consultancy who specialise in Retail service charges and Property Solutions who are Office/Corporate specialists.
Property Solutions also produce the only cost benchmarking and RICS guideline compliance metrics in the UK market at present. As service charge experts we are aware that service charges can be complex, complicated and at times confusing. This helpful “introduction to service charges” gives a whistle-stop guide to what a commercial service charge is and what to watch out for.
A service charge is the cost incurred by a Landlord for the delivery or supply of services in a tenanted or multi-tenanted building and/or estate which, through accounting transactions, is recovered from the tenants.
There is currently no legislation that applies to commercial property service charges – unlike their residential counterpart – and therefore the lease between a tenant and the landlord is the most important document as it forms the legal basis upon which the landlord recovers the costs of providing and delivering the services from the tenant.
The lease will define the nature of the services to be supplied, but typically these will include maintenance, repair or replacement of the fabric and service installations (including plant), soft services (such as security and cleaning), utilities/energy and management. These services are essential for the effective running of the building and for the operational performance of the tenants occupying the space.
Service charge costs are rarely constant from year to year as they are influenced by inflationary factors, variances in service levels and irregular capital expenditures (Capex). Capex is sometimes equalised through the collection of funds – reserve, sinking and/or depreciation – which avoids the peaks and troughs that can catch tenants with relatively short-term leases off-guard.
Why should a business care?
An efficiently managed building has a direct impact on the operational performance of a business and service charge cost levels represent a material part of total occupancy costs.
While reductions in service charge levels can be achieved, this should not be done at the expense of keeping the required service levels. It is important to ensure that the range of services delivered corresponds with those defined in tenants’ leases and furthermore meet their operational needs. However, there is often a misalignment between tenants’ requirements and those of landlords, particularly in mixed-use buildings and where leases are of variable lengths.
Compliance of the service charge costs with the provisions within a tenant’s lease is therefore paramount. Ensuring that service contracts are correctly interpreted and managed is similarly important. On behalf of tenants this can mean a reduction in their annual service charge liability and for landlords identifying these issues can mitigate the risk of challenge to irrecoverable costs in the future.
The apportionment of a service charge can be undertaken in different ways and while some leases are prescriptive others offer general guidelines on the practice. The RICS Professional Statement mentioned above provides useful guidance on apportionment but, again, the lease is the first and most important point of reference.
Service Charge Accounting
The accounting requirements in the Professional Statement have been made more robust and are supported by the ICAEW Technical Release – “Accountants’ Reports on Commercial Property Service Charge Accounts” – which recognises that accountants providing these reports will need to call upon other specialisms in order to be able to comment meaningfully on lease and service contract compliance. It is believed this will bring about a significant improvement and consistency in terms of the scope and value of service charge year-end certifications. The ICAEW Technical Release also seeks to improve the use and reporting of accruals in service charge accounts. Accrual accounting is the most prevalent basis upon which service charge accounts are prepared. It is often the case, however, that many accruals are wrongly called such and even when this is not the case, a control account for accruals is rarely set up in order to match them off as the relevant invoices are received and duly paid.
On the whole the RICS Code compliance metrics included within SCOR (the Service Charge Operating Report) for Offices and Retail have shown marginal improvements year on year. There is, however, with a worrying trend over the last two editions showing the better adopters are improving, but those seemingly unconcerned with the guidelines are falling further behind.
Whether you are a landlord, managing agent or occupier, Bellrock Group can help ensure that your service charges are managed in the best way possible.
Link to our second article An Introduction to Service Charges – Am I paying the correct proportion of the service charge?