Service Charges on Commercial Property
If you are renting or thinking of taking a lease over commercial property, you may have to pay service charges in additional to rent, so you should check how they may affect your tenancy. We look at the various commercial property service charge provisions in this article.
What are service charges in relation to a commercial property?
Usually, most commercial leases will contain a clause regarding service charges. These are the costs which your landlord will incur for running and maintaining the shared parts of the building or estate and the landlord can charge you and the other tenants for such costs.
It is normally the tenants who will be responsible for paying all service charges as set out in their commercial leases, however, such services by the landlord will need to be enjoyed by some or all occupiers in common, for example, building-wide air-conditioning. By contrast, the cost of services that will be enjoyed exclusively by an individual occupier such as the occupier’s own power consumption will usually be met by that occupier only and not shared by other occupiers.
Generally, service charges can include maintenance and repairs to shared areas such as common stairwells and corridors, building insurance and management charges. It’s become very common for service charges to also include costs for shared services such as a cleaner or gardener or to maintain a lift.
Typically, commercial property service charge covers the following, although the specifics will vary from property to property;
- General repairs (which will include structural repairs)
- Refuse and waste collection
- Air conditioning
- Staffing costs- including property management fees
- Insurance costs
Commercial property service charges would not normally include the following:
- Any initial costs incurred in relation to the original design and construction of the fabric, plant or equipment;
- Any setting up costs that are reasonable to be considered part of the original development cost of the property;
- Improvement costs above the costs of normal maintenance, repair or replacement or
- Future redevelopment costs.
If you would like to read more on what services might be included in the service charges and generally how service charges are calculated, please read our other service charges blog which can be found here.
A sinking fund/a reserve fund
In addition to the service charge payments, the landlord may collect some additional funds to put into a reserve/sinking fund account which additional funds the landlord believes are needed to cover any unexpected shortfall.
If there are going to be major improvements or if the full replacement of major items will be required at some point in the future, for example, the replacement of a lift, window frames or a roof, doing external decorations, structural repairs or repainting, your landlord is most likely to implement a sinking fund to recover the cost of such improvements or replacement from all occupiers in advance over a period of time.
The reserve fund is usually built up over a short period of time of two or three years and leases sometimes provide how much is to be contributed each year. If the lease does not specify the yearly amount to be contributed, then the landlord will determine the amount of the contributions to be made. However, such contributions need to be just and reasonable and the occupiers can potentially challenge such contributions in court if they believe they are unreasonable.
If any contributions are to be made by the occupiers, such contributions should be held ‘in trust’ on behalf of the leaseholders by the landlord until utilization of the sinking fund becomes necessary. This means that there needs to be a separate bank account to the service charge monies to comply with the current law.
Also, any contributions paid into the reserve fund are generally not repayable when a flat is sold, but they may be if the lease provides for this.
Advantages of a sinking fund
The advantage of having a sinking fund that is collected as part of a service charge is that occupiers will contribute to the larger replacement costs gradually over a period of a few years instead of paying a one-time considerable charge from the landlord at the time of replacement.
Also, leasehold properties may be easier to sell if there is a sinking fund because this will avoid the buyer being overly concerned about having to pay for considerable unanticipated expenses for major works.
Disadvantages of a sinking fund
One disadvantage of having a sinking fund is that any amount of money that has been paid into the sinking fund will generally increase annual costs. In addition, another disadvantage, from an occupier’s point of view, can be that an occupier’s lease might expire before the sinking fund needs to be utilized. This might mean that the occupier may not recover the contributions they have made to the fund because it will be difficult to get money released when it has been paid and not used and the landlord is under no obligation to return any such contribution. This can be taken into account at the point of sale, where the new owner takes control of the relevant share of the sinking fund and reimburses the seller.
Also, if the sinking fund is operated by the landlord, the contributions towards the fund should be recovered separately from the service charges so that any confusion over what these contributions relate to is avoided.
Likewise, if you decide to sell your property, the money you paid into the sinking fund will be retained as capital to cover any repairs which have resulted from general wear and tear while you were living at the property. So, you will not be able to recover those contributions that you have made.
Service charges in commercial property: new best practice
The Royal Institution of Chartered Surveyors (RICS) has this month published the first edition of its Professional Statement: Service Charges in Commercial Property.
The Professional Statement sets out best practice in the management and administration of service charges and it will apply to all service charge periods commencing from 1 April 2019.
There are nine mandatory requirements:
(1) All expenditure that the owner and manager seek to recover must be in accordance with the terms of the lease
(2) Owners and managers must seek to recover no more than 100% of the proper and actual costs of the provision or supply of services
(3) Owners and managers must ensure that service charge budgets and explanatory commentary are issued annually to all tenants,
(4) Must ensure that an approved set of service charge accounts is provided annually to all tenants
(5) And that a service charge apportionment matrix is also provided annually.
(6) Service charge monies must be held in one or more discrete bank accounts.
(7) Interest earned on a service charge account must be credited to the account.
(8) When 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 a resolution of a dispute, any service charge that has been raised incorrectly should be adjusted to reflect the error without undue delay.
Disclaimer – our articles are designed to give you guidance and information. There is no substitute for proper direct advice, particularly as everyone’s circumstances are different. If anything in this article may affect you, please contact us for advice that is specific to your circumstances.