_RICS Service Charges in Commercial Property 1st Edition

Published in September 2018, the RICS Service Charges in Commercial Property 1st Edition succeeds the current Service Charge Code 3rd edition. 

There are several benefits for tenants, and potentially significant implications for landlords. For landlords, the key change is that it is now compulsory, therefore levelling the playing field and providing greater certainty for tenants. For tenants, this means all RICS service charges must be clear and transparent for all and not only those whose landlords followed the guidance as best practice.

One of the main causes of disputes on service charges between landlords and tenants is a lack of clarity around charges. For example, where a landlord has agreed a capped or fixed service charge as an incentive to secure a new tenant, it enforces that the landlord must now pay for any shortfall, and unscrupulous landlords cannot try to recover the shortfall from other occupiers. The service charge matrix showing the basis for recovery of costs must be completely transparent and disclosed. Similarly, the treatment of Reserve and Sinking Funds will be closely monitored, and audited with purpose and transparency.

The change that will have the biggest impact for landlords will be the new mandatory annual timescales for budgeting and settling service charge accounts. Until now, unless a lease specifically stated otherwise, a landlord could go back several years to recover costs owed, with a potentially significant impact on tenants’ cashflow. Service charges on different commercial buildings will now also be easier to compare, so that prospective tenants or investors can make more informed decisions. 

Most landlords will have reviewed these requirements with close regard and be ready. But the fundamental principles of good management of budgets and close monitoring of reactive, planned and projected future expenditure have never been more important. 

Landlords may face additional costs for higher levels of reporting and regulation, but practitioners already use independent auditing under the code, which in most cases is good value and a clear and fair way to show independent accounting of the year’s expenditure. In some cases, audit costs can be disproportionate for very small sites. 

Landlords now must be able to justify service costs to tenants and so need to keep much tighter control of costs. A clear protocol for escalation if issues arise or if costs or services are challenged provides a much clearer remedy to genuine service charge disputes, which benefits both landlords and tenants.

Although the code has changed, the fundamental drivers behind why a landlord seeks to recover costs from an occupier, or why an occupier may want to maintain control of these costs and service levels, remain. Service charges and running costs impact the bottom line and these pressures will drive occupiers and their consultants to rigorously ensure service charges are administered correctly. This will be especially important in the retail sector, which is seeing significant disruption.

The new rules will undoubtedly lead to test cases revolving around the wording of leases. Problems may arise, for example, where older leases are silent on the scope of certain repairs or services. In these circumstances, in the absence of agreement, the landlord may need to prove the benefit to the tenant if these works are to be included and recoverable. Furthermore, if there is a benefit to the tenant it may be difficult to determine if this is a common or an individual benefit. 

To ensure compliance with the new code from April, landlords will need to set unified and additional cost categories, ensure relevant and clear wording in new leases, and consider meaningful consultation and budgeting for year-end budgets each year. 

Although the new code provides clearer and stronger ground for redress of disputes, it should not necessarily mean an increase in disputes between landlords and tenants. It should instead provide the clarity that underpins the need for greater consultation and dialogue between landlord and tenant.  

Consultation and flexibility will ensure successful collaborative relationships and high-quality service delivery. Landlords and tenants should embrace the changes, not just to recoup costs, but to ensure better and more relevant services. It is quality of service and the correct application of service levels for different sites and occupiers that makes for good value and delivery of effective service charges. 

Knight Frank’s Property Asset Management team manages over 2,900 properties across the UK, amounting to 70 million sq ft of real estate and with annual rents of over £800 million. Each year Knight Frank collects £55m in service charges for corporate landlords, and its team of 280 colleagues manage properties valued at over £12 billion. 

For more information, please contact:

Sam Cookman, Partner, Knight Frank and Elizabeth Fletcher, Associate, Knight Frank