Service charges in commercial property A guide for occupiers rics.org/servicechargecode
RICS April 2011 ISBN: 978-1-84219-679-3 Published by: RICS Parliament Square London SW1P 3AD United Kingdom No responsibility for loss of damage caused to any person acting or refraining from action as a result of the material included in this publication can be accepted by the author, publisher or RICS. RICS Sustainability 02 Service charges in commercial property
Contents Introduction 04 Why do we need the Code? Aims and objectives of the Code Limitations of the Code Understanding service charges 05 Value for money and quality of services Budgets and accounts 06 Cost headings Management fees Allocation and apportionment 07 Repairs to fabric, plant and equipment 08 Improvement and refurbishment Environmental sustainability 08 Sinking/replacement and reserve funds 09 Dispute resolution 10 For more information 11 Service charges in commercial property 03
Introduction The Royal Institution of Chartered Surveyors (RICS) has published a Code of Practice for its members who are involved in all aspects of service charges for commercial property. This Code of Practice is now generally accepted by the property industry as setting best practice principles for the management and administration of service charges in commercial property. This guide written specifically for occupiers of commercial property, gives an overview of the Code and will help you to understand the following topics: understanding service charges budgets and accounts allocation and apportionment repairs to fabric, plant and equipment environmental sustainability sinking funds/replacement and reserve funds dispute resolution. This guide aims to raise awareness of the Code among occupiers of commercial property and to outline what to expect when discussing service charges. It does NOT override the Code or lease in any way. Reading this guide will not equip you with enough detail to conduct your own negotiations you should always seek professional advice when taking on or renewing an existing lease. This guide will help to ensure that your advisers are working within the recommendations of the Code as far as is practical. 1 Why do we need the Code? The property professionals you deal with should always act with professional care, diligence, integrity and objectivity. However, service charges have been a frequent cause of dispute between owners and occupiers. In many cases, disputes arise because of poor communication between all parties, therefore the Code places great emphasis on the need for improved communications, transparency and timeliness. Although the Code is not mandatory, there are implications for professionals who do not take best practice into consideration. For example, in cases of professional negligence, the court is likely to take account of any relevant guidance notes published by bodies such as RICS when deciding whether or not a practitioner acted with reasonable competence. Practitioners who do not follow recommended practice may have to explain in court why they decided not to adopt the recommended practice. Aims and objectives of the Code To improve general standards and promote best practice, uniformity, fairness and transparency in the management and administration of service charges in commercial property. To ensure timely issue of budgets and year-end certificates. To reduce the causes of disputes and give guidance to resolving disputes where these do occur. To provide guidance to solicitors, their clients (be they owners or occupiers) and managers of service charges in the negotiation, drafting, interpretation and operation of leases in accordance with best practice. Limitations of the Code There may be some circumstances where the suggested best practice in the Code cannot be applied. If this happens, the practitioners should always explain to you why this is the case and keep a record of their reasoning. Whilst the Code cannot override existing leases, there is a trend towards shorter lease terms which means that renewals will become more frequent and opportunities to apply best practice will occur more often. The Code was written with larger properties in mind, so owners and occupiers should use common sense when applying the Code to smaller properties particularly in terms of cost-benefit issues. 1 In this guide, the term owner includes any person or company (e.g. a manager) who receives or collects the service charge monies; the occupier is any person or company who pays the service charge (e.g. a tenant) 04 Service charges in commercial property
Understanding service charges All businesses have to pay for property related overheads or running costs. Typically, these costs include services such as the provision of heating, lighting, cleaning, security, and so on. Costs may also include works such as maintenance, repair and replacement (where beyond economic repair) of any fabric, plant, equipment and materials. The test of whether you will be asked to pay such costs is that they should be beneficial and relevant to the needs of the property, its owner, its occupiers and their customers. Together, these costs make up the service charge. The service charge usually comprises the direct cost of the services to the business, often including a management fee payable to the person or company who administers the services. As an occupier of commercial property, you are entrusting a portion of your business overheads to an external organisation. For this reason, the core principle of the Code is that the service charge should be administered on a not for profit, not for loss basis. Owners must demonstrate a high degree of competence, integrity, objectivity and transparency in dealing with the service charge accounts. In practice, this means that: the property owner should obtain competitive quotations for the various services and should select suppliers based on a value-for-money assessment of the services offered the costs of the services should be transparent so that everyone involved is aware of how the costs are made up the owner must ensure that all costs have been incurred in accordance with the lease owners should hold service charge monies in one or more separate bank accounts. The Code specifically proposes that owners should recognise their duty of care to occupiers whose money they are spending and that occupiers have a right to challenge the service charges being levied. Service charges can be advantageous to occupiers for a number of reasons, but mainly because: the costs are relatively fixed, budgeted and known in advance having a fixed on account overhead helps you to manage cash-flow and budgets you do not need to devote staff time to procuring services or dealing with problems of supply. Nevertheless, service charges have often been a source of dispute between owners and occupiers and that is why the Code emphasises the need for good communications and transparency among all parties. For example: owners should actively communicate with occupiers to ensure they are clear what services they can expect to receive and how much they are required to pay occupiers should be notified as soon as possible if forecasts of costs need to be revised (known as variance) or if there are unforeseen variances occupiers should be notified as to which items should NOT be included in service charge costs. Value for money and quality of services The quality of services will depend upon, and should be appropriate to, the location, use and character of the property. Owners should procure quality service standards to ensure that value for money is achieved at all times. The aim is to achieve value for money and effective service rather than simply trying to achieve the lowest price. Owners should not profit from the provision or supply of services. Save for charging a reasonable fee to reflect the costs of managing the services the amount recoverable by an owner is limited to the actual costs of supplying the services. Service charges in commercial property 05
Budgets and accounts Owners should provide you with: an estimate (budget) for the likely service charge for the year ahead, including an explanation of the itemised costs (delivered no later than one month before the start of the service charge year) a statement setting out in detail the expenditure incurred for the previous year (delivered as soon as possible after the service charge year-end, but certainly within four months). Good communications are essential and owners should make sure that the accounts clearly explain the reasons why any actual costs were different from budget estimates. In addition, owners should ensure the layout of accounts is similar each year, so that everyone who reads them can easily compare changes year-on-year. If you wish to ask questions about the accounts you should do so within a reasonable period the Code suggests four months from the date the certified accounts were issued. If you do not agree with the accounts you may want an independent review (for which you have to pay) or you may require copies of documents relating to certified accounts. Cost headings The overall service charge is made up of various costs for a wide range of separate services. It is important to be able to compare the charges and cost-effectiveness of one property against another, or against an industry standard, so the commercial property industry uses Industry Standard Cost Headings. The list covers all the common items that are likely to appear in a service charge budget or accounts, ranging from utilities such as gas and electricity to management such as accounting fees and site management resources (such as receptionists and concierges). Several companies publish analyses of service charges which take an average of the service charges for similar properties and therefore provide a guide against which you can compare the service charge for your property. However, property is not mass produced in similar formats (as is a car, for example) and therefore each property will have its own variations from the average. Beating the benchmark does not necessarily prove that the service charge is value for money or that those services are delivered efficiently. Management fees The fee for the management services should be the reasonable price for the total cost of managing the provision of the services at the location. To minimise disagreements between owners and occupiers, all costs should be transparent. In particular, budgets and accounts should explicitly show: the management fees; and the cost of site-specific management and resourcing. Owners should take care to ensure that the management fee associated with the service charge is just that. This fee should not include the cost of managing other (non-service charge) aspects of the property. The total price for the management fee should be a fixed fee for a reasonable period (e.g. three years). In the past, it was common to link the management fee to the total price of services. This meant that the greater the cost of services the more management fee had to be paid a source of many disagreements. The Code requires the management fee to be on a fixed-price basis and should not be linked to a percentage of expenditure. 06 Service charges in commercial property
Owners may need to charge supervisory fees where other professionals (e.g. HR teams or building surveyors) are involved. However, these fees should not be simply added to the overall management fee. Instead, they should be allocated to the cost category most appropriate to the particular work being supervised. The detail may not seem important to you because you will simply look at the total bill. However, it has been introduced to ensure that the management costs are transparent. It also makes it easier to benchmark the cost of management, knowing there are no hidden extras. Allocation and apportionment Where there are several businesses occupying one property the costs for services need to be shared. It is likely that each separate occupier will have different needs so it is common for each occupier to pay a proportion of the total service charge for the property. The proportion could be calculated using a number of methods but the aim should always be to ensure that occupiers bear a proportion of the total costs that is fair and reasonable and reflects the availability, benefit and use of the services. The method and details of the formula used to calculate your share should be clearly communicated to you by the managers and it is essential that this matrix is reasonable and can be seen to be fair to all occupiers of the property. The various items that are covered by the service charge will be listed in an expenditure schedule. You should be given a copy of both the apportionment matrix and the expenditure schedule together with a clear and easy-to-follow commentary on how the expenditure is allocated between the schedules and how those schedules are apportioned between relevant occupiers. The apportionment system means that owners will usually be able to recover all the expenditure on operational services through the service charge. However, sometimes this may not be possible. The owner is responsible for the service charges attributed to unlet properties and for any specific concessions granted to individual occupiers. These charges should not be passed to existing occupiers. The owner will need to bear a fair proportion of the costs attributed to their own use of the property (e.g. where an on-site management office is used as the owner s regional office) and also for any concessions granted to individual occupiers. The apportionment matrix should be reviewed regularly to ensure that it is still fair after any changes to the occupation or use of the property. And, as with all other aspects of service charges, changes should be explained and shared with everyone concerned. Any services that are used by some occupiers but not others should be excluded from the main schedule and only allocated to a separate schedule which is apportioned among the relevant occupiers. Service charges in commercial property 07
Repairs to fabric, plant and machinery Service charges should usually be limited to the recovery of the reasonable costs of maintenance, repair and replacement (usually where beyond economic repair) of the fabric, plant, equipment and materials necessary for the property s operation. Service charge costs will not generally include: 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 any setting up costs that are reasonably to be considered part of the original development cost of the property improvement costs above the costs of normal maintenance, repair or replacement Improvement and refurbishment Who should pay for improvements or replacement of equipment, introduction of new technology and refurbishment of the premises, and so on, is complex, and will vary from lease to lease. For example, installing a closed-circuit television (CCTV) system might be expensive but could reduce the costs of manned security services. The general rule is that initial provision is funded by the owner. To reduce the potential for dispute, all such proposals should be discussed and negotiated in a transparent manner and on the basis of cost-benefit. Sometimes the costs of such works can be recouped from the sinking fund or by using a reserve fund to spread the cost over more than one year. future redevelopment costs. Service charge costs may include improvements or enhancement of the fabric, plant or equipment where such expenditure can be justified. Managers should provide the facts and figures to support and justify such a proposal. Environmental sustainability Owners and occupiers should be aware of the environmental impact of their respective operations and adopt a cooperative and collaborative approach in recognising and managing the environmental impact of the occupation and management of commercial premises. The recent emergence of green leases in the UK may be one way of addressing these issues. Green leases are standard commercial property leases with a number of voluntary and/or legally binding clauses pertaining to cooperation with the aim of reducing energy and water consumption and waste production. Where leases are already in place, there may be value in owners and occupiers entering into a non-legally binding memorandum of understanding, which provides a roadmap for cooperation between the parties on improving the environmental performance of buildings. 08 Service charges in commercial property
Sinking/replacement and reserve funds For any property there are likely to be occasional one-off costs for replacing major items of equipment (e.g. a heating system), or for periodic works such as external redecoration. Instead of charging for these costs when they arise which would mean you might suddenly be faced with a much larger service charge bill for one year it is common practice to spread the cost over a number of years by collecting an annual contribution to a separate fund. A sinking (or replacement) fund is used by the owner to build up money to pay for repair and replacement of major items of plant and equipment. The owner should make the payments due from any empty premises on the property. The owner should give you a clear explanation of the way the contributions to the fund are calculated and should take care to provide a reasonable estimate of likely future expenditure, rather than simply collecting monies for unidentified future items. Sinking and reserve funds are less common these days, despite their advantages, because of the extra administration costs and tax issues involved. A reserve fund is used by the owner to cushion the impact of unequal expenditure across a number of years. For example, money could be set aside over more than one year in a reserve fund to spread the cost of redecorations over a manageable timeframe. The monies collected for either a sinking or reserve fund should be placed in an interest-bearing account held in trust for the occupiers and crucially separate from the owner s monies. Service charges in commercial property 09
Dispute resolution In the past, poorly managed service charges often caused disputes between owners and occupiers, ranging from whether or not the lease permits a service to be provided, whether the expenditure itself is value for money or even matters of apportionment. The Code aims to cut the level of disputes. Inevitably, though, disagreements will arise from time to time. You have a right to reasonably challenge the propriety of expenditure on services, although you will need to bear the costs of the challenge, unless other arrangements have already been agreed (e.g. by court determination). RICS Dispute Resolution Service (DRS) is a two-stage dispute resolution process that includes mediation and expert determination. The DRS has access to a service charges panel of trained and experienced service charge practitioners to help resolve such disputes. For further information contact: RICS Dispute Resolution Service Westwood Way Coventry CV4 8JE t +44 (0)20 7334 3806 e drs@rics.org Alternative Dispute Resolution (ADR) has been introduced because the courts are increasingly encouraging people to resolve all sorts of disputes from divorce to service charges without the need to go to trial. The courts are determined to encourage everyone to use ADR and, in fact, may ask for evidence that it was properly considered. Furthermore, you may be penalised in costs if you do not give proper consideration to using ADR, even if you win at trial. It is worth noting that if you have a dispute over service charges it may also affect other occupiers of the property. This means that it can be helpful to deal with related disputes from more than one occupier at the same time. 10 Service charges in commercial property
For more information For more information We hope this guide is useful to you. If you d like to know more about service charges or view the RICS Service Charge Code visit our website rics.org/servicechargecode The City of London Law Society and Practical Law Company have both drawn up service charge lease provisions which have been specifically designed to comply with the principles and provisions of this Code. These are available as downloads from the following links: Service Charge Provisions for an Office Building: http://www.citysolicitors.org.uk/fileserver.aspx?oid=976&lid=0 Service Charge Provisions for a Shopping Centre: http://www.citysolicitors.org.uk/fileserver.aspx?oid=975&lid=0 http://property.practicallaw.com/6-505-4928 For general guidance on leasing business premises please visit leasingbusinesspremises.co.uk If you want to receive independent, impartial advice from a qualified RICS member with good local knowledge, contact us: ricsfirms.com alternatively email contactrics@rics.org or call the RICS Contact Centre 0870 333 1600 Service charges in commercial property 11
rics.org/servicechargecode RICS HQ Parliament Square London SW1P 3AD United Kingdom Worldwide media enquiries: e pressoffice@rics.org Contact Centre: e contactrics@rics.org t +44 (0)870 333 1600 f +44 (0)20 7334 3811 Advancing standards in land, property and construction. RICS is the world s leading qualification when it comes to professional standards in land, property and construction. In a world where more and more people, governments, banks and commercial organisations demand greater certainty of professional standards and ethics, attaining RICS status is the recognised mark of property professionalism. Over 100 000 property professionals working in the major established and emerging economies of the world have already recognised the importance of securing RICS status by becoming members. RICS is an independent professional body originally established in the UK by Royal Charter. Since 1868, RICS has been committed to setting and upholding the highest standards of excellence and integrity providing impartial, authoritative advice on key issues affecting businesses and society. RICS is a regulator of both its individual members and firms enabling it to maintain the highest standards and providing the basis for unparalleled client confidence in the sector. RICS has a worldwide network. For further information simply contact the relevant RICS office or our Contact Centre. Europe (excluding United Kingdom) Rue Ducale 67 1000 Brussels Belgium Asia Room 1804 Hopewell Centre 183 Queen s Road East Wanchai Hong Kong Americas 60 East 42nd Street Suite 2918 New York, NY 10165 USA Oceania Suite 2, Level 16 1 Castlereagh Street Sydney NSW 2000 Australia t +32 2 733 10 19 f +32 2 742 97 48 ricseurope@rics.org t +852 2537 7117 f +852 2537 2756 ricsasia@rics.org t +1 212 847 7400 f +1 212 847 7401 ricsamericas@rics.org t +61 2 9216 2333 f +61 2 9232 5591 info@rics.org.au United Kingdom Parliament Square London SW1P 3AD United Kingdom Africa PO Box 3400 Witkoppen 2068 South Africa Middle East Office F07, Block 11 Dubai Knowledge Village Dubai United Arab Emirates t +971 4 375 3074 f +971 4 427 2498 ricsmiddleeast@rics.org India 48 & 49 Centrum Plaza Sector Road Sector 53, Gurgaon 122002 India t +91 124 459 5400 f +91 124 459 5402 ricsindia@rics.org t +44 (0)870 333 1600 f +44 (0)207 334 3811 contactrics@rics.org t +27 11 467 2857 f +27 86 514 0655 ricsafrica@rics.org APRIL 2011/ VP/908PG