Service charges can unfortunately get very confusing, even for the experienced property-management expert. There can be endless lists, costs, and accounts that seem difficult to understand within the context of the property.
Often the best way to begin unravelling the service charge mystery is to go back to the real basic principles of them, in order to see how the detail then reflects, or rather should, reflect this.
After all, they are supposed to be summarising the running costs of an actual property, which are then fairly shared out between relevant occupiers and owners.
Therefore here are 10 foundational principles of how service charges should be structured. These are for the more involved landlords, investors, and property managers who often have the task of first creating and setting up these charges, however others such as solicitors and tenants at the receiving end of these will also find these helpful.
The actual practical outworking of service charges is a separate issue – things like accounts and communication of these - whereas these are the more nuts and bolts of how they’re shaped.
1. Apportioned Costs
The ‘apportionment’ of service charges is all about how they are shared between different people. So if you have two flats above two shops, then each of these may pay one quarter of the costs for looking after the same rear yard area.
It’s often as a percentage, so 25% as above, and it may sound obvious, but it should always add up to 100% so that everything is covered. A slight difference of, say, 99.98% may be okay though on the basis of a ‘rounding error’ when calculating each one.
Make sure you know how this percentage is calculated, and that it’s fair. The usual basis is on the amount of area, so an area twice the size of another may pay twice as much service charge through a percentage twice as high.
Other areas may be needed though, for example the size of the Rateable Value, number of bedrooms in a property, or even a ‘weighted’ basis where you need to manually adjust in order to reflect the over- or under-use of the property.
2. Scheduled Costs
The actual costs incurred need to be organised into different schedules, often numbered from 1 upwards and with a brief description like ‘internal areas’ or ‘common parts’.
The idea is that different people will pay for different schedules depending upon how they benefit from those types of charges.
So if you take the example of the two flats above two shops, then ‘schedule 1’ costs may be for anything to do with the external areas and main building structure, something that all four occupiers will benefit from and so may pay 25% each as per the above apportionment.
But let’s say there is a shared internal stairway leading to the flats with costs such as weekly cleaning and maintaining the electrical system. Because only the two flats benefit and effectively use these areas then you can create a ‘schedule 2’ for, say, ‘internal parts’ where only the two flats pay these costs at 50% each for example.
3. Chunky Costs
As you include various costs in the service charge, the rule of thumb as to how much these should be for them to be reasonable, which normally equates to a straight forward repair or service.
Therefore you must be careful not to make these too big or chunky, and be on the verge of improvements and added-value which can be over the gist of service charge obligations.
So let’s say you have a leaking flat roof; it’s probably okay to include an allowance for a straightforward patch repair, rather than a whole new flat roof. However one word of warning, sometimes these minor repairs are wasted if a whole new roof is the only way to deal with longer term, which you may need to look into.
4. Extra Costs
Watch out for any extra costs creeping in that should not really be in the service charge.
Two typical ones are ground rent on long leases, and another, insurance premiums for the building. Although people may well end-up paying eventually, technically these may need to be a separate recharge and frequency of payment.
And watch out for things like insurance premiums being fair, with any commissions for others involved clearly explained.
5. Building Costs
On a separate note, make sure that you’re including the right buildings in the correct fashion. This may sound obvious, but you can mistakenly begin amalgamating costs on two separate properties that is not only unfair, but may cause issues if these two properties were ever separately sold and you had to split the service charge.
A typical example is where the same owner has two separate properties, with separate access ways and services that just happen to be next to each other. They may even share the same car park at the rear, but strictly speaking it’s worth running two service charges together.
However, sometimes it is worth a bit of common sense and keeping as one whole service charge, but using things like schedules above to ring-fence the costs of each building.
6. Management Costs
Whoever is managing the property and service charge can often place a charge in the service charge for this, reflecting true actual involvement. Often this is an external managing agent, but even a self-managing landlord may still want their time and cost in there.
In addition to making sure this is fair, make sure it’s only related to the service charge, as opposed to other management duties like rent collection of individual tenants, or any bolt-on services.
7. Expenditure Costs
The basic items of a service charge are the actual costs incurred at the property, known as expenditure items. These range from practical ones like cleaning and servicing electrical items, through to more general services such as taking professional advice or the accountant’s cost for certifying the accounts.
Ideally these should be under standard cost-headings that can not only help compare like-for-like with previous years’ costs at the same property, but other comparable properties as well.
You then need to make sure that everything has been logically categorised, and understand what is exactly included, particularly in more general ones like repairs and maintenance. Another example is providing gritting on external areas in winter, and whether this falls under a general ‘landscaping’ expenditure item or a more specific one.
8. Controlled Costs
Once the main accounts are completed, they will churn out what each liable-person owes, often a tenant through a lease.
As a separate issue that tenant may have restrictions within their lease to confirm that there is a cap on how much can be charged, or even a fixed amount in total. There can also be methods of standard increases to these over time.
These are separate calculations though that the ultimate landlord or owner must pick-up. So, if the service charge accounts say a tenant owes £800, but their lease restricts actual charges to £600, then the landlord will need to cover the £200 difference rather than spread out over other tenants.
This can still be stated in the accounts, but clearly so.
9. Void Costs
In a similar line, any vacant units still need to pay service charge, as the principle is that they still have the right to use these even though practically they don’t have an occupier in to benefit from them. That’s assuming no other arrangement is in place of course.
This is often by the ultimate owner or tenant, maybe between occupiers or with new build properties before they are even sold.
10. Commencement Costs
Knowing when costs begin with people is important, so even though service charge accounts tend to run annually, these may have been carved up between different responsible people.
So, if one tenant occupies for the first four months, for it then to be empty for another 4 months, for a new tenant to take over afterwards, then the old tenant, landlord, and new tenant will each have a 4-months slice of the costs.
You also need to watch these dates right at the very beginning of, say, a new build property as well, with different sales and letting dates and trying to amalgamate expenditure from the owner actually during the completion of the build.
Getting to the Bottom of Service Charges
So when you’re faced with endless accounts and lists of data within service charge details, don’t panic and assume they’re automatically in correct. Sometimes it’s unfortunately inevitable to have this complexity in order to fairly note the details of each property, although where possible it’s important to keep nice and simple.
So take a step back, and understand what the basics of the property are and who is needing to pay for these costs. Go through these above pointers to see how things have then been structured to then make sure the final accounting and costs are right.
And if in doubt, ask someone. After all, service charges exist in order to communicate the right way to divvy up the costs on site, and need to be understood.
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