To charge, or not to charge: for services in commercial properties

Molly Whitehouse examines recent efforts to bring greater clarity to the code for professional standards for service charges in commercial properties.

The code for professional standards for service charges in commercial properties is set to be re-launched and a consultation is open until 26 October 2024. More of a helpful reminder than anything else…

On 17 September 2024, The Royal Institution of Chartered Surveyors (RICS) published a public consultation for "Service Charges in Commercial Property professional standards" which is set to launch in the summer of 2025. 

Building on the first edition published in 2018, the forthcoming second edition seeks to update the framework of best practices and recommendations for managers and landlords when administrating and managing service charges in commercial property. 

The objective of the second edition is not to change the recommendations presented in the first edition published in 2018, but to present the recommendations in a more comprehensible manner, as well as provide further clarity on what is expected to meet best practice.

The second edition serves as a helpful reminder of the core principles being "communication, transparency and timeliness". The new edition aims at placing further emphasis on legal professionals adhering to the industry best practices when drafting and interpreting lease provisions, clearer guidance on resolution when disputes arise and even more emphasis on establishing smoother relationships between landlords, tenants, and managers. 

The consultation sets out in detail best practice recommendations to ensure that the core principles and mandatory requirements in section 2 and 3 of the consultation are met.

The key recommendations are summarised below: 

• Service charge year end accounts should include a statement signed by the manager confirming the accounts, and any information recording the actual costs that the landlord has incurred in providing the services to the property. This reiterates the need to ensure transparency and to promote better working relationships between the landlord, manager, and tenant.
• Ensure proficient communication with the tenant so that any reasonable issues can be dealt with promptly and effectively. The consultation re-emphasises the need for clear communication between the parties and for managers to provide, if requested, access to copy invoices. Managers should also hold regular meetings with tenants and should inform them of key contact details so that uniformity is achieved.
• Reduce court action between the parties and seek to resolve matters by negotiations or through alternative dispute resolution (ADR). The consultation reiterates the need to include in all new leases an ADR provision and even if a lease does not contain an ADR provision, the parties should still agree to use ADR as an alternative to Court. 
• Value for money and appropriate level of service should be front of mind for all managers when procuring quality service standards for the property. Managers should review costs every three years and look to review contracts so that competitive quotations are obtained (unless it is impractical or not cost effective to do so). The aim for managers should be to show that service methods are being continually reviewed to achieve greater value for money.
• Improvement or enhancement works would not normally be recoverable under service charges. Therefore, the recommendations remind managers that if they provide sufficient evidence to show that the improvements have cost-benefits for the tenants that override the terms of their lease, then the cost of these works might be recoverable. Managers will need to provide evidence to support their proposals to their tenant.
• Certificates provided by the manager and annual statements of service charge expenditure should be supported by an independent review of the service charge year end accounts in line with the requirements of the Institute of Chartered Accountants in England and Wales.
• Ensure that all legitimate service charge queries are reasonably raised by the tenant. Further emphasis is placed on tenants setting out why they are withholding any payments and how the withheld amounts have been calculated. Tenants should not be entitled to withhold payments of service charges unless it is unreasonable to make payment. The recommendations remind landlords, managers, and tenants to have  on-going dialogue to seek to address any issues and to avoid matters escalating into a dispute.
• Competent financial practices must be followed by managers. Where the requisite timescales for providing tenants with budgets and service charge accounts cannot be adhered to, the manager should provide a prompt explanation  for the  delay. The consultation places greater emphasis on managers communicating with their tenants and expressly states that notification of any delays will not dispense with the requirement of producing a mandatory budget.   
• Having a "duty of care". Those involved in the management and administration of service charges should act within professional care standards and with diligence, integrity and objectivity. For instance, the consultation sets out how managers should run their teams, how to deal with staffing issues and management charges to ensure standards are being met.   
• Allocation and apportionment of all service charge expenditure should be transparent, documented in writing to the tenant with full details of basis calculation and apportionment of individual costs and should be re-examined periodically. The guidance recommends that floor area apportionment is the simplest option and makes it clear that rateable value apportionments are no longer recommended.
• Reasonable endeavours must be taken by all landlords, managers and tenants to comply with all practices set out in the consultation. In particular, the new recommendations expressly states that those responsible for preparing accounts should use "all best endeavours" to comply with  the Industry Standard Cost Classifications. . These were introduced in the first edition however greater emphasis is placed on their use in this consultation.
• Generating income from services and activities at the property requires full transparency.  Managers must provide clear statements of policy as to where the relevant cost and income is allocated. 
• Existing and new lease provisions must be fully understood as many service charge disputes arise from a failure by the parties to take account of their respective rights and liabilities under the lease. The consultation reiterates that provisions in the lease will prevail, however, there is an emphasis on practitioners using the guidance when interpreting existing provisions.  If there is any doubt regarding the service charge obligations, then legal advice should be sought.
• Sinking and Reserve Funds or depreciation charges as previously recommended are to be held in one or more separate discrete bank accounts to be maintained "in trust" for tenants.

In our experience over the last few years, landlords have been more accommodating to tenant demands, in particular, in increasing the number of items that previously used to be included but are now excluded from the list of items that may be recovered through the service charge. 

We are also seeing landlords being far more punctual in delivering final accounts. 

This may well be a result of previous versions of the code and recommendations, or a change in market conditions, or more likely both.

The RICS proposed changes for dealing with service charges in commercial property, seeks to provide clearer guidance and transparency, which in turn will help managers/landlords navigate complex service charges with greater understanding and less conflict with their tenants. 

Why not have your say on it all? The consultation is open until 29 October 2024 to provide your feedback and help shape the future of service charges.

Molly Whitehouse is an Associate at Trowers & Hamlins.