What is a service charge?
Service charges are payable by a tenant to the landlord for services that the landlord is obliged to provide under the terms of the lease. Often a landlord will employ a managing agent to carry out those services on their behalf.
Services can include repair and maintenance of roofs, foundations, window frames, guttering, shared drains and pipes, and can also cover wider communal areas such a private estate road or shared car parking facilities (sometimes differentiated as an “estate charge”).
Full details of the services should be contained in the lease, which will also state when the service charge payments are due.
How is it calculated?
Most modern leases allow for the service charge to be payable in advance of the landlord incurring the costs, based on an estimate of costs in the coming year. The service charge is therefore based on what a landlord or their managing agent think they are going to spend in the coming year.
At the end of that year, the landlord should provide a statement of the actual costs. If they exceed the estimate, they will invoice the tenant for the shortfall (known as a "balancing charge").
If the landlord has spent less than estimated, a credit for the overpayment should be carried forward as a credit to the tenant’s next service charge payment.
How much will it be?
This is the million-dollar question. As part of our usual pre-lease enquiries, we would usually expect (as a minimum) to see service charge accounts for the past 3 years, and a budget for the current year.
However, these only show a pattern of spending and an estimate of upcoming expenditure - the reality is that service charge payments can go up or down, and can vary wildly from year to year.
For example, extensive works to common parts could become necessary during the lease term which were not anticipated at the outset (particularly if the lease term is for 10 years or more), or if the cost of sourcing materials or labour goes up significantly (which given the political climate of late is very much a real possibility).
So what is the solution?
From a tenant’s perspective there are various options such as:
- agreeing a service charge cap, so that the service charge will never exceed a specified amount each year during the term; or
- agreeing fixed annual increases, so that a tenant has certainty over what their outgoings will be.
Both of the above have potential downsides for a landlord, as they do not allow for full recoverability of costs. It is therefore important that these principles are discussed at Heads of Terms stage before a draft lease has been issued, so that a tenant can maximise their negotiating potential.
Get in Touch
For further assistance on any landlord and tenant matters, please get in touch with Emma Chater, Partner in Commercial Property at mfg Solicitors LLP on 01527 831 691 or by email at Emma.chater@mfgsolicitors.com.
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