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Service charges - a future without tears?

15 August 2006

Alan White explains how the RICS' new Service Charges: A revised Code of Practice and Guidance Notes could spell a future with fewer disputes between landlords and tenants

Service charges are a big item in the budgets of property occupiers and are the source of much ill-feeling between landlords and tenants often because tenants, who pay the service charge bill, feel they have little or no control over cost or service quality. Facilities managers are invariably caught in the middle of these service charge issues, trying to manage their budgets which are usually being screwed down by the finance directors of their employing companies or their clients.

Against this backdrop and with MP's mailbags allegedly weighed down with letters protesting about the unfairness of service charge arrangements, the RICS has released a revised Guidance Note and Code of Practice about commercial property service charges. This can be found at www.servicechargecode.co.uk.

The Code applies to the managers of commercial or mixed use property, to owners and investors, to occupiers and businesses which use commercial property where service charges are payable.

The key objectives of the Code are to:
...reduce conflict
...produce a budget for future service charges on time
...ensure the total service charge provision account is 'break even'
...bring about better communication and transparency.

The Code applies to new leases after 1st April 2007 and, where possible, to all existing leases. However, clearly the Code cannot 'overwrite' current leases, so the parties are encouraged to align where possible to the Code and gradually come into line over time.

Services will be provided on a 'not for profit, not for loss' basis. This allows suppliers of services to make a reasonable return on the services they provide. The costs will be transparent so that all parties are aware of how the costs are built up. The manager will issue budgets to occupiers with an explanatory commentary at least one month prior to the start of the service charge year and reconciliations will be no later than four months after the financial year end.

Business managers entrust a large operating cost line to the external manager looking after services provision and cost and it is entirely reasonable for them to be notified of any significant variances to the forecast. Prompt notification of unforeseen variances in the total annual spend must be made with an explanation about how this is being mitigated. A well managed service charge account should easily facilitate both transparency and timeliness in the provision of information to all parties involved, occupiers, services providers and the owner.

Service charges will be apportioned using one of the recognised methods - a fixed percentage, fair proportion, floor area or rateably related. Whatever apportionment method is used, the principle is that it reflects the benefit of the services for each occupier and will be transparent to all those involved.

The rationale for the apportionment between occupiers will be reviewed regularly to assess the need to change either the methodology or the apportionment matrix. This will take account of changes over time, for example, units may be added to a shopping centre or the use of a property may change resulting in different demands for services and so changing the cost and payment structure.

Poorly managed service charges are the cause of frequent dissatisfaction between owners and occupiers. Implementation of guidance in the Code will minimise disputes between the facility manager and occupier. The biggest issue causing this is poor communication. FMs must create the means to ensure good communication opportunities so that not only are services delivered effectively for the benefit of all but occupiers must also be able to understand what they can expect in terms of quality of service and the resultant costs.

Of particular interest is the subject of management charges. The fixed percentage arrangement is swept away to be replaced by a 'reasonable fee for the total cost of managing the provision of service' which as circumstances change, will rise and fall over the course of the lease.

Detailed provisions are laid down about how to deal with interest on service charge accounts, sinking, replacement and reserve funds and what happens to these on the change of ownership and the treatment of 'non-core income' in shopping centres.

Should these arguments persist after the Code becomes effective, the RICS has a two stage Dispute Resolution Service which can assist parties to reach an amicable settlement ¨C drs@rics.org. This Service is Quality Assured and is the UK's largest alternative dispute resolution provider for property and construction disputes dealing with around 9,500 cases per year.

Much will also depend on the ability of occupiers to measure the cost of supplied services across their portfolio and against properties elsewhere. This benchmarking is currently very difficult indeed due to the variations in the coding of different heads of expenditure by managers and cost indexes. To meet this problem, the Code proposes a cross-industry set of agreed cost codes. Work on this has already started in order to reconcile the IPD Occupiers code established as the International Total Occupancy Cost Code measurement with that of the JLL run Oscar codes. Again, this will take time to achieve because of the necessary IT changes required by managing agents and FM suppliers. A set of Industry Standard Cost headings appears in the Code document.

Surprisingly, no mention is made of benchmarking research carried out elsewhere - for example, the Actium Consult Total Office Cost Survey [TOCS] or the research from Loughborough University, sponsored by national service charge Property Solutions [UK] Ltd - which looks at the efficiency, effectiveness, administration and costs associated with the management and provision of services in multi-let buildings. Neither is there mention about service charge management and accounting across the USA and Australasia where there is much to learn about the service provision culture. Perhaps these omissions will be covered in the continuing work of the RICS Steering Committee on the subject.

This is a very welcome contribution to a difficult area of property and facility management. It is to be hoped that all FMs will familiarise themselves with this Code which is set to become industry standard practice over the next 12 months.

...Alan D White is chair, RICS FM Faculty and Director, Lenborough Consultants


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