Finding the right balance when it comes to agreeing service charge costs
Hannah Al-Shaghana, who is a commercial property solicitor, discusses the complexities associated with service charge costs, and how they affect both landlords and tenants.
In the current economic climate, with most businesses severely affected by spiralling energy prices, many of my franchising clients tell me how this is seriously impacting the profitability of their business. Increasing service charge costs is another factor that affects them and many are wondering whether it may be time to relocate.
In this article, I discuss the trends that I am seeing in relation to service charge negotiations. Tenants, more than ever, require full disclosure and transparency on all costs payable under their lease agreements.
Rent is normally a fixed amount payable over an agreed period of time. A service charge, however, is generally a fluctuating amount that reflects costs incurred by the landlord in relation to the maintenance of an estate or building in which the tenant has their property.
As such, a bigger spotlight is now directed at what expenditure is recoverable via the service charge.
Here is a summary of the key trends I have observed during the last few years:
Service charge caps
There has been an increased demand to set either a fixed service charge or one where the cost of the charge is capped. This is mainly driven by the rise in energy costs and a rise in buildings’ insurance premiums.
Landlords are naturally opposed to offer caps because they fear having a shortfall in their annual management costs. However, I have witnessed a shift in recent times. Some landlords are prepared to compromise on a service charge cap by accepting one of the following two options:
a) Fixing the cap for a relatively short period, such as the first two or three years of a lease;
or
b) Carving out particular costs that will not form part of the service charge cap, such as an increase in utility costs.
Service charge exclusions
The costs and services which can be recharged should be detailed clearly in any lease agreement. Most modern commercial leases contain very comprehensive provisions about what can be recovered under a service charge.
I am also noticing that tenants are starting to scrutinise these costs and wish to have some of these costs excluded from the overall service charge. For instance, there is a certain level of scrutiny as to whether any type of ‘improvement or replacement’ of equipment should form part of a service charge.
This potentially widens the costs that can be recharged to a tenant. For example, a landlord could decide to change the air conditioning system within a building, even though the existing one is still in good working order.
If a lease states that the service charge may include any costs of ‘improvement or replacement’ of such items, then the new air conditioning costs can be recharged to the tenants under the terms of the agreement.
However, tenants clearly don’t want to discover that their service charge contributions are funding redevelopment work. Service charges should really be used to repair and maintain common everyday items.
Therefore, there are ways of reducing or excluding certain costs. One example of a service charge cost exclusion is where it is sometime more economically viable to purchase new equipment, rather than repair old machines etc.
Sustainability
It is well documented that commercial buildings, generally, have a high carbon footprint. And landlords are under huge pressure to reduce this carbon footprint. One significant way of doing this is to improve energy efficiency of a building. This can be achieved by upgrading the fabric of the building.
Other areas for improvement may involve the heating, ventilation and lighting systems within a building. To what extent is it fair and reasonable for these costs to be passed on to the tenant as a service charge?
No one should forget that landlords are under significant pressure to make their buildings ‘greener’ but should these additional costs be incurred by tenants?
Conclusion
Whether you are a tenant or a landlord, it is important to ‘place your cards on the table’ and be open and transparent about costs. This will enable fair and reasonable negotiations to take place between both parties. Ultimately, a landlord wants a solvent tenant who can pay their rent on time.
Likewise, a tenant needs clarity and control over service charge costs, so they fully understand what is payable under their lease agreement. Tenants need to be able to budget effectively during these increasingly difficult economic times.
