The RICS Professional Statement on Service Charges in Commercial Property (the Professional Statement) comes into force for service charge periods commencing on or after 1 April 2019.  What is it and why should we take notice?

Unlike previous codes of practice on service charges, this one has been published as a professional statement, meaning it contains mandatory requirements or rules that a member or firm is expected to adhere to.  Only if there is a justifiable good reason for not following it can it be avoided, and in that case the surveyor’s clients must be specifically informed in writing.  As such it is hoped that it will have the teeth that previous codes have perhaps lacked, in order to tackle the lack of transparency that still plagues this area of commercial property practice.  It aims to promote best practice, uniformity and fairness and to improve professional standards.

Service charges are designed to cover the maintenance, repair and replacement costs of fabric and services within a property.  They should never encompass improvement costs or fees relating to the owner’s investment interest, such as asset management fees and rent collection costs.

The Professional Statement contains nine mandatory requirements (or core principles), which are supported by best practice principles focussing on matters such as:

  1.  the transparency of service costs;
  2. timeliness in issuing budgets and statement of actual expenditure;
  3. the fair and reasonable apportionment of costs between occupiers; and
  4. ensuring the cost of works represents value for money and is not profit-making.

As with previous codes, the Professional Statement cannot override the terms of a lease, but specific reference to code compliance in leases and in heads of terms is becoming increasingly common. For many years management contracts have demanded that managing agents comply with the RICS codes of practice.  With the application of professional sanctions if the Professional Statement is ignored, this requirement will now be more meaningful than ever.

An issue that has been highlighted by Peter Forrester, chairman of the RICS Commercial Service Charge Professional Group, is the move in recent years towards shorter lease lengths, which makes it more difficult to manage and recover the costs of long-term major repairs and replacements.  The tenant under a five-year lease is not going to accept liability for the replacement of a boiler or re-covering of a roof with a 25-year life span.  This, Peter points out, could be readily addressed by the proper use of sinking and reserve funds in leases.  These funds are strangely misunderstood, or not understood at all, by both the surveying and legal professions, but essentially can be described in the following way:

A sinking fund is intended to provide for the one-off cost of replacement of a wasting asset, usually plant and equipment, the life cycle of which would ordinarily run beyond the term of the lease.  A reserve fund in contrast is intended to meet the cost of future maintenance and upkeep of the fabric and equipment, such as periodic redecoration during the term of the lease, in order to smooth out any variations in the amount of service charge payable each year.  Tenants do not like surprises and planning for expenditure in this way at the outset of the lease would help to avoid disputes arising further down the line.

So, who holds the money in these funds and what happens at lease expiry?

Sinking funds should specifically be held on trust for the owner and occupiers from time to time, such that they effectively belong to the building and can be transferred with the building on sale if necessary.  There is therefore no requirement for any part of the fund to be repaid to a tenant upon lease expiry, as it exists for the benefit of the building.  Conversely, as a reserve fund relates to those costs that are reasonably incurred during the term of the individual lease, it is to be regarded as belonging to the tenant.  If the fund has not been exhausted by expiry of the lease, the tenant is entitled to repayment of any monies it has contributed to the fund.

This article was originally published by CoStar News.