service charge structure property management guideUnfortunately, service charges can get very confusing, even for the experienced property-management expert. There can be endless lists, costs, and accounts that seem difficult to understand within the context of the property.

Often the best way to begin unravelling the service charge mystery is to go back to the fundamental basic principles to see how the detail then reflects, or instead should, reflect this.

After all, they are supposed to be summarising the running costs of an actual property, which are then fairly shared out between relevant occupiers and owners.

Therefore here are ten foundational principles of how service charges should be structured. These are for the more involved landlords, investors, and property managers who often have the task of first creating and setting up these charges; however, others such as solicitors and tenants at the receiving end of these will also find these helpful.

The actual practical outworking of service charges is a separate issue – things like accounts and communication of these - whereas these are the more nuts and bolts of how they’re shaped.

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1. Apportioned Costs

The ‘apportionment’ of service charges is about how they are shared between different people. So if you have two flats above two shops, each of these may pay one-quarter of the costs for looking after the same rear yard area.

It’s often a percentage, so 25% as above, and it may sound obvious, but it should always add up to 100% so that everything is covered. So a slight difference of, say, 99.98% may be okay, though based on a ‘rounding error’ when calculating each one.

Make sure you know how this percentage is calculated and that it’s fair. For example, the usual basis is on the amount of area, so an area twice the size of another may pay twice as much service charge through a percentage twice as high.

Other areas may be needed, such as the size of the Rateable Value, number of bedrooms in a property, or even a ‘weighted’ basis where you need to adjust to reflect the over-or under-use of the property manually.

2. Scheduled Costs

The actual costs incurred need to be organised into different schedules often numbered from 1 upwards and with a brief description like ‘internal areas’ or ‘common parts’.

The idea is that different people will pay for different schedules depending upon how they benefit from those types of charges.

So if you take the example of the two flats above two shops, then ‘schedule 1’ costs may be for anything to do with the external areas, and main building structure, something that all four occupiers will benefit from and so may pay 25% each as per the above apportionment.

But let’s say there is a shared internal stairway leading to the flats with costs such as weekly cleaning and maintaining the electrical system. Because only the two flats benefit and effectively use these areas, you can create a ‘schedule 2’ for, say, ‘internal parts’ where only the two flats pay these costs at 50% each, for example.

3. Chunky Costs

As you include various costs in the service charge, the rule of thumb as to how much these should be reasonable is reasonable, which usually equates to a straightforward repair or service.

Therefore you must be careful not to make these too big or chunky and be on the verge of improvements and added value which can be over the gist of service charge obligations.

So let’s say you have a leaking flat roof; it’s probably okay to include an allowance for a straightforward patch repair rather than a whole new flat roof. However, one word of warning, sometimes these minor repairs are wasted if an entirely new roof is the only way to deal with longer-term, which you may need to look into.

4. Extra Costs

Watch out for extra costs creeping in that should not be in the service charge.

Two typical ones are ground rent on long leases and insurance premiums for the building. Although people may end up paying eventually, technically, these may need to be a separate recharge and frequency of payment.

And watch out for things like fair insurance premiums, with any commissions for others involved clearly explained.

5. Building Costs

On a separate note, make sure that you include the suitable buildings in the correct fashion. This may sound obvious, but you can mistakenly begin amalgamating costs on two separate properties that are not only unfair but may cause issues if these two properties were ever separately sold. You had to split the service charge.

A typical example is where the same owner has two separate properties, with separate access ways and services that happen to be next to each other. They may even share the same car park at the rear, but strictly speaking, it’s worth running two service charges together.

However, sometimes it is worth a bit of common sense and keeping as one whole service charge, but using things like schedules above to ring-fence the costs of each building.

6. Management Costs

Whoever manages the property and service charge can often place a charge in the service charge for this, reflecting true actual involvement. Usually, this is an external managing agent, but even a self-managing landlord may still want their time and cost in there.

In addition to making sure this is fair, it’s only related to the service charge, instead of other management duties like rent collection of individual tenants or any bolt-on services.

checklist small property management guideCLICK HERE to immediately download a Fact Sheet summarising the 5 key factors to cost-effective service charges at any property interest.

7. Expenditure Costs

The essential items of a service charge are the actual costs incurred at the property, known as expenditure items. These range from practical ones like cleaning and servicing electrical items to more general services such as taking professional advice or the accountant’s cost for certifying the accounts.

Ideally, these should be under standard cost-headings that can not only help compare like-for-like with previous years’ costs at the same property but other comparable properties as well.

It would help make sure that everything has been logically categorised and understand what is precisely included, particularly in more general ones like repairs and maintenance. Another example is providing gritting on external areas in winter and whether this falls under an available ‘landscaping’ expenditure item or a more specific one.

8. Controlled Costs

Once the main accounts are completed, they will churn out what each liable person owes, often a tenant through a lease.

As a separate issue, that tenant may have restrictions within their lease to confirm a cap on how much can be charged or even a fixed amount in total. There can also be methods of standard increases to these over time.

However, these are separate calculations that the ultimate landlord or owner must pick up. So, if the service charge accounts say a tenant owes £800, but their lease restricts actual charges to £600, then the landlord will need to cover the £200 difference rather than spread out over other tenants.

This can still be stated in the accounts, but so.

9. Void Costs

In a similar line, any vacant units still need to pay a service charge, as the principle is that they still have the right to use these even though practically they don’t have an occupier to benefit from them. That’s assuming no other arrangement is in place, of course.

This is often by the ultimate owner or tenant, maybe between occupiers or new build properties before they are even sold.

10. Commencement Costs

Knowing when costs begin with people is essential, so even though service charge accounts tend to run annually, these may have been carved up between different responsible people.

So, if one tenant occupies for the first four months, for it to be empty for another four months, for a new tenant to take over afterwards, then the old tenant, landlord, and the new tenant will each have a 4-months slice of the costs.

It would help if you also watched these dates right at the beginning of, say, a new build property, with other sales and letting dates and trying to amalgamate expenditure from the owner actually during the completion of the build.

Getting to the Bottom of Service Charges

So when you’re faced with endless accounts and lists of data within service charge details, please don’t panic and assume they’re automatically correct. Sometimes, it’s inevitable to have this complexity to fairly note each property's details. However, keeping nice and simple is important (we have five essential service charge factors here).

So take a step back and understand the basics of the property and who needs to pay for these costs. Then, go through these above pointers to see how things have been structured to ensure the final service charge budgets and accounting and prices are correct.

And if in doubt, ask someone. After all, service charges exist to communicate the right way to divvy up the costs on-site and need to be understood.

Need More Help?

checklist small property management guideCLICK HERE to immediately download a Fact Sheet summarising the 5 key factors to cost-effective service charges at any property interest.

Check out more property-management resources here, or contact us for help and advice.

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