A guide to the RICS Professional Statement.
The RICS Professional Statement, (PS) has been endorsed by the property industry and is considered to be a further step towards formalising service charges.
What is the RICS Professional Statement trying to achieve?
The key aims and objectives of the PS are to:
- improve general standards and promote best practice, uniformity, fairness and transparency in the management and administration of service charges in commercial property;
- ensure timely issue of budgets and year end certificates;
- reduce the causes of disputes, and to provide guidance on the resolution of disputes if these arise; and
- provide guidance to solicitors, their clients (whether Landlord or Tenant) and managers of service charges in the negotiation, drafting, interpretation and operation of leases, in accordance with best practice.
The 9 Mandatory requirements are as follows:
- All expenditure that the owner and manager seek to recover must be in accordance with the terms of the Lease.
- Landlord’s and managers must seek to recover no more than 100% of the proper and actual costs of the provision or supply of the services (but as above, the Lease terms will prevail and therefore if the service charge payable is expressed as a fixed percentage, where the costs incurred are less than the agreed percentage, the terms of the Lease remain paramount and this principle will not override the Lease).
- Landlord’s and managers must ensure that service charge budgets, including appropriate explanatory commentary, are issued annually to all tenants.
- Landlord’s and managers must ensure that an approved set of service charge accounts showing a true and accurate of the actual expenditure constituting the service charge are provided annually to all tenants.
- Service charge monies (including reserve and sinking funds) must be held in one or more discrete (or virtual) bank accounts.
- Landlord’s and managers must ensure that a service charge apportionment matrix for their property is provided annually to all tenants.
- Interest earned on service charge accounts or where separate accounts per property are not operated, a proper and reasonable amount of interest calculated on normal commercial rates must be credited to the service charge account after appropriate deductions have been made.
- When acting on behalf of a tenant, practitioners must advise their clients that if a dispute exists any service charge payment withheld by the tenant should reflect only the actual sums in dispute.
- When acting on behalf of a landlord, practitioners must advise their clients that following resolution of a dispute, any service charge that has been raised incorrectly should be adjusted to reflect the error without undue delay.
However, as with the preceding codes, the PS cannot override the terms of the Lease which takes precedence nor will a failure to meet the standards set out in the PS negate or limit a Tenant’s liability to pay any service charge due under the Lease.
So how can the PS assist Tenant’s when negotiating a New Lease or a Lease Renewal?
The key is for the service charge provisions in the Lease to be drafted by reference to the PS placing a contractual obligation on the Landlord to adhere to the PS when delivering and administering the service charge.
This is a point for the Tenant / Tenant’s Surveyor who should be looking to push for the inclusion of this at the point of agreeing the Heads of Terms. In turn the Tenant’s Solicitor will be better placed to insist upon the same when negotiating and agreeing the form of Lease.
The PS sets out the industry-accepted best practice in respect of service charges and should be adopted where possible.
In accordance with the Core principles and the best practice recommendations the following points should be considered by Surveyors, Tenant’s, Landlord’s and Solicitors when negotiating and agreeing the service charge provisions:
- Look to agree a fixed Management Fee so that there are no nasty surprises and no hidden mark-ups. Management fees should relate only to the actual work carried out in managing the service charge.
- Management fees charged as a percentage of the total expenditure are no longer considered appropriate. Instead the fee should be fixed subject to annual review or increases in line with indexation even if this results in a shortfall in the recovery of service charge – the crux of the PS is to promote and achieve best practice.
- Push for a method of apportionment which is fair and reasonable. Depending on the size, location and type of building it may be necessary to divide the services into schedules with costs apportioned to those Tenant’s/Occupiers that benefit from the services. Take for example, the revolutionary Shopping Centre evolving to devote more and more space to cater for leisure facilities, such as cinemas, play-areas etc. where not all of the occupiers will benefit from the services to the same extent. The use of schedules will be essential in achieving a fair and proper apportionment.
- Rateable value apportionments are no longer recommended.
- Look to include a service charge dispute mechanism allowing either party to require the resolution of disagreements through alternative dispute resolution. When agreeing this you should be thinking about including a right to challenge the service charge accounts. Think about timing i.e. allow for sufficient time to inspect the year end accounts and to query the same in the event of a discrepancy before they are deemed final. The PS recommends 4 months from issue of the accounts.
- Request for the inclusion of a provision which requires Landlord’s or their Managers to issue service charge budgets within a timely manner to include an explanatory summary and apportionment matrix. The Core Principles suggest budgets should be issued at least one month prior to the start of the service charge year. Remember transparency is key in terms of the way services are provided, managed and how costs of the services are recovered.
- Always try to request exclusions. Certain items of expenditure should not be recovered from the Tenant and should be carved out of the Service Charge. These include:
– Any initial costs (including the cost of leasing of equipment) incurred in relation to the original design and construction of the fabric, plant or equipment.- Any setting up costs, including costs of fitting out and equipping the on-site management offices that are reasonably considered part of the original development cost of the property.
– Any improvement costs above the costs of normal maintenance, repair or replacement. Service Charge costs may include enhancement of the fabric, plant or equipment, where such expenditure can be justified following an analysis of reasonable options and alternatives, and with regard to a cost –benefit analysis over the term of the occupiers’ leases.
– Future redevelopment costs.
– Costs and fees relating to the Landlord/owner’s investment interest, such as, asset management and rent collection, cost of letting units and matters between the Landlord/owner and individual Tenant e.g. enforcement of lease covenants, dealing with Landlord’s consent for assignment, sub-letting, alterations, rent reviews, additional opening hours etc.
– Costs attributable to void premises and the Landlord’s own use of the property.
– Any costs arising out of the negligence of the Manager or Landlord/owner.
- As well as exclusions, think about “credit” against the Service Charge. The general consensus is that where the Landlord/owner invests in an item which generates an income stream and which is not funded via the service charge, then they should be entitled to receive the income but if the service charge (via the Tenant’s) has provided either the initial capital or ongoing services for that item, then the income generated should be credited against the service costs. For example, income derived from a promotional activity is to be credited to the marketing budget.
- If you are taking a short term lease of say, five years, try to avoid signing up to an obligation to pay into a sinking fund or reserve fund which may result in you having to bear a proportion of large costs for items which might have a life expectancy far beyond the term of your lease and which you are unlikely to benefit from.
- Watch out for provisions around Minimum Energy Efficiency Standards (MEES) and EPCs. As you will no doubt be aware from 1 April 2018 it became unlawful for a Landlord to let a commercial property with an EPC rating of “E” or below and as at 1 April 2023, the regulations will also prohibit the continuation of the existing lettings with an EPC rating of “E” or below. Remember the obligation for compliance rests with the Landlord/owner and the cost of obtaining an EPC should not be recouped from the Tenant’s via the Service Charge.
What then for Existing Leases?
Although the PS cannot override the terms of the already agreed or existing Lease, the service charge provisions should still be interpreted as far as possible in line with the principles and practices set out in the PS.