Viewpoint - 30/11/2023

The rising cost of service charge caps – is it time for a rethink?

Greg Barraclough in our property management team examines the increasing financial burden that service charge caps present for commercial property landlords.

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Service charge caps explained

A service charge cap is where a tenant’s financial liability towards the maintenance of common services is capped. If expenditure exceeds the annual cap, the landlord must fund the difference. These caps have been part and parcel of property management life for some time now, and it’s understandable that a tenant would want to protect themselves by including this provision in their lease.

A growing problem for landlords

Landlords have had until recently the luxury of relatively well controlled price increases and inflation. Where caps were sensibly considered and correctly drafted, with nominal annual increases applied and a means for the rate to be increased at set periods throughout the lease, landlords were protected from incurring a shortfall, unless there was a specific unforeseen repair.

The last few years however have seen significant cost increases, particularly for utilities like electricity. Managing these increases has been challenging for most of us in respect of our homes, but they have brought an entire new set of challenges for the commercial property management sector. 

Over and above the obvious challenges of renewing electricity rates and budgeting for these, where tenants have service charge caps agreed, landlords are seeing a budget shortfall.

Time for a rethink?

But what now? With some properties experiencing up to a 300 per cent plus increase in electricity costs during the energy crisis in 2022 and continuing into 2023, this has far exceeded any standard service charge cap review provisions. 

On some sites and buildings, the common electricity supply can be very low, and these increases will have had a relatively small impact. But, on a multi-let office, where the common supply is powering several lifts, lighting, heating, ventilation, and air conditioning, costs are much higher, and the risk of caps being exceeded and landlords incurring a shortfall liability is much greater.

So, is it time to have a rethink? Going forward if caps are to be agreed should they be specific to certain costs? Would it be reasonable for costs such as electricity, which has become incredibly volatile, to be excluded? Or is it just a case of we continue as we have, and landlords accept the potential risks of agreeing to a cap in the first place, especially if it means they can let a space as opposed to it remaining empty? 

Whatever the answer is here, it is undoubtedly more important than ever that service charge caps are fully considered, and the managing agent is consulted before anything is agreed. 

 

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