It is the lease that is the starting point as to when the service charge budget is set as it may have express provisions (clearly stated in the lease) that must be adhered to. Service charges are either a fixed or variable percentage with clearly stated contribution clauses but others will have very general and brief/restrictive contribution clauses such as ‘to pay a fair proportion of the cost of maintaining and repairing party walls and structures, shared pipes and wires and other things used in common’.
This somewhat woolly description means that leaseholders may not always agree on its interpretation and often compare the cost of their service charge contributions to those paid by others in the same block, especially if they have similar leases. However working out the cost on different sized flats is a percentage cost based on a number of factors. So the apportionment should generally show the following:
- The amount of rooms (usually bedrooms) in each flat especially if the block has a similar number of identically written leases;
- The size of the flats calculated by floor area and which is usually considered the most fair and is the most commonly used because a larger flat will have cleaning and decorating/maintenance liabilities than those of smaller flats;
- What facilities are provided and which flat uses them, (such as lifts or main front doors);
- The rateable value in largely pre-1990 leases (council tax banding).
- Other considerations can include the place and the view.
The methods used for applying apportionment will be one of the following 3 ways:
- A simple fraction, where a building with 20 flats with each flat owner paying one-twentieth of the service charge expenditure;
- A simple percentage, so one twentieth would be 5%;
- A variable percentage, where some flat owners may pay more because of size or overall number of rooms. For example if 10 flats have one bedroom and the other 10 have two, then the first 10 may pay 4% and the other 10 pay 6%.
Knowledge of the block, a site plan (or both) can also help to make sure the costs are divided fairly but the apportion payable per flat always needs to total 100%.
If there is no apportionment then leaseholders and freeholders can apply to the First Tier Tribunal to get them to decide what is payable under s27a of the Landlord and Tenant Act 1985. The FTT not only has the jurisdiction to decide whether the charges are reasonable but also to decide:
- Who is liable to pay;
- Who to make the payment to;
- The amount to be paid;
- The date of payment and how it is payable.
The FTT can also vary a defective lease as long as certain criteria is met.
Dividing the Budget
The budget should be divided into clearly marked categories and subcategories and could look something like this:
- Accountant: Fees paid to an accountant to Audit or Certify the year-end service charge reconciliation.
- Bank: Fees charged by the bank in relation to the developments bank account.
- Company and Secretarial Services (if applicable).
- Consultancy Fees and other costs in providing and reviewing all legally required risk assessments and audits.
- Managing Agent: Fees paid to the managing agent to include salaries and employment costs. In the case of RMCo’ s these fees are agreed between the agent and the company directors.
- Solicitors: Fees for the collection of service charge arrears as after a certain amount of time, they are often handed over to a debt collection company.
Health and Safety
- Health and safety audit of the common areas;
- Fire risk assessment;
- Maintenance of the fire control panels, air/smoke vents systems, lightning conductor systems;
- Water risk assessment;
- Five-year periodic electrical inspection;
- Maintenance of emergency lighting.
- All Risk buildings insurance costs where recoverable through service charges;
- Liability Cover for directors and officers;
- Insurance Revaluation to make sure adequate cover is in place (about every three to five years).
Most leases will usually allow the building up of funds to give a safety net for both planned and unplanned long-term expenditure. One is known as a reserve fund and the other is known as a sinking fund.
A buildings surveyor can put together a capital expenditure (CAPEX) report which will highlight how much is required to place in these funds each year.
Although the terms are used interchangeably, they both work in completely different ways.
A reserve fund is used to put aside money for work that is required on a regular basis, such as redecoration of the common areas. It can be drawn upon should the service charge account be empty and works need doing as a matter of urgency. It is also easy to gain access to it. If the lease doesn’t make provision for a reserve fund, if one is established then it’s not usually challenged because most leaseholders recognise it as being of benefit. On the other hand occasionally it will be challenged because the lease makes no provision for it.
A sinking fund however is set aside for larger, less frequent repairs, such as replacing a roof, windows or lifts as a building ages. The lease should set out what the sinking fund is to be used for and it is usually paid on the same percentage charge as the service charge contribution. How much should be paid is usually determined by a cyclical maintenance report carried out by a qualified surveyor. This report will find the parts of the building that will need replacing over time and the prospective cost which in turn is divided by the years expected to pass before the work is required.
Holding the sinking fund in trust (with a Trust Deed) will avoid the consequences of an insolvent freeholder where the liquidator may try to seize the fund if it is not clearly designated as a sinking fund. The account should also give a good rate of interest (just like the service charges) but care should be taken of any limitations set down in the Memorandum and Articles of Association (or other documents).
The only time the sinking fund can be drawn on for any other purpose is when the lease permits it to be used temporarily to finance the cost of routine services.
Unless the lease states otherwise, both funds are not refundable when a flat is sold and even at the end of the lease term, the leaseholder is still not entitled to repayment of the contributions made during the time of ownership.
ESSENTIAL GUIDELINES AND GOOD PRACTICE
Once the overall context of the budget is established, there are essential guidance and good practices that should be followed:
- The ‘reasonableness’ of the charge for any item of expenditure should be able to be explained as leaseholders can approach the FTT for a determination of whether:
a) The service charge costs were reasonably incurred;
b) The services or works are of a reasonable standard; and whether
c) An estimated service charge, payable before costs are incurred, is reasonable.
They can’t however avoid liability to pay service charges on the grounds of hardship. If repair work is reasonably required at a particular time and is carried out at a reasonable cost and to a reasonable standard, the tenant must pay the corresponding service charge dictated by the terms of its lease.
- The budget should be as close to the previous year-end accounts as possible (and the other way round) unless any discrepancies can be fully explained. It is the standard of budgeting that can decide manager credibility with leaseholders. For example any significant underestimation can cause problems when a) there is not enough money in the service charge account and b) leaseholders are not going to be happy when they are expected to make up the shortfall on top of the next years contributions. Setting a budget is however not an exact science and in an old building such as ours, it can be very difficult to project exactly what will be required and when.
- Artificially low forecasts of the costs for the following year are a breach of consumer protection legislation even though it is often used by developers as an incentive to make purchasing a property more attractive. The developer can walk away with the profits or at least distance themselves through whoever manages the block, but it will cause major problems for leaseholders later on.
- Budgets should be in the same format as the annual accounts (with the same expenditure headings) to enable leaseholders to make proper comparisons.
- Enough time must be allowed for the review period to enable leaseholders time to comment.
- Any annual increases (such as increments to staff salary) must be allowed for.
- Any contract reviews for services and supplies to the budget period should be linked where possible so that increases and costs can be confirmed in advance of the budget being set.
- Any ‘one-off’ costs should be allowed for.
- VAT should be allowed for but it is not normally recoverable on residential property invoices.
- Some contracts charge by lunar month and not monthly (meaning 13 payments are made instead of the monthly amount multiplied by 12);
- Current expenditure is usually the best sign of future costs but any marked changes need to be able to be explained;
- For items such as utilities there are likely to be fluctuations, such as heating costs. Approval should be sought from the client which will be the freeholder or resident management company.
- Consult leaseholders and residents associations.
- Ensure the budget is sent out giving enough time for leaseholders to comment and/or raise questions.
- Invite all leaseholders to an annual budget meeting whether they are owner-occupiers or renting landlords.