Commercial property accounting – a law unto itself?

COMMERCIAL PROPERTY is big business in the UK and office stock has grown three-fold in recent years. The money involved is huge but accounting for services charges – which can boost rent by as much as £70m per year – is unregulated and patchy.

A few landlords produce detailed, timely accounts, but many content themselves with a scrap of paper detailing an end of year balance and some nominal information.

The problem is well recognised; the Royal Institution of Chartered Surveyors (Rics) recently updated their service charge code of conduct and professors at Kingston University published a study of accounting practice, compliance and disclosure. But some argue still more should be done, calling for regulation similar to that which protects residential renters.

Dr Timothy Eccles and Dr Andrew Holt, authors of the Kingston University report, pointed to “widespread complaints” over service charges. In the absence of proper accounting, businesses have little basis on which to judge the appropriateness of the levies, potentially fomenting conflict.

And accounting for service charges is a complex business. Questions such as the responsibilities of owner and occupier, different consumption of services by occupants and the duration of services all come into play. For example, a resident with a two-year lease would not want to shell out for extensive roof repairs; in the same way, landlords must have funds available for emergency repairs – necessitating advance service charging – yet residents might question whether their monies amount to an interest-free loan if no improvements are made for many years.

Service charges are written into the rental contract, meaning there is no standardisation and the details are entirely subject to the expertise of those drawing it up. Lawyers and surveyors typically take the lead in this, but landlords also have a hand, adding layers of variability to an already complex operation.

Eccles and Holt found accounting for service charges is seen as a “very, very low value activity in property management”. The group property manager of an international retail financial services company confirmed: “The accounting piece is the piece that gets done at the end and gets left off.”

Complaints centre on the level of information provided by landlords – sometimes just one piece of paper with the budget on it – as well as its understandability, relevance, reliability and comparability. As well as this, service charge accounts are often significantly out of date, lacking an auditor sign-off and subject to the caprices of ‘in-house’ style.

Huge differences in the size, purpose and additional services provided in commercial property is one reason the issue has come under scrutiny, but this has led some to dismiss regulation as impossible. Chris Edwards, a member of the Rics steering committee on service charges, said it would be “hugely hard” to draw up watertight rules, claiming the most recent code of practice, published in May, is enough to effect substantial improvements.

Members are bound to follow the code, which contains a number of key elements: leases should include a dispute resolution clause; the cost of improving or equipping a building should not be included in the services charge; and the charge should be “demonstrably fair and reasonable”.

However, Edwards admits adherence has been mixed. The first edition of the code in 1996 introduced industry standard cost classification, yet recent research showed only 50% of managers honoured the requirement.
Perhaps most importantly, the code can only be followed if and when it does not violate contractual agreements. If a contract has already been signed yet differs from the code, it takes precedence and Rics members, no matter how eager to please, have their hands tied.

Despite this, Peter Forrester, Savills director of building and project consultancy who worked on the Rics code of practice, also believes it will be effective. He noted that the code is a pan-industry effort with input from stakeholders such as the British Council for Offices, the British Property Federation, and tenant and landlord groups.

“There is no doubt that landlords, occupiers, managers – all of them need educating on this issue,” he said. Forrester described the residential market as “heavily legislated”, saying: “It doesn’t always work, there are legal cases nonetheless and under the current regime legislation in the commercial market is unlikely.”

Those who say the Rics code is sufficient claim that businesses have far less need of protection than residential renters; the laws that protect individuals leasing homes extend back to early last century and beyond, and accounting for services charges is firmly set out within them.

Report authors Eccles and Holt said regulation is a “highly divisive issue” among industry members. The Rics roadshow on service charges was to some extent “an exercise in rallying chartered surveyors so as to avoid the need for government intervention”, while moves to “badge” competency and bring in voluntary quality checks could raise professionalism around accounting for service charges, arguably rendering regulation unnecessary.

Users of service charge accounting might not agree. Business tenants who are regularly landed with perfunctory, out-of-date figures or impossible-to-decipher accounts may feel regulation would help to make sense of the expense, potentially bringing down costs in the process. But without support from industry members or a pro-regulation regime, this is unlikely to get off the ground.

David Barrass, managing director of service charge consultants Property Solutions, who collaborated on Eccles’ and Holt’s report, described office renters as a fragmented group that “don’t know or care much about services charges – they just want the space”. Retail renters, by contrast, are more organised because the levies affect their bottom line, and have formed the Property Managers Association to protect their interests.

Commercial rental costs are so high – particularly in London – that the service charge can pale into significance, despite the fact that the total annual charge in England and Wales is estimated to be around £4bn. For this reason, although accounting for services charges is widely accepted as a significant and unruly problem, greater impetus for change is needed; without it, commercial tenants will just have to trust to the Rics code, and hope the professionals drawing up their lease will do the same.