The UK’s April inflation rate was 7.8%, down from 8.9% in March, in a continuing downward trend. This is welcome, albeit it does not mean prices are coming down – rather, they are not going up so quickly.
During such a tough period, how can landlords and tenants work together to manage increasing costs and weather the financial storm for their collective long-term benefit?
Service charges: current challenges
In Achieving the right balance, I noted that service charge is a mechanism to ensure that a landlord can recover the costs it incurs in providing services for the benefit of its tenants. The intention of a service charge cap is not to allow a tenant to avoid the costs it should pay but to limit its exposure and to ensure that its landlord keeps a close eye on the costs it incurs.
This continues to be true but setting a cap that protects the tenant and does not expose the landlord, unfairly, to cost increases is now increasingly difficult and the result of tenants having fixed or capped service charges is often that landlords need to meet the excess from their own pockets.
In tenant negotiations, we have seen an increase in resistance to service charge caps, even on shorter-term lettings where these had become more commonplace, or service charge caps being set considerably above previous running costs. Further, it is often argued that utility costs should be excluded from any cap due to increasing energy prices.
Landlords and tenants are facing substantial increases in costs up and down their supply chains as rising costs affect all businesses. In this environment, a tenant will want its landlord to ensure that the services are provided at a competitive price and that any discretionary spend on non-core services is limited.
Additionally, tenants can be expected to resist clauses calculating a managing agent’s charge for administering services by reference to a percentage of the utilities costs. With costs rising sharply, it seems unreasonable that this should also lead to an increase in the managing agent’s fee. Instead, tenants will likely insist that any such fee is a reasonable amount and properly incurred.
Finally, tenants will want access to the financial information which sits behind the service charge to ensure that landlords are charging costs only where appropriate to do so and on a fair basis. Service charge certificates need to be capable of challenge for a sufficient period to allow the tenant to interrogate the costs incurred.
Parking and EV charging
The installation of electric vehicle charging stations is increasingly common and motivations for installation can differ – is the main driver to meet a customer need or to improve the ESG credentials of an asset?
Whatever the motivation, capital expenditure is likely to be incurred when reconfiguring any car parking and installing charging points, parking controls and payment machines.
If a landlord intends to retain the income from parking and EV facilities, it seems only fair that it should meet both any initial costs and ongoing costs associated with them, rather than seeking to pass these on to its tenants via the service charge.
Utilities costs
Clauses that require a commercial occupier to use the landlord’s preferred supplier of electricity, water or other services are likely to be viewed with greater concern than in previous years as tenants need to keep a firm grip on exposure to increases in cost.
Where use of a nominated supplier is required, it is likely that any tenant will want a commitment from its landlord to shop around for a good deal and to review arrangements regularly, taking advantage of cheaper deals as they become available.
The current economic climate is also affecting the previously and common requirement that a tenant should keep premises lit outside trading hours and signage illuminated.
This is now an expensive use of resource and likely to be resisted. Moreover, it does not sit well with the broadly accepted aim of promoting energy efficiency and reducing energy wastage.
Energy efficiency works
Much has been said regarding “green lease clauses” as landlords and tenants continue to try and find a middle ground but what seems clear is that there is no one size fits all. The high cost of utilities may even support the green agenda in that payback periods for new technologies may be reduced.
More than ever, review of a robust EPC is hugely important so the landlord and the tenant have a genuine understanding of the energy efficiency rating of the property and common parts. An analysis can then be done as to what works may be justified to increase that rating in a way which, if properly considered, could benefit both.
Should a landlord wish to undertake energy efficiency works and seek a contribution from a tenant, it would be logical that the works undertaken should benefit the tenant during the term of its lease and have a minimal impact on its use of the property. If a genuine benefit to the tenant can be shown, the tenant may be comfortable in making a financial contribution. Alternatively, if a tenant is planning on undertaking works to the property, it may approach the landlord to seek a contribution for any consequential increase in the energy efficiency of the landlord’s investment which will play forward to its value – for example, the installation of LED lighting.
To sum up
Both landlords and tenants appreciate the need to keep a tight control on costs in the face of increases beyond their control.
What can be afforded should reflect the relative degree of benefit to the parties and, where there is an opportunity to minimise costs, it is likely to be in everyone’s interests to do so.
Ruth Clare is a partner in the real estate division at Shoosmiths LLP
