Residential service charges have risen significantly in the past 12 months. These increases have been caused partly by the elevation in energy costs, which has led to higher expenses regarding the heating and lighting of common parts, coupled with the increase in building costs caused initially by supply chains tightening and a lack of experienced building contractor workers in the labour market.
These more discrete issues have been exacerbated by general inflation and rising interest rates. Landlord employers will no doubt also now be faced with pressure to increase their employees’ wages in response to the cost-of-living crisis.
These issues have led to an increase in service charges seen by leaseholders throughout 2022, which in turn has resulted in a growing number of lessee challenges on the basis that the higher demands were unreasonable. However, landlords can take steps to reduce the risk of potential disputes.
Communication
Under section 27A of the Landlord and Tenant Act 1985, residential leaseholders can apply to the First-tier Tribunal (Property Chamber) for a determination of their liability to pay and the reasonableness of service charges. The rapid and substantial cost rises in the past 12 months were generally unforeseen and were factored into few annual budgets as a result. Not all landlords had funds available to wait until the end of the service charge year to seek the uplifts from their expenditure.
Landlords are advised to carefully document reasons for the increases to their expenditure and their attempts to mitigate the rises, such as obtaining and sharing alternative quotes. Not only will this help landlords establish the reasonableness of the costs, but early transparency and regular updates may also assist in avoiding lessee challenges.
Landlords should also pay close attention to the lease formalities and statutory requirements for recovering services expenditure, as these are likely to come under greater tenant scrutiny.
Insurance renewals
Most residential leases of multi-let buildings require the landlord to insure the property to the cost of its reinstatement. That figure will probably have inflated last year as the cost of rebuilding increased, possibly substantially. A revaluation or reassessment should be considered when renewing building insurance. Providing evidence of having shopped around and details of the policy without request may help explain to tenants why premiums have risen.
Reserve funds and rescheduling
It may be tempting to look to reserve funds to help meet unbudgeted costs. However, landlords should consider what the leases say about the purpose of such funds: often the monies are to be held on trust for major repair work. Tenants may agree to release cash to make payments not permitted by their leases but this can only be a temporary measure.
If there is no reserve fund, it may be necessary to borrow to finance significant works. However, higher interest rates will make borrowing more expensive, increasing a project’s overall cost.
It may be preferable to revisit a building’s planned repair and maintenance schedule and delay non-essential works until later, when, hopefully, leaseholders are in a better position to finance them.
Section 20 consultation problems
Rising costs exposed issues with consultation procedures for qualifying works and long-term agreements under section 20 of the Landlord and Tenant Act 1985 (as amended by section 151 of the Commonhold and Leasehold Reform Act 2002) contained in the Service Charges (Consultation Requirements) (England) Regulations 2003 (or the similar Welsh regulations).
The procedures take months, while last year building costs rose daily and contractual offers to fix energy prices often lasted little longer. Penalties for not consulting reduce recoveries to £100 per lease per year for qualifying contracts and £250 for works.
Under section 20ZA(1) of the 1985 Act, the FTT may dispense with the requirements if satisfied it is reasonable: in other words, the leaseholders were not prejudiced. Last year saw many landlords proceeding in the hope of retrospective dispensations. Whether these decisions will be challenged or repeated in 2023 remains to be seen.
Energy costs
According to the Office for National Statistics, UK electricity prices rose by 66.7% and gas by 129.4% in the year to January 2023. While many residential tenants pay their suppliers directly for energy used by their leasehold properties, service charges often include the cost of utilities the landlord has incurred.
Landlords should only charge the agreed proportion of the cost of energy used and the standing fee plus VAT (at 5%).
Landlord businesses may be able to take advantage of the new Energy Bills Discount Scheme, which will replace the current Energy Bill Relief Scheme for non-domestic customers from April 2023 to April 2024.
Suppliers will automatically apply the reductions, which should be passed on to leaseholders. Most households automatically get a £400 discount to their bills under the Energy Bill Relief Scheme but this may not happen if energy is paid for through a landlord.
Any eligible address (which excludes care homes and student accommodation) will be able to apply from 27 February 2023. Landlords receiving a tenant’s discount should pass the reduction on.
There are a range of options available to landlords to reduce energy expenditure, including understanding and reducing consumption, implementing practical efficiency measures, renegotiating supply contracts and investing in on-site generation.
Simon Hartley is a partner in the property litigation department at Weightmans
